How to escape currency volatility and contagion in the globalized world of finance

By Edward Harrison of Credit Writedowns. This is a modified version of an article I posted yesterday at the Big Picture based on two recent articles I wrote on currency news in the Baltics and the Middle East. The question I ask is this: now that finance is global and capital can move in and out of markets and countries on a dime, how can any country protect itself against the volatility of currency markets?

There has been a lot of talk about sovereign debt risk since the Dubai World panic over Thanksgiving. You have seen pressure not only on government obligations in Dubai, but also in Greece, Spain and Ireland and a spillover into other unrelated markets. At issue is how best to weather a crisis given the Impossible Trinity of free movements in capital, independent monetary policy and fixed exchange rates. A country can pick two, but no one can have all three.

The hallmark of a crisis is the wholesale and indiscriminate move to safe havens by investors. The likelihood of market contagion is huge as was well demonstrated during the Asian Crisis and Russian devaluation in 1997-98 and the collapse of LTCM.  The events in Dubai certainly show this as well.

How do you protect your domestic financial markets from this kind of thing? Different foreign exchange regimes can be useful in preventing worst case scenarios. But, every solution has its problems; there is no magic bullet for countries looking to escape the volatility of financial market globalization. Until we develop a more stable currency framework, you can expect volatility to play out via FX.

Going it alone

For small countries this is especially problematic. Many had adopted the Icelandic model of free movements in capital, independent monetary policy and flexible exchange rates. This has worked pretty well for the U.S. But when Iceland’s currency collapsed last year, sending that country into depression, it sent shudders down the spines of policy makers in small countries everywhere.  If Iceland was brought to its knees by a run on the country’s currency, small countries everywhere have had to re-think how to avoid Iceland’s fate.

Currency union as a solution?

Some countries have adopted currency unions to solve this problem. This is the ‘Euro’ model of free movements in capital, no monetary policy control and internally fixed exchange. The Persian Gulf states of Saudi Arabia, Kuwait, Bahrain, and Qatar are now embarking on that path.

Ambrose Evans-Pritchard reports:

The move will give the hyper-rich club of oil exporters a petro-currency of their own, greatly increasing their influence in the global exchange and capital markets and potentially displacing the US dollar as the pricing currency for oil contracts. Between them they amount to regional superpower with a GDP of $1.2 trillion (£739bn), some 40pc of the world’s proven oil reserves, and financial clout equal to that of China.

Saudi Arabia, Kuwait, Bahrain, and Qatar are to launch the first phase next year, creating a Gulf Monetary Council that will evolve quickly into a full-fledged central bank.

The Emirates are staying out for now – irked that the bank will be located in Riyadh at the insistence of Saudi King Abdullah rather than in Abu Dhabi. They are expected join later, along with Oman.

The Gulf states remain divided over the wisdom of anchoring their economies to the US dollar. The Gulf currency – dubbed “Gulfo” – is likely to track a global exchange basket and may ultimately float as a regional reserve currency in its own right. “The US dollar has failed. We need to delink,” said Nahed Taher, chief executive of Bahrain’s Gulf One Investment Bank.

The project is inspired by Europe’s monetary union, seen as a huge success in the Arab world. But there are concerns that the region is trying to run before it can walk.

Given recent events in Europe concerning Greece, Ireland and Austria, and speculation about a bust up of the Eurozone, one might think the desire to initiate currency unions has weakened.  But it has not.  I reckon events post-Dubai World make the pull toward a currency union even greater. The disruption caused by this financial crisis has buffeted smaller countries with sovereign currencies because of a lack of currency controls and the destabilizing effects of ‘hot money.’ Iceland, which suffered the worst fate of small nations, has now been fast tracked for EU membership. Latvia has allowed its economy to suffer depression in order to maintain a peg to the Euro in the hopes of escaping the downside of small country monetary independence.

Meanwhile tiny Estonia looks like it may make it in to the Eurozone by 2011. EU statements are fairly non-committal so far. But, I see this as a real test case because Estonia has built a fairly solid case for entry.  Moreover, Estonia would be tiny as a percentage of Eurozone GDP and further positive signs of its likely inclusion would help stabilize the situation in Latvia and Lithuania where the budgetary problems are severe.

The problem with internally fixed exchange rates in a currency union is it binds countries into a one-size-fits-all monetary policy. If fiscal policy, business cycles and macro outlooks do not converge, someone will suffer. This was a major reason we saw a massive property bubble in Ireland and in Spain as these countries overheated.  And, inevitably, economic collapse and depression is the result.

