Currency Crisis?

Good morning,

The US market did well last night. US stock stumbled in the early going, but strength among blue chips and financials helped the broader market to fight its way back to log an impressive gain for the session. AT the closed, there were 64% advances and 34% declines for DJIA and 60% advances and 36% declines for S&P 500. DJIA closed 1.33% higher at 10,081.31 and S&P 500 was up 0.68% at 2,162.29. The impressive end to the session also helped the stocks in my portfolio. PTEN was up 1.72% to close at $17.70; EIX up 0.33% at $33.19, XTO up 0.49% at $45.30, CAH up 1.79% at $29.08, OSG up 1.17% at $43.08 and Watts Water up 1.45% at $31.57. The only stock that went south was Digital River. It closed at $23.70, down -2.19%. Those who follow my blog will know that I was not keen in Digital River even though it appeared in my filtering screen. So did you make money from these stocks I recommended?

After my chat with my friend yesterday morning, I spent the whole night reading articles and blogs about currency crisis, and I was surprised to see so many articles on the subject. Most believe strongly that there will soon be an economy crisis caused by their expected currency crisis. What is currency crisis? There is no exact quantitative definition of a currency crisis, but it generally involves a sudden and rapid fall in the value of one or more currencies. It is more likely to happen in an emerging market economy that has borrowed a lot of money in foreign currency.

Let’s say country A has a high level of foreign currency debt, either in its public or private sector. At some point, for some reason (recession fears, for example), the people holding that debt get worried that the country may not be able to pay off that debt. They start selling stocks and bonds in country A’s currency, and converting their assets back into “hard currency” (dollars, euros, yen, pounds – things that are unlikely to collapse in value). That drives down A’s currency because more people are selling it than buying it – which makes it even harder for country A to pay off its foreign currency debts (since they just went up relative to its’ decline in currency value), which makes other investors panic and sell, and so on and so on. These dynamics can be amplified by the actions of currency speculators, who will sell a currency short if they think it is ripe for a currency crisis, and may therefore trigger the crisis and making themselves a lot of money. Currency crises can do lasting damage to countries suffering them. Loss of foreign investment hurts the real economy, often triggering a recession. Devaluation of the local currency makes imports much more expensive, reducing the standard of living. The policy measures required to boost a currency’s value – increasing interest rates (to attract investors) and reducing deficits (to restore confidence in your ability to repay your debts) – are the opposite of what you ordinarily want to do during a recession.

Many are predicting that the budget deficits and low interest rate will trigger inflation in US. Excessive debt levels point to excessive inflation in the past and suggest that GDP growth, having been over-stimulated, will contract more severely than expected but it has not happen so far. Also, a rapidly expanding Federal Reserve balance sheet and quantitative easing (“money printing”) are directly weakening the US dollar while foreign appetite for US debt is waning. On a global basis, there is a growing shift away from the US dollar both as a reserve currency and as an international medium of exchange, as well as a developing US dollar carry trade threatening to put additional pressure on the dollar. The massive US stimulus spending package, possible inflation and the likely devaluation of US currency have led these nations, notably China and Japan - the two largest holders of US debt, to become very concerned about a huge loss in the value of their assets held in US dollars. These countries are reducing the amount of US dollars they own and converting them to gold and other currencies in order to find alternative ways to hold their assets and maintain the value of their currencies.

At the same time, I am concerned with the huge amount of Europeans’ loan to emerging markets. Western European banks hold almost all the exposure to the emerging market. They account for three-quarters of in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom – a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles. As US remains a key outlet for emerging markets, a severe US downturn could have more serious consequences for emerging market economies than expected as domestic demand could be difficult to shore up the growth.

I am no currency expert but I do know that these developments could cause a big decline in the stock market, so I am watching the situation closely and since my Cycletrend and KUTE system has not change its' forecast,I am sticking on to my belief that the markets will continue trading within the broad range and my strategy is to continue to buy at dip and sell at target currently.

Have a good day.

Francies Cheng
BBus MAppliedFinance