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08/10/2008 | The Credit Crunch's Effects Outside the United States

Stratfor Staff

Markets the world over were hammered on Monday by bad economic news out of Europe, Japan and the United States. All of the world’s largest stock indexes plummeted, with the U.S. S&P 500 closing down 3.85 percent, the British FTSE plunging 7.85 percent, Germany’s DAX dropping 7.07 percent and Japan’s NIKKEI falling 4.25 percent. Even crude oil lost $5 a barrel.

 

Most eyes remain on the United States, and U.S. financials certainly are the trigger, but it is time to start looking elsewhere for the effects. Despite being in the grip of an unpopular presidency and a bitter election campaign, the U.S. system has proven capable of generating a national plan to deal with the credit crunch in the form of a $700 billion bad asset rehabilitation program. Flawed and unproven the plan may be, but it is a plan that is not just on the table but now has been signed into law. Very soon it will take effect.

But that is not what is happening elsewhere.

European banks on the whole are not nearly as healthy as their American counterparts. Spanish banks aside, most European banks have not been as involved in subprime lending, but that is where the favorable column ends. Scandinavian banks are heavily involved in the Baltic tiger economies, all of which are now in recession. Austrian banks are exposed to Balkan markets, which are notoriously fickle. Central European banks are inexperienced and undercapitalized. German banks’ corporatist links make for some creative accounting at times, while British banks are awash in Russian assets with questionable intentions. French banks have to put up with a higher degree of state intrusion, while Italian banks are not exactly the pinnacle of human financial achievement.

The point of all that being that while Europeans are correct in that subprime is not nearly as dangerous to them as it is to the Americans, any credit crunch — regardless of its cause — is going to hammer Europe far harder than it will the United States because the European financial structure is weaker than its American counterpart.

And that is before one even considers solutions. The European equivalent of the U.S. Federal Reserve — the European Central Bank — lacks the authority to regulate bank policy; that power remains in the hands of the union’s 27 members. And there is no Europe-wide equivalent to the U.S. Treasury Department. So most potential policies that could deal with the rising credit crisis at the European level essentially need to be formed ad hoc by 27 different states — each with veto power. And even the United States couldn’t get a bailout plan through Congress on the first try.

Japan faces a different problem. Its system is predicated upon relentlessly cheap credit to ensure maximum employment at the cost of profitability. Lack of capital is never a problem, because the government continuously floods the system with cheap cash. One effect of this is interest rates that have been at or very near zero for 10 years now, and this is the root of Japan’s problem.

Investors — Japanese and otherwise — take out yen-denominated loans at near-zero percent interest, but then take the money out of the country, exchange it for other countries’ currencies, and invest it in places less economically moribund than Japan. This makes the yen fall and the other currencies rise, earning the money mover a tidy profit in what is called the “carry trade.”

Or at least it does until such time as there is a global scare — such as, say … Monday. Spooked money movers then cash in their foreign holdings and seek yen, so that they can pay off their yen-denominated loans before changing exchange rates make the whole operation loss-making for them. The result is a stampede toward the yen as the money movers who have built up these yen-sourced but foreign-denominated investments violently unwind their positions.

The immediate result is that the yen skyrockets — by 5 percent against the euro just Monday. Japan’s domestic economy is probably already in recession. Now the yen can look forward to a sharp appreciation, which will destroy the competitiveness of Japan’s already-faltering exports. And with hundreds of billions — and probably trillions — of dollars locked up in the carry trade, Japan is about to suffer from a number of problems that make U.S. subprime look positively balmy in comparison.

It isn’t so much that all in America is bright and cheery right now, but that while the United States is indeed facing problems, those problems are not structural, as they are elsewhere. Even chronic issues such as the budget and trade deficits are more a sign of America’s strength than its weakness, since for a country to run such deficits someone has to be willing to purchase its debt. Amid all this chaos Monday, most Americans probably missed that the dollar was up sharply versus pretty much every currency in the world (aside from the aforementioned yen) — and has been for the past couple of weeks.

Stratfor (Estados Unidos)

 



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