Currency peg as a solution?

If not internally fixed rates, how about externally fixed rates? Foreign currency pegs are also problematic. Look no further than the escalating tension between China and the U.S. over China’s peg. China is buying up massive amounts of Treasuries, not just because easy money from the Fed encourages a current account deficit in America, but also because the Chinese exchange rate is fixed at an inappropriately low level.  Their macro policy serves to import asset price and consumer price inflation into China during boom and deflation during bust. During the bust, acrimony mounts and protectionism can result. For small countries, a currency peg can be especially deadly unless they harmonize their economic policies. Just ask Latvia or Argentina.

Capital controls?

The last method countries have used to deal with the Impossible Trinity is by instituting capital controls. Brazil has attempted to deal with this by instituting currency controls, which some are heralding as a necessary measure. Other nations like Nigeria have also revived exchange controls in the wake of crisis. But Iceland used capital controls when it got into problems and it still suffered an economic meltdown.  The Russians had a lot of capital controls too before they defaulted on their own government debt in 1998, precipitating the Long-Term Capital management crisis.

My take?

There are no silver bullets: not capital controls, not currency union, not pegs. The safest (and probably only) way for a country to weather contagion in a sovereign debt crisis is to maintain low levels of debt in both the public and private sector through appropriate fiscal and monetary policy and robust macro-prudential regulation.

One point I failed to make in my original post on Barry’s site is how much the banking sector has added to volatility in this crisis. So, when I point to macro-prudential regulation, I am really thinking of the banking sector. In small countries especially, regulators should scrutinize moves by lenders abroad because a lack of local knowledge always, always leads to poor investment and lending choices. Look at the Swedish banks in the Baltics or the Austrian and Greek banks in the Balkans or the Swiss banks in CEE. And because these countries are small, the balance sheet bloat of the banks’ foreign adventures makes them too big to bail.  That is the problem Iceland faced.

In the lead up to this crisis few nations took the route I am describing and now their citizens are paying the price.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. dlr

    What about only allowing long term debt, like longer than 10 years? Or only allowing debt denominated in the local currency?

  2. jdmckay

    Generally good post IMO… thanks. I do think it’s too generalized, however, to make sense of what’s driving all this. Specifically, detailed assessment of what’s actually being produced/sold in the economies represented by the various currencies.

    I quibble w/a couple details. You say:

    China is buying up massive amounts of Treasurie

    More accurately, China has bought, as in their treasury purchases leveled out around 5/09, they have declared thier strategy to diversify FOREX holdings (8/09) and their trends since then have reflected that statement.

    Market Watch/Deborah Levine (12/15):

    China’s Treasury holdings were flat, though it also shifted its holdings from short-term bills to longer-dated debt.

    China has reduced its Treasury holdings since May by $2.6 billion, according to Alan Ruskin, head of currency strategy at the RBS. In the same period, they have bought close to $75 billion in Treasurys maturing in more than one year.

    “China’s T-bill mountain built up in the heat of the crisis is melting, but the net inflows into the U.S. have moved from a flood to a dribble and most recently a sharp stop,” he wrote in a report.

    Net inflows from China since earlier this year “have now fallen very sharply as a share of the change in China’s reserves, consistent with the idea of a step-up in Chinese diversification away from U.S. dollar assets,” according to Ruskin.

    1. psychohistorian

      China’s stop in buying Treasuries along with the mid east trying to set up a Euro type currency for themselves tells me that the music propping up the American dollar as Reserve Currency is about to stop. Maybe as soon as early next year.

      Does everyone have a chair?

      1. jdmckay

        China is better off purchasing some territory, for example, parts of Botswana like we did with the purchases of Louisiana and Alaska.

        On more generalized scope, China is doing that. Not buying territory though… they have an abundance of that.

        Rather increasing move from Forex holdings to hard assets. And they’re doing it on a wide spectrum: raw materials, legitimate technology purchases, and now… more & more, emergence of their own homegrown cutting edge “stuff”. Some advanced engineered materials, they are now emerging among best in the world at design/testing/manufacturing expertise. In carbon fiber, some good evidence they are now ahead of the pack.

        And despite very inaccurate & non-representative depictions in the west, they’ve made massive commitments to both green energy and cleaning up their fossil fuel production/consumption… by far more then we’re doing here.

        Last time I was there (10 mos ago), on freeway just outside Beijing, I witnessed wind capture devices from passing autos… nearly a mile of these things. I was told there was a 1/2 dozen or so other such test platforms, each w/varying design/technology as they ferret out feasibility issues. As I found out inquiring, this was 100% homegrown, designed conceived and built in China.

