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Currency mismatch

People, the economy and capitalism are changing constantly. This dissuades us in applying dead rules to evaluate a present situation.
As stated before the devaluation of the currencies in some countries in the nineties turned out bad. Instead of a boom, the economy contracted. The main reason behind this event is a currency mismatch.

A country only devaluates its currency when there's already a loss in confidence in the currency. But when this devaluation reduces the value of the assets expressed in the devalued currency versus a large part constant debt in foreign currencies on the liability side of the balance sheet, a mismatch can occur. If this happens in such degree that the liabilities become greater than the assets the country or company becomes virtually insolvent.

We have noticed another kind of mismatch in Europe in 2002 when insurance companies saw their solvency rate decline when the stock market fell. Today even after having recapitalized their balance sheets, we know it'll take at least another two years to restore their solvency rate to previous levels

So many kinds of mismatches can appear (the Freddie and Fannie cases?).
In case of rising interest rates the borrow-short and lend-long strategy will surely make victims.

The currency mismatch however accumulates on the other risks. That's why you need to be careful when investing abroad. It's not just another kind of risk, you add a risk.
On top of that it's a difficult to understand the currency risk. Currencies may be compared to languages. Fiat money is no more than a word to express a price but doesn't represent real value just like a language is the expression of something but is not the something itself.
If you have none or insufficient knowledge of the language, you'd better stay out.

When a country is confronted with a classical currency mismatch it has several weapons at its disposition: it can raise real interest rates and take the risk of falling in a sharp recession or it can allow the currency to fall farther and risk widespread bank bankruptcies. Neither is attractive. In most cases it'll balance between the first and the second option.

With a “classical” currency mismatch I point at the developing world where in general assets are local and liabilities are largely expressed in a foreign currency often the dollar.

Today we see already the positive effect of a declining dollar, thus reduced liabilities for developing countries (mainly Brazil). Again following the textbook a revaluation of the currency (Real for Brazil) should express worries for the local economy because it translates itself in a decreasing competitive environment. But when we look at Brazil and Argentina, here too we seem to have an opposite effect. A “currency lucky-match” perhaps!

For the US we should not fear a currency mismatch for almost all of its assets and liabilities are expressed in the same dollar currency.

Is there nothing to fear anymore? Have the kind of financial crises as known in the nineties disappeared? Let's move on a little and move towards what I call a “reversed currency mismatch”.

In Japan and many Asian countries, a lot of assets are invested in dollar denominated assets while liabilities are expressed in local currencies. Suppose for a moment that the dollar would fall to historic low levels and I mean really low, something like 1,70 $/eur (to remain in my language) or lower.
Then imagine or calculate the effect on the balance sheet of many Japanese banks and insurers. On top of that apply the cures necessary. The cures are the opposite of the aforementioned measures for developing countries. In a reversed currency mismatch they must lower interest rates or/and lower the exchange rate.
When we take Japan we notice that lowering interest rates will be rather difficult and that lowering the Yen is an already ongoing process.
Of course not all assets in Japan are dollar denominated assets, which means that the value of the other assets in Yen versus the liabilities in Yen are also determine the solvency rate of the banks. But these assets have been decreasing in value too; a drop in value that resulted in a lot of bad bank loans

I like to put some originality in my texts and this view provides a different look at the Japanese problem. The interventionism of Japan in the currency markets in an attempt to stay competitive and to safeguard its export markets, could lead to a financial crisis which will push or already does push them in intervening in the currency markets even more. All this to avoid a “reversed currency mismatch”!
I even wondered are interest rates so low because of a bad economy? There are ways to figure it out. Just this one: they focus solely on the dollar!

Next step

Capitalism is about money and greed and its destination cannot be changed. Governments manoeuvre on the Stream of Time and they can only steer more or less skilfully.

For this particular reason I don't accept conspiracy theories. Conspiracies do not last long and are regularly revealed before completed (look at the Hunt brothers).
But manipulations do appear regularly.

