Currency Wars_ The Making of the Next Global Crisis - James Rickards [129]
Chaos
Perhaps the most likely outcome of the currency wars and the debasement of the dollar is a chaotic, catastrophic collapse of investor confidence resulting in emergency measures by governments to maintain some semblance of a functioning system of money, trade and investment. This would not be anyone’s intention or plan; rather it would simply happen like an avalanche brought about by the layering of one last financial snowflake on an unstable mountainside of debt.
The instability of the financial system in recent years has been dialed up through the greatly increased diversity and interconnectedness of market participants. Embedded risk has been exponentially increased through the vastly expanded scale of notional derivatives contracts and leverage in the too-big-to-fail banks. The exact array of critical thresholds of all market participants is unknowable, but the overall system is certainly closer to criticality than ever before for reasons already discussed in detail. All that is required to initiate a collapse is a suitable catalyst relative to the lowest critical thresholds. This does not have to be a momentous event. Recall that both small and large fires are caused by the same-sized bolt of lightning, and what makes for conflagrations is not the lightning but the state of the world.
The catalyst might be noteworthy in its own right, yet the link between catalyst and collapse may not immediately be apparent. Following is one scenario for the catenation of collapse.
The triggering event happens at the start of the trading day in Europe. A Spanish government bond auction fails unexpectedly and Spain is briefly unable to roll over some maturing debt despite promises from the European Central Bank and China to support the Spanish bond market. A rescue package is quickly assembled by France and Germany, but the blow to confidence is severe. On the same day an obscure but systemically important French primary bond dealer files for bankruptcy. Normally trouble in Europe is good for the dollar, but now both the dollar and the euro come under siege. The double-barreled bad news from Spain and France is enough to cause a few Dutch pension fund dollar stalwarts to change their minds in favor of gold. Although not usually active in the to-and-fro of dollar trading, the Dutch push the dollar “sell” button and some snowflakes start to slide. In Geneva, another dollar-critical threshold is crossed at a hedge fund, and that fund pushes the “sell” button too. Now the slide is noticeable; now the avalanche has begun.
The dollar quickly moves outside its previous trading range and begins to hit new lows relative to the leading indices. Traders with preassigned stop-loss limits are forced to sell as those limits are hit, and this stop-loss trading just adds to the general momentum forcing the dollar down. As losses accumulate, hedge funds caught on the wrong side of the market begin to sell U.S. stocks to raise cash to cover margin calls. Gold, silver, platinum and oil all begin to surge upward. Brazilian, Australian and Chinese stocks start to look like safe havens.
As bank and hedge fund traders perceive that a generalized dollar collapse has begun, another thought occurs to them. If an underlying security is priced in dollars and the dollar is collapsing, then the value of that security is collapsing too. At this point, stress in the foreign exchange markets immediately transfers to the dollar-based stock, bond and derivatives markets in the same way that an earthquake morphs into a tsunami. The process is no longer rational, no longer considered. There is no more time. Shouts of “Sell everything!” are heard across trading floors. Markets in the dollar and dollar-based securities collapse indiscriminately while markets in commodities and non-U.S. stocks begin to spike. Dumping of dollar-denominated bonds is causing interest rates to surge as well. This has all happened before high noon in London.
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