        China is… literally, a massive test bed/laboratory for real time development of wind energy technology right now. Same w/clean coal.

        Meanwhile, on this side of the pond (the “greatest country in history”), we’re taking the free market, (I presume) democratic approach. Good thing, ’cause… at least as the “experts” tell me, this approach leaves us free from the encumbrances of inefficient central government planning, leaving our vast capitalist genius free to innovate.

        Right now, it’s manifested in a kind’a in a holding pattern… TARP’ing. I hear it was damn good idea… genius in finance actually. We just got’a wait a little while for it to kick into gear. Good thing too… gives everyone a chance to rest after exhausting experience in these recent years consuming, consuming… innovating new ways to make more money out of less so that we can consume some more. I mean, really… how much consumption can a human being take?

        And besides, the echo of that giant sucking sound is just beginning to smack us in the ass… it’s going to take a little while for that echo to bounce around and alert the masses that something’s happened here, whatever that something is. I mean, we don’t even know how many jobs got sucked yet, let alone what kind’a “job creation” we’re going to do after the jobless counting pros finish their good work determining how many jobs we need to create.

        Beyond that, the US is dealing w/major capacity issues still to be ferreted out. For one, there’s just too many folks right now w/piddly little homes already full to capacity of consumables… where they going to put any more? Way I see it, after TARP kicks in and jump starts the impending housing boom, we all can upscale our current sq. footage limitations so we have enough comfortable space for next round of frenetic consumption, plenty of space to put all the new stuff.

        And as Yves explained the other day, those Chinese haven’t been playing fair in this deal… making all our stuff. We just need to flex our muscles a little bit, get those Chinese to adjust their currency a little bit, and order will be restored once again.

        Good thing all these Chinese tech innovations are being done by paens (peons??? WTF is a paen?) or whatever they are, ’cause if they were not busy getting all the new stuff we need ready, we might not have enough stuff to consume when we’re all rested up, TARP kicks in and we shift back into heavy duty consuming mode again.

        So anyway, I’m grateful Yves sophisticated understanding of trade accounting has all this covered, gives me a lot’a comfort. Because from my unsophisticated, non-finance backround… especially given my only knowledge of the place comes from having been there a few times, hob-nobbed w/the “paens”, forged what until a few days ago I thought was productive relationships w/hi-tech manufacturers, learned the language etc. etc… in my dark cloud of ignorance, I somehow thought the the USA is basically fucked.

        Who needs reality when you’ve got accounting?

    2. MyLessThanPrimeBeef

      China is better off purchasing some territory, for example, parts of Botswana like we did with the purchases of Louisiana and Alaska.

      This buying and selling of parts of a a nation has been done before and I am surprised it’s not been done more often among capitalist nations. And they call themselves capitalists?

  3. David

    The prescription is common sense, but I guess it’s worth saying anyway: a debtor is a slave. Stay out of debt. The people generally want that. But the bosses don’t permit it.

    As a crazy example in our own country, remember how the US government was really paying down the debt during the early Clinton administration. Well Clinton announced that we were killing the long-term bond market and this couldn’t be permitted, so we should start to run deficits to support the bond market! And they did, and there was nothing the people could do to stop him.

    If it were fiction it would be too improbable. But it’s fact.

  4. DownSouth

    Edward Harrison said: “The safest (and probably only) way for a country to weather contagion in a sovereign debt crisis is to maintain low levels of debt in both the public and private sector through appropriate fiscal and monetary policy and robust macro-prudential regulation.”

    That prescription, however, is anathema to the neoliberal-neocon axis.

    I live in Mexico, and the situation here is that the Mexican government since the crisis of 1994 has been very frugal and has maintained a low level of debt. In fact, it managed to accumulate almost $100 billion of USD in forex. The Mexican private sector, however, was not nearly so prudent. When the current crisis hit it was heavily indebted in dollar-denominated obligations. The peso fell from about 10 pesos to the dollar to 15.5 pesos to the dollar, but due to intervention by both the Mexican and US (by the Fed opening a swap facility) governments, has now recovered to about 13 to the dollar.

    And as research has shown over and over and over again, private debt always has a way of becoming government obligation. The Mexican government has intervened to bailout various private enterprises.

    Neoliberalism is highly profitable. It entails turning the wolves loose on a population. Regulation is all but eliminated. For instance, just compare those bank charges in the United States that have caused such an uproar to what Mexicans pay for the same services. Mexican banks, which are almost all foreign owned, charge in excess of 50% interest on credit cards. The charge for a NSF check in Mexico is almost $80.