In a conspiracy theory there's a large cooperation between various people with various interests, the aims are kept secret and there is a long term strategy based on principles.
Manipulation is performed by a diversity of people aiming at short term profits.
We may say that the gold and silver market is manipulated by some big players without any coordination, just for their own profit but we can not state that a conspiracy theory keeps the prices low in the context of a general economic view.
You'll tell me that manipulation cannot hold the price of gold and silver down that long and that much though. You're right. But gold and silver have lost their privileged status long ago and will not regain it (systemic collapse excluded). Over the past decades gold had in an increasing way to compete with a scale of other investment opportunities. The growth of the financial economy offered much more attractive alternatives for traditional investments. Once again we debouch into the main issue of this story namely the power of capitalism.

One of the “individuals” who can manipulate the markets is the US. It can manipulate the markets by using its power and its privileged financial position.

Let us invent such a manipulation theory.

S'pose that a “reversed currency mismatch” threatens Japan and that the US is fully aware of its powerful position. It controls Japan de facto or better Japan is at the mercy of the US and realises it cannot get out of the vicious circle.
In a lesser degree this goes for many other countries.

The US wants to develop and increase its power status by controlling strategically vital commodities, by keeping its military supremacy and by spreading its financial and economic influence. Doesn't sound very realistic but we'll go on ;)

To achieve their strategic goal, the US needs to spend huge amounts and the low saving quote within the US does not allow the government to rely on internal financing. Since Reaganomics the US is condemned to borrow abroad. Internal borrowing would debouch into the exhaustion of the capital market and drop the US economy in a severe depression.

The flooding of the world by dollars has its purpose but without the gained reserve status of the dollar it would not have been possible. Nothing comes before the circumstances are present. And again, circumstances change constantly and have to be re-elaborated within the framework.

We can criticize the Americans for many things but we cannot ignore that they are masters in money matters. This is one valid reason to mistrust the present government in its financial policy. In a normal environment their policy is simply insane and many common people interpret the policy correctly as insane in a classical context. But is it a classical and normal context?
I say it is not.

Once the US became aware of the financial and economic power they possess, they gratefully (ab)used the context and right they are.
A great part of our world is captured in the financial US-web.

A combination of a strong consumption economy, the reserve status of the dollar, the financial risks run by those who invested in dollar denominated assets and the vicious circle they are in, the seize of their financial economy and the unbelievable marketing machine behind it, has fooled many.

But not Europe I hope. The creation of a unique currency is the smartest geopolitical move over the last decades and the US knows it. The political charade is the result of the frustration that Europe is not under the control of the US. Therefore the US needed to execute another strategic move to seize control over the Old Continent and it did so by gaining control over Europe's energy sources in the ME.
Brzezinski's wrote in his book, The Grand Chessboard - American Primacy And It's Geostrategic Imperatives published in 1997, the following: "In that context, how America 'manages' Eurasia is critical. Eurasia is the globe's largest continent and is geopolitically axial. A power that dominates Eurasia would control two of the world's three most advanced and economically productive regions. A mere glance at the map also suggests that control over Eurasia would almost automatically entail Africa's subordination, rendering the Western Hemisphere and Oceania geopolitically peripheral to the world's central continent. About 75 per cent of the world's people live in Eurasia, and most of the world's physical wealth is there as well, both in its enterprises and underneath its soil. Eurasia accounts for 60 per cent of the world's GNP and about three-fourths of the world's known energy resources."
The vicious circle in which many Asian countries find themselves must provide the US with sufficient funding. The recent plunge in the dollar is therefore no more no less than a warning to those who dare to contest its supremacy. Proof of this is the in and out talk of the government representatives.

As the decline in the dollar is only a warning and because the US won't kill the bottle containing its oxygen, the dollar must recover soon. The current account deficit is not a catastrophe yet, the budget deficit is no larger than the one Reagan ran and the international funding is assured. So what's the problem?
The only way the US can reduce the current account deficit is by going into a real recession for a prolonged period but that will not happen until the year 2005. In that year the US must return to financial austerity again for the deficits would turn out to be uncontrollable then. After all the government interferences to delay the recession must inevitably lead to a rather severe recession and a correction in the financial markets.
See a recent occasional paper http://www.imf.org/external/Pubs/NFT/Op/227/index.htm and the recent declared intentions of the Bush government to reduce the federal deficit in the next years (could be an election stunt though).

The cradle of capitalism has spread its financial tentacles and it won't release until it has seized world power. Will it come that far? I have no idea.
What I do know is that capitalism strives for eternity and therefore has to die, for eternity is only met through death.


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