Just to snuff out any de-couple-ist resistance to the notion that this is now a global financial pandemic, news on Monday of another IMF bailout (Ukraine) was followed by a bout of rate slashing in South Korea (official borrowing costs cut 75bp to 4.25 per cent), a collapse in Japanese, Chinese and Hong Kong stocks.
Markets are roiled - seemingly everywhere - and it’s all taking its toll on the dollar/yen carrying trade, which is continuing its epic unwind.
The yen rally has now courted a G7 response, indicating nothing less than possible joint intervention. If that happened, it would be the first Bank of Japan currency intervention in four years.
Interestingly, the key factor linking a US recession to the rest of the world according to Roubini is a commodity crisis.
He writes:
A US hard landing followed by a European, Chinese and Asian slowdown will lead to a much lower demand for commodities pushing down their price. The fall in prices tends to be sharp because – in the short run – the supply of commodities tends to be inelastic; thus any fall in demand leads to a greater fall in price – given an inelastic supply curve – to clear the commodity prices.
And indeed in recent weeks the rising probability of a US hard landing has already lead to a fall in such prices: for example oil prices that had flirted with a $100 a barrel level are now down to a price closer to $90; or the Baltic Dry Freight index – that measures the cost of shipping dry commodities across the globe and that had spike for most of 2007 given the high demand and the limited supply of such ships – is now sharply down by over 20% relative to its peak in the fall of 2007. Similar downward pressure in prices is now starting to show up in other commodities.
No surprise therefore that despite an emergency Opec cut of 1.5m last Friday WTI Crude was trading 4.7 per cent lower this morning.
Ken Rogoff, former chief economist at the IMF, highlights the connection between commodities and sovereign debt crises. He tells FT Alphaville (our emphasis):
Even a normal global recession would surely have triggered a rash of sovereign debt crises (not necessarily defaults if they are bailout out). Falling commodity prices and tighter global credit conditions have been leading indicators of sovereign debt crises for two centuries (as Carmen Reinhart and I show in charts in our “Panorama paper”). What is happening now goes beyond that, the financial panic that was centered in Europe and the US up until a couple of weeks ago has fanned out into emerging markets, particularly those with large current deficits and significant financing needs (the latter generally being due to corporate rather than public debt.)
Parity between the dollar and the euro is certainly a possibility, but when the crisis fades, the dollar will probably give back a lot of the ground it has gained in recent weeks.
Rogoff brandishes a couple of very long-term charts to prove his point:
If history teaches us anything therefore, the current sell-off in commodities from all-time inflation-adjusted highs just this summer will undoubtedly lead to a bout of sovereign defaults.