    To call banks in Mexico “Mexican” is almost a misnomer. Analysts estimate foreign capital controlled 80 to 90 percent of the assets of the 43 banks registered by the CNBV at the end of 2008. The largest banks are the U.S.-owned Banamex, the Canadian-run Scotia Bank, the United Kingdom’s HSBC, and Spanish-owned Bancomer (BBVA) and Santander. Bank of America, Prudential, Wal-Mart and J.P. Morgan, among others, have also entered the Mexican financial services market.

    The profits from Mexico’s credit card bubble have been flowing north to U.S. financial giants and across the Atlantic to Europe’s money centers.

    Of course when cardholders can’t pay back the money the banks have loaned in these scams, then the banks demand that the government step in and indemnify the banks for their loan losses. That is neoliberalism in a nutshell. And of course when the government steps in and pays the banks off for their bad lending practices, this means that the government must cut back expenditures on social welfare programs.

    Sound familiar? There’s no doubt in my mind what Bernanke and crew have in mind for the United States.

    The difference is that the United States doesn’t have a gun pointed at its head by the United States like Mexico does. “Our perception of the United States has been that of a democracy inside and an empire outside: Dr. Jekyll and Mr. Hyde,” the Mexican writer Carlos Fuentes said.

    Fuentes wrote that back in 1992. In the interim a real question has arisen as to whether the United States still has a functioning democracy or not.

    1. Costard

      Currencies are governmental obligations. Private debt only affects them insofar as revenues are gleaned from unsound industries. The Mexican government is quite large; its tax regime is heavily tilted towards business and particularly towards nationalized companies. If you’re at all familiar with the situation vis a vis PEMEX, you should know that Mexico has been cannibalizing industry – and in fact, fomenting private debt – in order to keep public debt levels low. These off-balance sheet arrangements are what necessitate bailouts, and they (along with the fall in crude) are also a good reason for the peso’s lost ground.

      Check your assumptions. Over-indebted businesses are almost always the result of government intervention, a la protective regulation, cartelization, subsidies and bailouts, things that exist in droves both in Mexico, and in the US. Nature does not produce fat lions. You can call this whatever you want – neocon, neokeynesian, fascist, communist – the point is it’s bad policy.

      PS, regarding bank charges. If you want to see another high number, look at the credit card delinquency rate in Mexico.

      1. Hugh

        “Over-indebted businesses are almost always the result of government intervention, a la protective regulation, cartelization, subsidies and bailouts”

        How does this view explain China?

      2. DownSouth


        Your comment is replete with horrible distortions.

        ► Blaming Pemex for Mexico’s currency devaluation is like blaming the subprime crisis on Fannie and Freddie. It’s the typical neoliberal half-truth or outright lie—find some government entity (like Fannie or like Pemex, which is 100% owned by the Mexican government) and then blame the entire problem on that entity. It matters little whether that entity significantly contributed to the problem or not. The only thing that matters to the neoliberal is that government is made to blame. Facts count for nothing.

        Your singling out Pemex conforms to this rhetorical strategy.

        Taxes on Pemex provide about 40% of Mexico’s public-sector revenues. Even when oil was at $140 per barrel, the Mexican government’s and Pemex’s budgeting was conservative. I believe the highest oil price ever used for budget purposes was about $70 per barrel. Pemex does indeed have a troubling outlook, but not entirely for the reasons you claim. The main reason for Pemex’s troubles are declining reserves and declining production. Pemex has invested heavily in the last couple years to try to reverse this trend. And because of the high tax burden, most of the capital budget has been paid for through borrowing. So obviously, the company cannot continue down this road indefinitely. And if it does, there will eventually be a crisis. But Pemex experienced no crisis in the last two years. It had little to do with the peso devaluation. Pemex has had no problems borrowing money for its capital spending program.

        Pemex’s financial condition is not nearly so dire as you would lead us to believe, as Standard & Poor’s March rating bears out:

        When oil prices were at their peak, Pemex hedged much of its production. Pemex’s payments to the Mexican government have not fallen below expectations. The Mexican government has not had to bailout Pemex.

        ► The Mexican government, on the other hand, has had to bailout the private banking sector. And banking in Mexico is a libertarian’s wet dream. In this Wild-Wild West atmosphere banking regulation is all but nonexistent. So your assertion that “over-indebted businesses are almost always the result of government intervention, a la protective regulation” has no basis in fact.

