Lehman On My Mind

The US government still has not reached an agreement on raising the debt ceiling, the markets turn their backs on Spain and Italy, stocks worldwide erase all their recent month's earnings in two days, gold is near its historic high again... Everybody seems to be expecting another big hit to the economy sooner rather than later. We have already been there, we should know what to do. Quoting the great Ray Charles "No peace I find, just this old sweet song keeps Georgia on my mind". In this case the name may not be Georgia but Lehman Brothers, and the 'song' may not be sweet at all, but we should have it on our minds...

Because while preparing for this kind of impact, what people are not figuring out is that they are inadvertently paving the way for said impact to be much stronger. Nobody seems to trust anybody else these days, and this is bad, very bad for market stability. No matter how long you have traded or invested with a counter-party, no matter how strong and risk-averse you have been for years; in the eyes of others nobody seems safe against what is coming. 

Lehman Brothers' situation was really bad, but it was the mistrust from its clients, partners and rivals that put it into a corner and accelerated its demise. This mistrust seems to be the general rule in financial markets these days. Today everybody is hedging against everybody else, buying insurance and taking CDSs (Credit Default Swaps) through the roof. This mistrust has enough power to stall the global financial markets; and as we recently became aware of, a financial crisis can transform in a fully fledged economic crisis in the blink of an eye. If that was to happen we would find ourselves in the much feared double-dip recession. I do not want to even think about what another economic crisis would mean globally when we are still struggling to make our ways out of the first one. However there is something I can be totally sure of: if such a double-dip recession happened, a lot of players would be out of the game very soon. A lot of companies, and most importantly some countries, would be unable to dodge a second punch when they are still dizzy from the first one.

A skyrocketing euro for a deep diving Europe

Although it is not the first time I write about why I think the actual exchange rate of the euro against other currencies is wrong (see here and here), the latest developments on the Eurozone's life well deserve a revision of the subject. A quick look at the Eurozone lets one see some not very encouraging facts. The Greek tragedy has been quieted down in the last days but is far from over. In fact almost everybody with eyes in the matter is expecting a default sooner rather than later. The only uncertainty seems to rest in knowing if it would be an orderly default, basically a giant debt restructuring effort (hopefully...), or a messy one.

On the opposite side of Europe we have Portugal, but it seems to be in the opposite side only geographically speaking, because its bonds have also been kicked out of investment grade and are now officially  'junk' grade like Greece's. This will make Portugal financing efforts (even) more difficult, which in turn could end with Portugal asking Europe for more money soon. And to complete the domino effect, this troubles are putting extra pressure into Italy's and Spain's not-exactly-buoyant finances.

Credit: Yahoo! Finance

But the euro simply does not care. As seen in the graph above, the euro is rising against the US Dollar, the British Pound and the Chinese Renminbi, and it is doing so with a specially notable rally in the actual week despite all the bad news surrounding the Eurozone. The european currency is spiking also against special cases like the Japanese Yen and the Swiss Franc, although this is a totally different matter. The Yen has its own set of playing rules because of the Fukushima incident, and the Swiss Franc had been overtly growing uncomfortable with its strength against the euro affecting their exports competitiveness. The case with China's Renminbi is a difficult one to analyze, but what happens with the Dollar and the Sterling Pound?