The Economist - 03.14.2020

(WallPaper) #1
The EconomistMarch 14th 2020 Finance & economics 61

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Buttonwood Involuntary code


Mixedsymptoms
Currenciesagainstthe$
%changeFebruary21st-March11th 2020

Source:Bloomberg

Russianrouble

Brazilianreal

Norwegiankrone

Australiandollar

Chineseyuan

Swedishkrona

Euro

Swissfranc

Japaneseyen

-10-15 -5 1050

T


here aretwo types of sellers in
financial markets. The first kind sell
because they want to. They may need
cash to meet a contingency; or they
might coolly judge that the risks of hold-
ing an asset are not matched by the pros-
pective rewards. The second kind sell
because they have to. The archetype is an
investor who has borrowed to fund his
purchase and has his loan called. If there
are lots of forced sellers, as can happen in
periods of stress, the result is a rout.
Involuntary selling can amplify any
decline in asset prices. A called loan is
not the only trigger. It might be a ratings
downgrade; an order from a regulator; or
a jump in volatility that breaches a risk
limit. What happens in the markets then
feeds back to the broader economy,
making a bad situation worse.
This brings us to the dollar. An ever-
green concern is the scale of dollar secu-
rities issued or held outside America. In
the midst of the financial crisis of
2007-09, the Federal Reserve set up
currency-swap lines with other central
banks to deal with a lack of dollars, as
borrowers outside America were caught
short. In stressed markets a spike in the
greenback is a tell. Investors sell what
they own to buy the dollar not because
they want to but because they have to.
So far the dollar has traded reason-
ably. In recent weeks it has rallied against
a clutch of currencies hurt most by the
slump in oil and commodity prices and
lost ground against the yen and Swiss
franc (the other havens in a storm) as
well as the euro (see chart). Perhaps there
are stresses out there, but they are ob-
scured by other factors weighing on the
dollar. There has been a sense that it is
due a fall. It looks expensive on yard-
sticks of value, such as purchasing-
power parity. The Fed’s interest-rate cut

earlier this month, with further reductions
likely, means that holding dollars has
become less appealing.
Yet it is easy to forget how bearish
sentiment on the dollar was in 2008. Many
expected it to fall in the teeth of a crisis
that had, after all, originated in America.
Instead it spiked as banks outside America
scrambled to get hold of greenbacks in
order to roll over the short-term dollar
borrowings that funded their holdings of
mortgage securities. In 2015-16 China ran
down its reserves by $1trn in part to meet
demand for dollars from Chinese compa-
nies who had borrowed heavily offshore.
And notwithstanding attempts by coun-
tries, such as Russia, to de-dollarise their
economies, the greenback is as central to
the world economy as it ever was. If there
are hidden strains in cross-border finance,
they will eventually be revealed by spikes
in the dollar.
It would be foolish to rule this out. No
doubt pockets of stress will emerge in the
coming weeks—a hedge fund, say, that has
borrowed dollars to buy riskier sorts of
assets and faces a cash crunch. But the sort

of aggressive borrow-short-to-lend-long
bets that intensified the 2007-09 crisis
have been much harder to make. Banks
have tighter constraints on their lending.
Panic by overborrowed foreigners does
not seem a first-order concern.
Other plausible, but voluntary,
changes in behaviour would affect the
dollar in a variety of ways, or not at all.
Foreign investors might simply choose
to sell (or refrain from buying) American
securities amid the current turmoil—a
sort of financial self-quarantine. But
surplus savings must be put to work
somewhere. Asian funds have been
steady buyers of overseas debt securities.
Japan’s Government Pension Investment
Fund, a $1.6trn pool of retirement sav-
ings, had signalled that it will increase its
holdings of foreign debt and equities in
the coming financial year. There is no
sign that it is backing away from this,
says Mansoor Mohi-uddin, of NatWest
Markets in Singapore. Indeed there is a
logic to its front-loading foreign-asset
purchases, as a means of weakening the
yen and helping Japan’s exporters.
Japanese funds have in recent years
preferred to buy euro-denominated debt,
because the costs of hedging euro cur-
rency risk is low. But if the Fed keeps
cutting rates, dollar hedges will become
cheaper. Currency-hedged Asian in-
vestors might then tilt towards American
assets. That would be neutral for the
dollar (because of the hedging) but a
welcome fillip for issuers of corporate
debt in America.
The dollar remains an unloved cur-
rency. Witness the surge in gold prices
spurred by seekers of an alternative. It is
the currency investors are forced to buy,
not the one they want to buy. The dollar’s
calmness is reassuring. A sudden spike
in its value would be a bad sign indeed.

A spike in the dollar has been a reliable signal of global panic. Are we due one?

tal-payments architecture.
The finance minister, Nirmala Sithara-
man, sought to allay depositors’ fears by
pledging that no financial institution
would “fall of the cliff” during her tenure.
The rbiattested to the soundness of the
banks and the safety of depositors. Less re-
assuringly, the comments echoed what
they had both said in September during the
collapse of yet another financial institu-
tion, the Punjab & Maharashtra Co-opera-
tive Bank.
While the technical issues were swiftly
sorted out, fundamental ones remain. The

resolution plan was far short of the $4bn
needed for provisioning, reckons Ashish
Gupta, an analyst at Credit Suisse, a bank.
sbihas said it does not intend to merge
with Yes, leaving the latter’s fate unclear
and, to use Mr Gupta’s careful phrasing, its
“reconstruction...unlikely”. The chaotic ap-
proach has complicated the life of other
small and mid-sized banks, he says, affect-
ing their liquidity and ability to raise de-
posits, which in turn may aggravate the
country’s deepening credit crunch.
This half-baked outcome was not inev-
itable. A private-equity investor says he

heard of more than 40 private-equity
firms, mostly from outside India, who had
expressed interest in buying Yes, only to be
dissuaded at the last minute by the thicket
of regulations, particularly for foreign in-
vestors, not to mention the business risks.
A handful of the same names are reported
to be in discussions with sbi about buying
stakes. Yet falling stockmarkets and finan-
cial mayhem make it an inopportune time
for dealmaking. Many of the former opti-
mists of Indian finance who bought into
Mr Kapoor’s story may never say yes so ea-
gerly again. 7
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