        Here’s a short discussion of the bank bailout situation in Mexico:

        In response to criticism that bad credit card accounts and other bad debts will precipitate a new financial crisis in Mexico, the banks and their government allies were not publicly worried in the days before the H1N1 (swine) flu epidemic hit. New lines of credit available from the International Monetary Fund and the U.S. Federal Reserve totaling $77 billion shored up Mexico’s potential foreign reserves to more than $150 billion this month, permitting the Calderon administration to announce it will support new economic investments. Oddly enough, the possible infusion of cash – which could prop up the shaky peso and serve as an emergency, hog-sized piggy bank for the financial institutions – was announced on April Fool’s Day in the United States.

        Almost as a sweetener, the Calderon administration plans to subsidize some lagging credit card debts. Unveiling a new program for federal workers enrolled in the National Social Security Institute (ISSSTE), the government declared it will lend cash-needy workers up to $3,000 at an annual “low” interest rate of 14 percent to help pay off credit card debts. The program will help the banks cleanse their books, but keep credit card holders in debt.

        ► You say that: “Currencies are governmental obligations. Private debt only affects them insofar as revenues are gleaned from unsound industries.”

        This is little more than a neoliberal fairytale, with absolutely no basis in fact or in logic, as the Mexican experience demonstrated. When the financial crisis hit foreign banks refused to renew dollar-denominated loans to private businesses in Mexico. The scrounge for dollars was on. Demand for dollars to repay dollar-denominated loans soared. This caused the price of dollars to soar. Private debt very much affects currencies.

      3. DownSouth

        And Costard,

        Just to give an idea of how completely, totally wrong you are in your assertions about the government-owned Pemex:

        Mexico started buying put options to protect this year’s oil revenue in July, Finance Minister Agustin Carstens told a Nov. 13 conference. That was when Mexico’s oil export mix reached a record $132.71 a barrel and Goldman Sachs said crude would extend a rally.

        Mexico may receive in November a $9 billion payment from the options contracts, Miguel Messmacher, chief economist of Mexico’s Finance Ministry, said in a March 11 interview. Rodrigo Brand, a finance ministry spokesman, declined to comment on the estimate or the government’s hedging policy.

        The hedging gains will help narrow Mexico’s fiscal deficit as a drop in exports and foreign investment may reduce the country’s output by 8.5 percent this year, the biggest contraction since 1932, according to Goldman Sachs.

        Granted, Pemex has its share of problems. But the tale you tell is devoid of any factual basis.

    2. JasonRines

      Great comment Down South. The U.S. citizens have a gun pointed at their own heads. Inflation and direct taxes are already turning the U.S. into a third world country. Who is left to loot around the world? Gangsters turn on each other when all the people are serfs. Mexican stand-off is a term I am certain you are familiar with.

    3. Colonel Kurtz

      Very informative.. The US is by the original constitution a democratic republic. A true democracy is 7 wolves and three sheep as a country. There is a famine and the wolves vote to have sheep for dinner to avert starvation. Ahhh democracy/mob rule. I do agree with you that the US is probably not a true democratic republic anymore.. If it still is then it is a very corrupt on run by the bank and for the banks.

    4. Vinny G.


      You make very good points about Mexico. The only thing is that the US is hardly a democracy anymore, and China is holding a gun to America’s head now.

      I have a question about the credit card situation in Mexico, because I understand there are no personal ID numbers (such as Social Security numbers). How can debt collection be enforced like this? Or is the 50% interest rate the way banks make up for losses?


      1. DownSouth


        The standard-issue ID here is one by the electoral commission, Instituto Federal de Eleciones or IFE. I don’t have a credit account, and being a US citizen don’t have a Mexican voter ID card, but when I opened my checking account I used my US passport.

        As far as 50% interest rates (that’s the low end of what the banks charge—only for “preferred” customers) being sufficient to make up for the losses, I think that’s the bankers’ pipe dream. Have you heard Bill Black talk about how sub-prime loans were used as a form of control fraud? Well credit cards here in Mexico are like subprime on steroids. And when it eventually all comes crashing down, and if the bankers can’t get the Mexican government to bail them out, it portends very bad things for US banks.

        For instance, Citigroup claims to have $30 billion invested in Mexico (Which may be one of the reasons the US Federal Reserve and the IMF were so quick to throw $77 billion at the Mexican government when the crisis hit). And as Kent Patterson in the article I linked above pointed out, Citigroup’s Mexican operations contribute mightily to its profits: “Sometimes called “the crown jewel” of Citigroup, Banamex alone earned nearly $1 billion in profits, a figure down $500 million from the previous year.”

        But, as Patterson goes on to explain, just get a whiff of the foundation of sand these profits are built upon:

        Taja says he knows people who earn less than $800 a month but have credit card balances exceeding $23,000…

        It used to be very difficult to obtain a credit card in Mexico. Then, like street hustlers hawking passes to strip shows, young “promoters” working for the banks appeared on the streets virtually handing out credit cards. From 2001 to 2008, the number of credit cards circulating in Mexico soared from 6.1 million to 26.1 million, according to Condusef. Maintaining offices in Los Angeles and New York, Banamex USA even offered a cross-border credit card program aimed at clients with friends or relatives in Mexico.

        (In 2008, Banamex inaugurated a branch in Calexico, California.)

        Eligible income levels were dropped to unheard of lows of about $300 monthly, only slightly above official definitions of “poverty wages,” and certainly not enough to establish any stability or cushion.

        An emblematic story involved a four-year-old girl, Daniela Elizondo, whose father was stunned to learn by mail that his daughter had been approved for a list of “select” credit card clients.

        For banks (and government), the Mexican credit card business is highly profitable. In the United States, complaints soared when credit card interest rates reached the 20-35 percent range, but in Mexico, the Total Annual Cost (CAT) for bank-issued cards rose from 37-103 percent in early 2008 and to 47-113 percent by January 2009, according to Sotelo.

        The CAT includes interest rates, assorted fees and the national value-added tax. A Condusef study found that a cardholder who began with a $1,000 debt and made only minimum payments would wind up forking over $7,500 in a 15-year period.

  5. RN

    Excellent summary of the state of affairs.
    I have two comments.
    …The safest (and probably only) way … maintain low levels of debt in both the public and private sector………….

    This is a partially true statement.

    It does not really matter to have public debt in domestic currency issued to domestic lenders(citizens).This will be repaid either in cash or in the form of inflation- but no fx crisis.

    ……China……to diversify FOREX holdings……

    In due course of time, this will transform China’s problems from dollar crisis to crisis in some other currency. This will no way eliminate fx crisis. It is only temp fix for China.

    Your reaction will be appreciated.

    1. Cullpepper

      ……China……to diversify FOREX holdings……

      In due course of time, this will transform China’s problems from dollar crisis to crisis in some other currency. This will no way eliminate fx crisis. It is only temp fix for China.

      Short of some completely unforeseeable political event (or a systemic global margin call, cough cough), I bet China will keep the peg right where it is.

      The de-coupling event will arrive when “peak oil” becomes a recognized fact in the marketplace. China will then have a choice- continue accepting inflationary-prone u.s. fiat dollars and worthless treasuries in return for goods and services, or unpeg and turn to the middle east and lock in preferred trading partner status with the countries that still have produceable oil fields.

  6. Cullpepper

    This idea gets periodically floated (and usually looked askance at) but why not create an artifical (arn’t they all?) currency based on a unit of energy? (kilo-calorie, or newton, or joule are the ones that get mentioned the most often.)

    Can we be honest? The “gulfo” or whatever the middle east countries decide to call it, is an invitation to buy oil (potential energy). What do you think it would be worth if there was no oil?

    I think the most attractive aspect would be the encouragement for people to create money by creating more energy. Unlike traditional fiat currency, the increase in energy availability makes the world better. There is an unmistakable correlation between per capita energy consumption and standard of living.

    1. MyLessThanPrimeBeef

      Currency based on a unit of energy?

      That is the Republican approach.

      The Democratci approach is to based currency on a unit of love.

      You can see more love makes the world better and more usage of love is positively correlated with higher spritual standard (more happiness) of living.

      For those without enough love, the government will put you on ‘love welfare’ where you receive a monthly allotment of love from a government bureaucrat.

      1. MyLessThanPrimeBeef

        I should also add that this is not a revolutionary new approach. People have been buying and selling love for a long time.

  7. Helevticus

    Appreciate your quality analysis, but which Swiss banks in CEE do you mean? To my knowledge there is not one Swiss-owned bank in the CEE countries. There are many CHF-denominated loans, which adds some spice to the story, but Swiss banks are – if anything – the counterparty in refinancing the lenders in question, not the ones long the loan default risk.

