TODAY’S CURRENCY AND FINANCIAL WARS 141not be the last such surprise. There are many important pegs
left in the international monetary system vulnerable to being
broken. Right now, the Hong Kong dollar and the major Arab
currencies are all tightly pegged to the U.S. dollar.
The Chinese Yuan is loosely pegged to the U.S. dollar too.
If the U.S. raises interest rates this year as the Fed has warned,
the stronger dollar may force those countries to break their
pegs, because their own currencies would become too strong
and hurt their exports.
If the Fed does not raise interest rates, the result could
be a violent reversal of current trends and a weaker dollar as
the “risk on” mantra causes capital to flow out of the U.S. and
back to the emerging markets. Either way, volatility is the one
certainty.
The other problem with the currency wars is what the IMF
calls “spillover” effects, also known as financial contagion.
Many mortgages in Poland, Hungary and other parts of Central
and Eastern Europe are made not in local currency but in Swiss
francs. The stronger Swiss franc means those borrowers need
more local currency to pay off their mortgages.
This could lead to a wave of mortgage defaults and a mort-
gage market meltdown similar to what the U.S. experienced in
- This shows how a decision made in Zurich can wipe out
a homeowner in Budapest. Financial contagion works just like
Ebola. Once an outbreak begins, it can be difficult to contain.
It may not be long before the Swiss franc sneak attack infects
investor portfolios in the U.S.
Financial contagion can also be a two-way street. It not
only creates dangers, it creates opportunities for investors who
can connect the dots in the currency wars. The easiest conclu-
sion you can draw and act on is this simple truth: Do not believe
government and central bank lies.
This maxim is not without historical precedent. You’ve
probably heard about Franklin Roosevelt’s own sneak currency