The Three Events Which Rocked the Forex Market in the First Half of 2015
In his seminal book Future Shock, futurist Alvin Toffler speaks of “too much change in too short a period of time”. Nearly half a century later, financial markets are beginning to feel the strains of future shock, and the one thing that seems to remain persistent, for now, is an encroaching weakness in global trade. It seems that the object glut of the late 20th, early 21st century is coming to an end, people satiated with cheap disposables and a prevailing lack of employment leaving them in dire want for the things they do need. At the other extreme of the formula lies a resulting market volatility that increase with the release of every new news item into this content-hungry world of otherwise bored consumers. The pool of young workers grows smaller as birth rates drop, but employment opportunities are diminishing at an even greater rate due to heightened life expectancy, later retirement, automation and the aforementioned plunge in global trade.
Three major episodes so far this year have brought home to anyone who had a doubt that the world is no longer the calm placid place that Toffler was looking twenty years back upon from his 1970s study. Nothing is evident; even the great can fall; and the smallest amongst us can let off an inordinately large sound.
Those Not-So Stable Swiss
For many years, the Swiss banking system was looked upon as an icon of respectability and solidity. Through two world wars and beyond, it has remained infuriatingly neutral; it maintains a boringly balanced budget; and the Alps will be there for ever. All but the latter changed as the year began with the bang of a peg falling – that which held the Swiss franc in collusion with the Euro. The Swiss National Bank introduced that peg in 2011 in order to maintain the exchange rate as a psychological level of 1.2 Euros to the franc. Unfortunately, the Swiss economy relies heavily on exports, tourism and services to the tune of 70% of its GDP – all which were adversely affected by an expensive franc. The result was a hoard worth $480b in the coffers of the Swiss National Bank. This state of affairs could have continued were it not for the European Central Bank’s decision to embark upon an ambitious program of quantitative easing, which entails printing the money required by the bank to purchase European government debt, pressuring the Euro downward and forcing the Swiss to print francs to maintain the parallel value. Last year, as a result, the franc lost 12% against the USD, and the Swiss had no choice but to unpeg their currency from the rapidly dropping Euro.. This it did unexpectedly on January 15th of this year, resulting in a 30% surge in the value of the Swiss franc overnight from 1.2 Euros to the franc to 0.85.
The immediate result of the move on the forex market was dramatic, especially in the retail forex trading sector, which is heavily leveraged. A year before, Citigroup published a report stating that this market accounted for about $400b in daily trades, a doubling over the space of two years.
Clients who had been heavily invested in the related currencies – not just the franc itself but those currencies that traded in tandem with it, such as the Euro and US Dollar – experienced a loss of equity that was swifter than the ability of their stop-loss orders to take effect; they suddenly held negative balances that margin calls would normally prevent; and the brokerages themselves were now debt holders whose market values plunged towards bankruptcy, as was the case with the UK retail broker, Alpari. One of the largest firms, the US broker FXCM, lost over 90% of its share value in the space of a day, forcing the SEC to halt its trading. The company only survived thanks to a $300m loan from the American holding company, Leucadia National.
Half a year later, the mayhem caused by the Swiss is nearly forgotten; but clearly, the butterfly affect in global finances is at play when the decision of a central bank in one country causes such mayhem in companies half way across the world – companies that have little dealings in the State of the former.
Beware of Greeks Bearing Bears
In a repeat of the Trojan Wars, it would seem that this time, the wooden instrument applying for entry into the Trojan Eurozone was Greece itself. Perhaps one of the leading factors in fashioning the Ionian Equestrian quadruped was the overthrowing of the Military junta, which had ruled for the past seven years. In an attempt to enfranchise left-wing segments of the population, the new government began to run huge deficits in order to finance public sector jobs, pensions and social benefits. The country’s defence outlay was one of the biggest in NATO, second only to the US, with the US, German and France selling it huge amounts of unrequired military stock.
Greece joined the EC (the European Communities, later to become the European Union) in 1981, which initiated a period of growth and (mainly) opulence. Infrastructure investments began pouring in to supplement the already popular tourism and shipping trades, and standards of living shot upwards. In 2001, Greece adopted the EU’s newly minted common currency – the Euro, and what followed was a seven-year 2.5-times surge in GDP-per-capita as the country began taking out loans to pay for development that now costed less thanks to the new currency. Between 2000 and 2007, Greece boasted the fastest growing economy in the EU – 4.2%.
Unfortunately, labour became more expensive, leading to a gradually diminishing competitiveness of Greek exports and a rise in trade and budget deficits. By the time the Great US Recession of 2008 began, European funds were drying up, and Greece, which by then had become the butt of reports on fiscal mismanagement and downright fraud, could no longer borrow additional funds to finance its obligations. Tax evasion was estimated to be worth over $20b in the second half of 2012, $80b of taxable income had been stored away in Switzerland, and the country was named the most corrupt in the Union – compliments of major banks, which assisted in administering the fraud. Had the country maintained its monetary independence, it would have been able to devalue its currency. Instead, wages fell by 20% from 2010 to 2014, leading to a recession, 25% unemployment and a severe escalation of debt-to-GDP. By 2009, this debt amounted to nearly $300b, or 130% of GDP.
The EC (European Commission), the IMF (International Monetary Fund) and the ECB (European Central Bank) launched a EURO 110b bailout loan in May 2010 to prevent a Greek sovereign default with the condition that it implement austerity measures and structural reforms, and privatize government assets. The following year, the aforementioned ‘Troika’ provided an additional EURO 130b, and private creditors agreed to extend maturities with lowered interest plus a write-down of 53.5% of debt. The steps taken improved the situation, and by 2014 the government had returned to a primary budget surplus. Additionally, the bailout program’s fourth review revealed that the structural surplus and unemployment had fallen, and the economy had actually grown by the end of that year. Still, no respite for citizens ushered in the anti-austerity, anti-establishment, left-wing Syriza party that vowed to ignore the terms of all bailout programs. The Troika immediately suspended all additional payments of assisting funds until the new coalition accepted the previous terms unequivocally.
So far, the steps have resulted in a plummeting stock market, increasing illiquidity and the implementation of capital controls that presently have Greeks forming lines at ATMs to extract their daily EURO 60 ration of cash. On July 5th, 61% of voting Greeks expressed solidity with the government’s position in a referendum that had two thirds of voters responding a clear ‘no!’ to continued austerity in return for a bleak future – even if the outcome would be an inglorious exit from the Eurozone.
Once again, markets worldwide responded by pressuring indices dramatically down, though considering the danger of contagion via other debt-ridden Eurozone countries, one would hesitate to express wonder at the butterfly reaction.
The Bear in the China Shop
One positive aspect of the Greek drama is that it has so far detracted attention from what many analysts see as a much more existential threat to the global economy – the Chinese crash of 2015. Luckily for most investors on this side of the wall, China’s financial markets are relatively closed to foreign investors, so the chances of contagion are relatively low. Still, one should examine the situation, especially as it bears striking resemblance to the American Crash of ’29 – everyone and his brother-in-law delving into stocks, an inflated real-estate bubble and every possible warning glaring loudly under the sun.
Chinese manufacturing, though still the envy of the rest of the world, has been slowing down for quite some time, causing a drop in the country’s demand for raw materials, and the central government has cut its growth expectations for 2015 to 7%. Although also an envious target, this represents the lowest expansion rate in more than 20 years; and, in fact, the HSBC Manufacturing Index fell at last reading to below 50, which marks the point between an expanding economy and a contracting one.
Over recent years, massive investments in infrastructure projects – highways, railroads, bridges, etc. – have created a false sense of a growing economy, accounting for 50% of GDP; however this overcapacity must inevitably lead to a correction.
Several factors besides the impact on global commodity prices cause serious. One is the start of a reversal in the level of working-age citizens, which peaked three years ago and has since been falling. A second factor is the levelling off of investment and the narrowing technological gap with the world’s richer countries, which serves as a forecaster of diminishing productivity growth. To return to the US of ’29 analpgy, property prices until now were inflated thanks to inflated credit flow; however, recent construction starts dropped by nearly 20% during the year’s first quarter. And finally, credit is astronomically high, presently sitting uncomfortably high at 250% of GDP.
Until now, the central People’s Bank of China has resisted easing monetary policy, and only recently began to undertake steps to ease the loan burden of local governments. Interest rates and bank reserve ratio requirements, though still high by world standards, have been cut three times since the beginning of the year. And regulators have suspended new stock issuances, which could harm domestic consumption.