    1. Edward Harrison Post author

      You are correct about the Swiss Franc debt and this is the problem. The actual institutions are not necessarily Swiss. For example in Czech, the largest foreign players are the Belgian KBC, the Austrians Erste and Raiffeisen and the French SocGen. But as we saw with AIG and Goldman, there are links that we can’t really know. You have to believe any impairment of these Swiss Franc loans will come full circle onto the Swiss banking system as losses, probably via connections between the Swiss Bans and these other banks. Remember how Creditanstalt created problems in 1931 was similar.

      1. Vinny G.


        Erste, Raiffeisen, SocGen are also huge in Romania, where they own most of the banking system. Volksbank, another Austrian bank, is common in that country slso, as are a few Greek banks. And Romania is a larger EU member nation of 20 million people with its own budgetary problems, and already on life-support from the IMF.


    1. JasonRines

      That is a good suggestion. In general, a lot more cross polination of content, debate and problem solving must occur online. Even if Neoliberals run the show until it all falls apart, it is worth the endeavor to have the solutions ready for when it does.

      To me, the only way you will get close to perfection in monetary management is by facilitating the citizenships to participate directly. Top-down management always comes down to an Emperor and a Chairman of a bank calling the shots and of course, ultimately such a duo are corrupted and steal the people’s wealth. We are just seeing it on a global basis now rather than nationally. Central Banking need not be destroyed in the process, portions of it are useful but the lack of representation creates faster fatality cycles of governments, spurs world wars and is inherently instable for this very reason. The CB model will evolve because other international unions such as BRIC are already building what I am talking about and the CB model will wind up needing to compete or it will go extinct (something I don’t believe likely to happen).

  8. sean

    Very good analysis relating to the situation in Ireland.

    Prior to joining the EMU, the precursor to eurozone entry, Irish sovereign bonds were 80 % purchased by domestic investors,20% by foreign investors.
    Up until this crisis broke an inversion of the above investment profile occurred.
    Also Irish banks availed of a vast pool of funding which became available after eurozone entry.Ireland never had a Glas/Steagal act and so there was no legal obstacle to overcome in interbank lending.
    Presently the ECB interest rate is around 0.5 % and deflation at 6.5% and this means the effective interest rate for those heavily borrowed is 7% which is completely out of synch with the economic cycle.
    Similarly during the ‘boom’ years interest rates were ridiculously low igniting massive internal inflation.

    The current situation where Irish banks purchase Irish government bonds at around 5% for 10 year bonds(which are now too toxic to be completely covered by private investors) and repo them at the ECB at 1% earning those same zombie banks effective rates of interest of 10.5% (Deflation rate of 6.5%) means there is absolutely no incentive for them to lend into the economy which was the original intention of the rescue.
    The above scenario alongside NAMA, the bank rescue vehicle is now dead in the water and is likely to tip Ireland into default in 2010 is akin to a man with a knife embedded in his chest.
    Barely alive he must get medical treatment but also cant take out the knife as this would mean immediate death .
    Similarly the Irish economy is also done for .Its just a matter of time before we default and whether Greece will get there first.

  9. Dan Duncan

    Turn the rewind buttons back exactly 100 years ago…

    On the surface it appeared that the Powers of GB, France, Germany and Russia were working together. [The US and Japan were on the periphery.]

    The problem was that being a one of the main Powers meant having to constantly put out a fire of some sort:

    GB with India and Labor unrest.
    France with Morocco and the Moors.
    Germany, being Austria-Hungary’s Daddy after A-H annexed Bosnia-Herzegovina.
    Russia Tsar disintegration.
    Japan flexing its muscles after kicking Russia’s ass and sorting out its Imperial role in Korea.
    The US, trying to be neutral, yet ascendant.

    For the most part, though, the Powers did manage to work together…

    But each year the bubbles of trouble would get just a little bigger until the Balkans blew up and the Archduke took a bullet.

    And now we have a similar bubbling beneath the surface, but this time we’re sorting out decades of financial imperialism.

    What was once the Powers splitting the spoils of commodity-rich Africa—now oil and the Middle East.

    Instead of GB and France, now we include Germany sans Austria Hungary. And they are still dealing with problems in the Balkans.

    Just like 1910, Russia is still in flux. They got rid of Tsar Nicholas II, but not until 1918. Will Tsar Putin and Oligarchs hold out that long?

    The parallels of the US of 2010 and GB of 1910 are striking. [No Gandhi here, though.]

    The parallels of China of 2010 and the US of 1910 are also quite remarkable.

    The Japan of 2020 will be as different from the Japan of 2010 as the Russia of 1920 was from the one from 1910.

