In Emerging Market Contagion Spreads, I presented a viewpoint that emerging market currencies have been under pressure because of falling commodity prices.

Commodity exporter currencies such as the Australian dollar, Canadian dollar, and Brazilian Real have been under pressure for the same reason.

Yen Connection

In addition to the commodity collapse thesis, Pater Tenebrarum at the Acting Man blog throws Abenomics into the mix of possible causes of the Currency Massacre in Emerging Markets.

Both Venezuela (socialist worker’s paradise) and Argentina (nationalist socialist paradise) have a problem with their foreign exchange reserves. In both cases it stems from trying to keep up the pretense that their currencies are worth more than they really are.

Since they have maintained artificial exchange rates – coupled with capital controls, price controls and other coercive and self-defeating economic policies – people have of course felt it necessary to get their money out any way they can. This includes making use of every loophole that presents itself, so that e.g. in Venezuela, so-called ‘dollar tourism’ has developed, whereby citizens travel abroad for the express purpose of using their credit cards to withdraw the allowed limit in dollars at the official exchange rate [then buy goods or bring back the cash to exchange on the black markets at much higher rates].

Now the governments of both Venezuela and Argentina have reacted – the former by introducing a ‘second bolivar exchange rate’ for certain types of exchanges, the latter by stopping to defend the peso’s value in the markets by means of central bank interventions.

To be fair, quite a few emerging market currencies as well as the currencies of developed countries that are large commodity exporters have been under pressure for some time. The Indonesian rupiah has basically crashed, the South African Rand and the Brazilian real have fallen to their weakest levels since the 2008/9 crisis sell-off, and even the Canadian and Australian dollar look a bit frayed around the edges these days.

We cannot help thinking that all this upheaval is the prelude to a more serious denouement down the road – perhaps sooner than most people currently think.

One of the sources of all this recent trouble is quite possibly Japan’s decision to inflate with the help of a generous dose of ‘QE’ and deficit spending. Although the yen’s anticipatory move lower could so far not really be justified by actual money supply growth, the fact remains that it did decline rather sharply. This in turn has put pressure on Japan’s competitors in Asia, which in turn has put pressure on their suppliers in commodity-land and has altered capital flows, etc.

Recall that the Asian crisis of the late 1990s was preceded by a devaluation in China, after which the yen started weakening rather precipitously as well. Of course the situation was different in that many of the countries hit by the crisis had their currencies pegged to the dollar at the time, but the point remains that a weakening yen preceded the event. A parallel is that there are once again quite a few countries that sport large current account deficits and have experienced major credit and asset booms. In short, there are many balloons waiting for a pin.

No US Hyperinflation

While misguided US hyperinflationists predicted the collapse of the US dollar, I expected a collapse in commodity exporter currencies. Please see my November 8, 2011 article Perfect Storm; Eight Reasons to be Bullish on the US Dollar.

I also expected a slowdown in China, a plunge in the Yen, and a currency crisis not related to a sinking US dollar (See March 12 2012 article Japan’s Debt Disaster and China’s Non-Rebalancing Act: Economic Toxic Brew Portends Currency Crisis).

Here we are, with still other currencies in the problem mix. Consider this chart of the Turkish Lira.

Turkish Lira vs. US Dollar

Since mid-2008 the Lira collapsed from 1.03 to 2.45 to the US dollar, a collapse of 58%. Turkey’s deputy prime minister Ali Babacan Blames Fed Tapering.

Babacan said the central bank was taking the necessary steps to deal with the situation, and said Turkey was protected against the swings in the market by its sound finances.

“The balance sheet of the government, the banks and households are quite well protected against market volatility.”

Turkey-Greece Connection

ZeroHedge notes Turkey’s liabilities have multiplied dramatically in recent years with over $350 billion of foreign bank exposure on an ultimate risk basis.

According to Gavekal, as quoted by ZeroHedge …

  • Turkey is not, however, showing any signs of stabilization. The lira continues to fall, and policymakers are doing little to contain the situation.
  • Not only is its current account deficit at nearly 8% of GDP – the highest in the MSCI’s emerging markets universe—but the country is also geographically closer and thus more dependent on the eurozone, whose economic recovery is painfully slow. Its political situation is also clearly very unstable.
  • Already fragile Greece is particularly exposed to the Eurasian republic. Turkish credit as a proportion of total Greek bank assets stands at over 5%, compared to 0.7% for the next two largest (Dutch and UK banks).

It’s difficult to know whether this is the start of a major currency crisis or if central banks can paper over these imbalances still another time, but things sure are heating up rather quickly on numerous currency fronts at once.

Mike “Mish” Shedlock