II Phase of Global Financial Crisis? 5 Interconnected Black Holes

London, UK - 28th November 2009, 21:35 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

Interconnected Black Holes

Recent movements in financial markets in regard to China, Dubai, PIIGS, Flying Yen and the Commodities Bubble may portend a second phase of the global financial crisis. Rising volatilities suggest that the 'bird and animal' behaviour crowds are fleeing certain asset classes and congregating at other havens as if in anticipation of several tremors! However, the rapidly unfolding interconnected five black holes suggest a potentially explosive mixture with extremely unpredictable events -- Black Swans -- in the offing that are totally unanticipated by the psychologies of the global investment crowds.

1. China’s banking regulator is signalling that it is tightening the reins on banks as concerns mount about their capital adequacy ratios. Sometimes the signals are public, like the China Banking Regulatory Commission (CBRC) statement and sometimes they are not so public at all. The CBRC is urging top Chinese banks to beef up their capital adequacy ratio and limit new loans for the rest of the year. Is that the end of the asset bubble music generated by the $1.2 trillion monetary stimulus applied since the start of the year alongside the near $600bn fiscal stimulus? Note that the asset bubbles spawned by Chinese lax lending have also spread outside of China especially into global commodities. As Shanghai and Hong Kong casino financial markets correct in response to the severe contraction in future lending, the global commodities bubble is also in danger of being pricked.

2. Little Dubai is in poor financial shape and is, basically, insolvent without a bailout from its neighbour Abu Dhabi. Whilst the rulers of the two nations are related, the bailout may come only after an example is made of the smaller nation. The more relevant question: Whether a technical default on Dubai’s debt may prove to be a trigger for something bigger in the sovereign debt markets? Whether or not this default takes place, it may lead to other sovereign risk events by way of domino effects. Basically, investors have priced emerging market debt as almost less risky than US Treasuries (T-bonds) and other major countries government debt. The Dubai default is likely to trigger a flight to quality and that means bad news for emerging market sovereign debt and good news for the US and a few other members of the G7.

3. PIIGS: Within the Euro-zone, government bonds of Portugal, Ireland, Italy, Greece and Spain -- the PIIGS -- are falling in value, yields are rising and spreads against German and French bonds are rising dramatically. Black Swan events that may come out of a developing sovereign debt crisis are also most likely in Eastern Europe where currency devaluations and real sovereign defaults are actually happening and have been happening since the start of the financial crisis in late 2007. As a result of the European black swans, the US dollar may end up rising and not falling against the Euro!

4. Flying Yen: Japan is increasingly concerned over the Yen’s strength as it hits a 14-year high against the US Dollar. The Yen is up about 10% against the Dollar in recent weeks, which is an issue for the Japanese since they export significantly more goods than they import. At this rate, the second largest economy in the world will not remain competitive with the attendant consequence that corporate and citizen tax revenues will fall dramatically in the coming 12 months. The national debt to GDP ratio which is approaching 200% will jump significantly higher. In comparison the US and UK national debt to GDP ratio, at below or near 100%, looks positively attractive. How long before the flying Yen becomes the sinking Yen?

5. Commodities Bubble: Essentially, food, fuel and metal prices -- including oil and gold -- are being dictated by global fund managers, investors and speculators and not the principles of Demand-and-Supply any longer. Note the significant gyrations in all commodity asset classes on a weekly and sometimes daily basis. This suggests the time may be ripe for the pricking of the global commodities bubble as a result of 1, 2 and 3. Note that oil and gold futures took a tumble after Dubai moved to delay repayment on billions of dollars of debt as the first step to restructuring, sending a shudder through globally intertwined financial markets.

What happens next? Is this the start of a second phase of the global financial crisis? Recently stock markets across the world and commodity markets including food, fuel and metals, have become increasingly correlated. As one asset class goes up so do the others including equities, oil and gold. Will all asset classes go down together as well or break away from their recent tight coupling? Early indications are that they may go down together as there is a flight to liquidity from illiquidity in the process of global deleveraging.


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