    So the citizens of Greece and Ireland should feel fortunate. They’ll get sorted out. It’s still early.

    But what about Spain and Italy…along with California and New York? What happens when Japan defaults on its own citizens…while the US Zimbabwe’s all the others’?

    It’s like the footage of the Tacoma Narrows Bridge: It catches a vibration and oscillates…each oscillation causing an even greater oscillation in response to the last…until the inevitable collapse.

    And through it all…China will STILL be buying Treasuries!

  10. i on the ball patriot

    Another method …

    Hand the keys back to the intentional bubble blowing gangster central banks and create your own utility based — free of bogus derivatives — currency. You have no obligation to a debt incurred through fraud.


    “Local Currency for Local Development

    Issuing and lending currency is the sovereign right of governments, and it is a right that Iceland and Latvia will lose if they join the EU, which forbids member nations to borrow from their own central banks. Latvia and Iceland both have natural resources that could be developed if they had the credit to do it; and with sovereign control over their local currencies, they could get that credit simply by creating it on the books of their own publicly-owned banks.

    In fact, there is nothing extraordinary in that proposal. All private banks get the credit they lend simply by creating it on their books. Contrary to popular belief, banks do not lend their own money or their depositors’ money. As the U.S. Federal Reserve attests, banks lend new money, created by double-entry bookkeeping as a deposit of the borrower on one side of the bank’s books and as an asset of the bank on the other.

    Besides thawing frozen credit pipes, credit created by governments has the advantage that it can be issued interest-free. Eliminating the cost of interest can cut production costs dramatically.

    Government-issued money to fund public projects has a long and successful history, going back at least to the early eighteenth century, when the American colony of Pennsylvania issued money that was both lent and spent by the local government into the economy. The result was an unprecedented period of prosperity, achieved without producing price inflation and without taxing the people.

    The island state of Guernsey, located in the Channel Islands between England and France, has funded infrastructure with government-issued money for over 200 years, without price inflation and without government debt.

    During the First World War, when private banks were demanding 6 percent interest, Australia’s publicly-owned Commonwealth Bank financed the Australian government’s war effort at an interest rate of a fraction of 1 percent, saving Australians some $12 million in bank charges. After the First World War, the bank’s governor used the bank’s credit power to save Australians from the depression conditions prevailing in other countries, by financing production and home-building and lending funds to local governments for the construction of roads, tramways, harbors, gasworks, and electric power plants. The bank’s profits were paid back to the national government.”

    More here …

    Deception is the strongest political force on the planet.

  11. verveAbsolut

    The more I read from Mr. Harrison, the more I find myself over at his blog as well. He’s one of the few(?!) good side commentators here at NC, I think. Quite a bit better than Jesse, at the least.

  12. Bruce Krasting

    “There are no silver bullets: not capital controls, not currency union, not pegs. The safest (and probably only) way for a country to weather contagion in a sovereign debt crisis is to maintain low levels of debt in both the public and private sector through appropriate fiscal and monetary policy and robust macro-prudential regulation.”

    Yeah, okay Ed but….. This is the real world. What country out there has low debt in the public and private sector?? I am not sure even Norway meets that definition. The answer is no one is going to avoid the impact of this problem. You and I and the MSM will be writing about this for the next year. It can only get worse in my view.

  13. Dane

    A big thumbs down on the new micro-sized font. It’s ridiculous. I can barely read it. It’s a distraction in and of itself.

    I read the blog for its content!

  14. Tangurena

    China survived the asian financial crisis of 1997 solely because their currency was not openly traded, and thus immune to attacks by currency speculators. Japan developed the idea that if only they had more US dollars in reserve, they could have outlasted the economic attacks (I think that Japanese position to be futile and the build up of reserves contributed to their L-shaped recession). Iceland’s economy collapsed because of the same pressures that caused many asian economies collapsed in the 1997 financial crisis.

    Any country that continues to trade in the “open market” is setting themselves up for a future financial pearl harbor from attacks by currency speculators.

    The Gulf currency union isn’t going to work because of conflicting desires by countries on what the currency should or should not be “based” on. The original concept was for the Khaleeji (which is one of the proposed names for the “gulfo”) to be pegged to the US Dollar. Pegging to the $ is why Kuwait has been having terrible inflation problems over the past few years. Pegging to a basket of currencies is undesirable to KSA as they’re dollar and gold lovers, but they don’t want to put any of their gold into the peg.

    I think the only realistic approach by nations is to declare economic attacks on currencies to be a form of warfare or terrorism, with public executions of the convicted speculators.

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