The Bigger the Bubble: Delving Deeper Into Competitive Devaluation

In anticipation of the FOMC meeting two weeks ago, the markets tumbled. The Dow dropped 582 points, or about 3.3 percent, and the S&P 500 lost 3.9 percent, 79 points. For the S&P, that was the steepest decline since the August 2015 correction. According to an article by Dawn J Bennett, “Investors are starting to understand that credit is tightening, as is monetary policy. Earnings are weak, and speculation about the actions of Janet Yellen and the FOMC this week added to the uncertainty. Of course, the FOMC did walk away from their zero interest policy, raising the Federal Funds rate for the first time in nearly a decade by 25 basis points, but will Yellen be able to make it stick? Worldwide, five central banks have raised interest rates since the financial crisis, and all of them were forced to reverse that decision almost as quickly as they made it. This could easily happen in the U.S. as well.”

Even this small hike could create a dangerous situation for the Fed and Europe, when the markets are finally beginning to sell off for everyone. When the U.S. Federal Reserve released its discount window documents in 2011, it became clear that most U.S. quantitative easing funds went to foreign banks in the European Union. In 2012, when the European banking system was at its worse. The Fed coordinated with the ECB to announce QE3 to help prop up the European banking system. Central banks work together globally to maintain stability but when things start to become difficult, they begin to look out for their own interests; this is when competitive devaluation of currencies starts.

“I believe that the cooperative relationship between the Fed and the ECB may be set to break down,” said Dawn J Bennett. “The Euro comprises 56 percent of the basket of currencies against which the dollar is valued, and Europe holds over $9 trillion in U.S. dollar denominated debt, which is called the U.S. dollar carry trade, and the FOMC move to raise interest rates could easily cause fault lines throughout that trade. Investors need to keep an eye on ECB monetary policy in the next months, because their actions carry significant impact to us in the United States.”

She continued, “We really do seem to be in an echo of the ’07/’08 crisis, and one that has the potential to be exponentially worse than that event. In 2007, the Bear Stearns High Grade Structured Credit Fund started to show signs of trouble, which eventually led to an emergency loan from the New York Fed than ultimately failed to save the company. Just as Bear Stearns froze redemptions on its credit hedge fund in 2008, two big hedge funds (Third Avenue and Stone Lion Capital) have done the same in the last few weeks. Add that news to the increased volatility resulting from commodity and energy selloffs, and we should be seeing a big red flag for risk assets. ”

Read more from Dawn J Bennett here: