Thursday, November 24, 2011
Imagine if you're a US company that closed a contract worth a few million in Australia after months of negotiations with a 10% margin for profits, one month later your profits are are wiped out if you don't hedge your contract in the currency market.
If you go through the annual reports of smaller companies listed on the SGX, you find that many don't hedge their contracts. A whole quarter or even one year of potential profits becomes losses due to large foreign exchange movement.
The large movement can also affect the competitiveness of a country. If a country's currency falls, it makes companies in the country more competitive. For export dependent countries like Japan, the govt intervene regularly in the currency market to make sure the Yen does not rise too quickly.
The movement of a currency can reflect the economic state of a country. If you have a troubled economy, your cirremcy would fall. However, forex markets do not merely reflect the state of the economy, they can amplify the weakness in the economy and make it impossible for govts to fix their economic problems. Mahathir once said forex speculation is evil during the Asian Crisis. He was ridiculed and laugh at by western commentators. Today, we see the problems in the Eurozone amplified not by the forex market but the sovereign bond market - speculators have driven the interest rates for the bonds of troubled countries to historic levels ...these countries may have been able to service their debt at lower interest rates now have a high risk of defaulting because interest rates are so high...because there is higher risk of them defaulting, rates move even higher in a self-fulfiling manner.
Of all the currencies, I choose to show the Aussie dollar because it most clearly reflects what speculators think of the state of the global economy. The Australian economy stands at the cross roads - it is a developed economy that export resources to emerging countries and a western country located nearer to Asia than the other Western countries. When the Aussie dollar goes up, speculators think the global economy is in the pink of health but when the Aussie dollar goes down, it is because speculators think the global economy is getting worse. Speculators can be wrong and constantly correct themselves. 1 month ago, they the Aussie dollar was 10% higher and they thought the global economy was back on its feet today they think the global economy will falter due to the Eurozone crisis. The wild swings in the Aussie currency reflects the uncertain outlook of the global economy.
So how will things unfold in the coming months? Minister Tharman thinks a severe slowdown will occur, the property speculators queuing up in Bedok think that good times for property is here to stay, Warren Buffett sees no sign of economic recession in USA. In the 2008 recession, there was clear consensus that the world economy will enter recession several months before the recession came - the reason was the economy was firing on all cylinders in 2007 with low unemployment and high capacity utilisation. When aggregate demand fell, there was plenty of fat to cut and it became clear a recession was on the way.
Today the US economic activity looks like this measured by the real time Ceridian Index
What has happened is despite making record profits quarter after quarter, US companies refused to expand payroll and invest for expansion due to the uncertain outlook and this has gone on form more than a year since the Eurozone crisis started. Today US economic activity is where it was in end 2010 and it spent one whole year zig-zagging going nowhere. It has not even recovered fully from the 2008 recession. Economists have speculated that the US will slip into double dip recession since mid 2010.
The US economy is largely domestic unlike Singapore's which is export driven and will go where our major trading partners take us. As the US economy struggle sideways, the homebuilding and construction sector has been falling for the past 3 years. The wildcard is when this sector recovers it might give some lift to the US economy. However, it is likely the Eurozone problems tip the US into recession before the US housing sector recovers. It looks like Germany is playing hardball with errant EU countries forcing them into economic austerity and capitulate to more monitoring by the EC authorities refusing any quick fixes such as ECB printing money to ease the problem. Delaying the solution framework to squeeze some fiscal discipline out or EU members is a risky business as the fiaancial markets go into a tailspin.
The falling Aussie dollar in Nov 2011 shows that collective speculators' expectation has completely turned around from a month ago. Contrast that with the relatively stable level of economic activity. Because speculators operate in a herd like manner sometimes with expectations running ahead of reality, some contrarian investors would position themselves against the herd to take advantage of these market "overshoots". The problem is speculators can get it right and their bets match up to reality and the markets go from one extreme to another. Speculators can also manufacture the reality they are betting on - a fall in a currency can cause investors to panic and take their money out of a country leading to more falls in the currency. Based on the Aussie dollar movement, we have again reached the point of high anxiety and fear in the financial markets - a point where the risk is high and so are the potential returns. While the global economy is certainly slowing, speculators seems to have bet on a more sinister outlook some kind of more severe global economic disruption drom the crisis in the Eurozone.
Posting Time 8:57 AM
Posted by Lucky Tan