CHINA'S CURRENCY POLICY AND YUAN REVALUATION

The Economist published a thorough discussion (link) of China's currency policy and reasons why yuan is unlikely to revaluate any soon.

CDS IN ICELAND

In Forbes, there is a brief article (link) on credit default swap in Iceland in the wake of credit crunch and external shocks that affect macroeconomic stability.

HOW WOULD EMERGING MARKETS SURVIVE MACROECONOMIC CRISIS

Bloomberg discusses how emerging markets would survive an economic crisis (link).

ICELAND'S INTEREST RATE GOES UP TO 15,5 PERCENT

From today's edition of Financial Times (link):

"Iceland has the highest interest rates in Europe after the central bank raised rates by 50 basis points to a record 15.5 per cent yesterday as it strove to restore confidence in its struggling currency and quench fears of a banking crisis. The move puts the tiny North Atlantic nation above Turkey’s rate of 15.25 per cent and comes just two weeks after it imposed an emergency 1.25 percentage point rise to 15 per cent, underscoring the depth of its problems. On top of the aggressive action taken by the central bank, the authorities are also considering further moves to ease investors’ fears, such as co-ordinated action by Nordic central banks to provide additional liquidity, if needed. There was disappointment that this proposed action plan was not unveiled yesterday. “A sluggish reaction will hurt the financial system, financial stability and the authorities’ credibility,” said Glitnir Research, the research arm of the Icelandic bank, in a report. “Moreover, non-action will also play a large role in the credit rating of Iceland’s sovereign debt, which is on negative outlook at all three major rating agencies, Moody’s, Fitch and S&P.” But the central bank did make clear it was prepared to bolster Iceland’s foreign exchange reserves in the near future. A policy rate increase in and of itself does not solve the problems that have developed in the FX swap market,” it said. “Increased issuance of risk-free bonds that are accessible to foreign investors should open up other channels for currency inflow.” Confidence in the krona, Iceland’s currency, has been damaged this year because of economic imbalances in the economy and fears over the viability of the banking sector. The krona has weakened by some 25 per cent against the euro this year. The inflation rate was 8.7 per cent in March, well above the government’s target of 2.5 per cent, and the central bank said yesterday it expected inflation to peak at 11 per cent by the third quarter of this year, pushing interest rates up further. “Persistent inflation will be most damaging to indebted businesses and households and can undermine financial stability for the long term,” it said. “It is therefore of paramount importance that inflation be brought under control.” Iceland’s economic weaknesses have been exacerbated by the deterioration in global financial markets, which have led to a drastic reassessment of risk and undermined confidence in its highly leveraged banks. On top of these macro-economic pressures, the authorities in Iceland also believe the country’s financial markets may have been weakened via a speculative attack by international hedge funds."

GERMANY'S FISCAL AGGRESSION

In a continuing and overpowering war against low-tax jurisdictions (link), German government hit out a tax attack on the Principality of Liechtenstein (link) by sending intelligence spies into Liechtenstein and bribing former bank employee to alledgly obtation bank client data. Angela Merkel, Germany's chancellor, has endorsed threats to isolate Liechtenstein if the latter does not ease bank secrecy rules (link).

Liechtenstein's GDP per capita equals 84,300 € ($125,000) per capita, which is about three times higher than Germany's GDP per capita. Principality's banking legislation is based on financial privacy. German government has continually forced Liechtenstein to sign information-sharing agreements that would enable German tax authorities to tax capital income of German entrepreneurs whose company is headquartered from Liechtenstein. Also, information-sharing agreements might impose sanctions and tax prosecution of German companies situated in Liechtenstein. The aggression on behalf of German government indisputably violates territorial sovereignity and financial privacy. Nevertheless, the latter is one of the most fundemental human rights.

ALAN GREENSPAN ON MORTGAGE CRISIS

In OpinionJournal, Alan Greenspan places an emphasis on the roots of mortgage crisis. He concludes that numerous price bubbles cannot be safely by policy initiatives.

Overnight, financial risk surged the price of risk, thus pushing the interest rates on various assets compared to relatively riskless U.S. Treasure Securities.

Global economic growth increased steeply and the level of risk suddenly became underminded which led to overnight speculations and mispricing of secured sub-prime mortgages. Thus, a crisis was a well-known accident waiting to happen sooner or later.

Source: Alan Greenspan, The Roots of the Mortgage Crisis, Opinion Journal, Wednesday, December 12, 2007 (link)

FALLING U.S. DOLLAR

The Economist has published a sound analysis of a falling U.S. dollar (link).

An interesting article brought up a couple of issues to be discussed. First, dollar crisis would be disastrous. The U.S economy is now expecting a recession. Even if it looms, the financial markets would force FED to raise the rates, slowing the recovery from recession. Consequently, euro would probably soar to new record-highs.

A major slice of global traded is accounted in dollars and most central banks hold the majority of foreign reserves in dollars. The tightness of euro has handed a chance of switching from one currency to another, pushing the value of U.S. dollar downward. However, different gueses about the possible worst-case scenario are nothing else but pure fears.

On the other hand, U.S. government bonds have fallen as investors haven't expected higher asset premiums. The dollar has peaked in 2002. Since then, consumption-induced borrowing has boosted current-account deficit. Recently, various incentives to import less and export more, have lifted the account deficit from 7 percent of the GDP to 5,5 percent.

The state of the U.S. currency is very much related to so called "cyclical divergence" between the U.S. and the economies in the rest of the world. Financial markets have prolonged the expectations about the interest rate cut. But, a weakening dollar is not a consequence of a single feature. A sizeable amount of assets have been stocked in the U.S. dollar, affected by credit-crunch mess. As growth prospects were weaker, the currency became cheaper. There is no doubt that a widening current-account deficit has left the dollar vunerable to external pressures.

In addition, rising oil prices and weak dollar has raised inflation expectations in gulf countries. Economically, those countries would have to let their currencies to rise to curb the inflation pressures and expectations. If their currency appreciate, other reserve currencies would arise. If the dollar-falling would continue to slide faster, the interest rate cut would have to be held back to prevent the decline in the value of dollar. True, there would be some trade-off pressures.

Speculations about the U.S currency situation are often overblown and there's little evidence, empirical and actual, that the dollar could slide deep into a chaotic slump. Yet, there is a question how long will dollar remain the world's leading currency (link).