International instability

Monday, October 27, 2008, 9:06 pm, by cmartenson

As bad as the US is, there are worse problems elsewhere.  This is why I think this credit crisis will not play out like any previously and why I think there's a better than even chance of a systemic banking crisis.

In times past when a country experienced a bubble or a banking crisis there was always a country next door that hadn't where the savvy could hide out.  Where does one hide out today?

Europe on the brink of currency crisis meltdown
The financial crisis spreading like wildfire across the former Soviet bloc threatens to set off a second and more dangerous banking crisis in Western Europe, tipping the whole Continent into a fully-fledged economic slump.

Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.

“This is the biggest currency crisis the world has ever seen,” said Neil Mellor, a strategist at Bank of New York Mellon.

Stephen Jen, currency chief at Morgan Stanley, says the emerging market crash is a vastly underestimated risk. It threatens to become “the second epicentre of the global financial crisis”, this time unfolding in Europe rather than America.

Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia – all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.

Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain. The US figure is just 4pc. America is the staid old lady in this drama.

Those figures in the bottom two paragraphs are quite the eye-openers. Somehow Austria's bank system loaned out 85% of Austria's GDP to emerging markets that are even now resorting to emergency measures to stem the erosion of the their currencies against the dollar.  The problem, apparently, is that these countries were loaned vast amounts of money denominated in dollars.  The faster their currencies fall the more it costs them to pay back their loans.   Some of these currencies have fallen by 40% in a matter of weeks.

So we're going to have to watch this very carefully. The reason this could lead to a systemic banking crisis is that some countries are going to have to resort to currency controls and outright defaults.  Not just one at a time, like the Russian and Argentinian defaults of 1998 and 2001, respectively, but potentially a dozen or more. But the world's banks are all now interlinked to a degree that prevents walling off a country from being easily done. Hence, the chance of a systemic breakdown increases.

And if you wanted to find a more severe crash in any market in the world it would be hard to beat what's happened to the rates for global shipping.  The measure of global shipping rates is known as the "Baltic Dry Index", and it has collapsed in a most dramatic manner.  

For companies that are in the business of shipping, this represents a 90% cut in their pay:

The biggest bubble of them all; globalization
Oct. 24 (Bloomberg) -- The 90 percent tumble in the global benchmark for commodity shipping costs since May exceeded the Dow Jones Industrial Average's plunge during the Great Depression, signaling globalization is ``the biggest bubble of them all,'' Bespoke Investment Group LLC said.

The Baltic Dry Index's drop from its peak just five months ago surpassed all of those, along with the Dow's 89 percent retreat from 1929 to 1932, according to Bespoke.

``The Baltic Dry Index had a meteoric run since the start of the decade, as it became one of the key symbols of the `globalization' trade,'' Paul Hickey, co-founder of the Harrison, New York-based research and money management firm, wrote in a report yesterday. ``It now appears that like any `new thing,' the globalization trade went too far.''

The Baltic Dry Index fell yesterday for a 14th straight session as the freeze in money markets curbed traders' ability to buy cargo on credit.

This means that global trade is rapidly slowing to a crawl with unknown impacts. The rates are plummeting as fewer international loads are competed for by a vast fleet of cargo ships whose carrying costs demand that they be used.

Certainly for the nearly record number of cargo ships that are being constructed somebody is going to take a huge hit.  Many will never be completed.  Dockyards and shipping companies alike will go under.  

Before too long we might expect shortages of some products to begin showing up here and there.

For those more visually oriented, here's the chart of the shipping rates.  Ouch.  Imagine trying to run a shipping business.  How would you set a budget and plan for this?  Clearly the monetary system is broken and dysfunctional.  The sooner we can all admit that, the better.

Baltic Dry Index