This is the sense in which the credit crisis will end when house prices stop falling.

Foreign Exchange Outlook : Deleveraging is a word that has now reached the mainstream. Call it what you like - capitulation, liquidation, contraction - cash is now king again. Heaven only knows how long it will take for "credit-worthiness" to be a viable concept again. Not to be overly simplistic, but if you can't lend on the word of honor of the borrower, how about lending against collateral? That works when the price of the collateral is known and there is a liquid market for the collateral.

This is the sense in which the credit crisis will end when house prices stop falling.

This gets a little tricky since we know prices always overshoot, but we may have some evidence-home sales rose 5.5% in the latest month, mostly due to unloading of foreclosed properties. The median sales price of single-family detached homes plunged from $405,000 a year ago to $239,000 last month. How much is enough? Rising sales are scattered across the country and it’s not a universal phenomenon yet… and globally, foreclosures and price drops are just starting in some places, like China.

What about other forms of collateral, like high-value manufactured goods or even commodities like gold? They gain value only when the sale price is known, as in the form of a bill of sale or receivable that can be discounted. We are back to factoring and discounted trade paper, which they had in Babylon. This is not such a bad thing but it speaks volumes about modern embellishments to the credit scene-dross, all of it.

Nothing says this louder than the ratings agency executives testifying to Congress last week. They tried to weasel out of acknowledging complicity in putting a rating on paper that deserved to be rated “zero quality.” Yes, there’s plenty of blame to go around but the ratings agencies seem the most venal, alongside the originators.

To get back to cash, Business Week reports that in Dubai’s lush luxury real estate market, lenders are requiring as much as 70% down. At another extreme, after the stock market meltdown in Japan in the early 1990’s, citizens preferred cash and postal (government-guaranteed) savings. Bankers used to go door-to-door politely asking housewives to make a bank deposit from the nestegg under the floorboards. The US is not Japan but there might be a universal human impulse to embrace risk aversion. Business Week reports that sales of home safes are up 50% in the past 4 weeks and currency in circulation is up sharply in the last month for the biggest increase since Y2K in 1999. You can see the chart at the St. Louis Fed website (http://research.stlouisfed.org/fred2/series/WCURCIR). It’s worth a quick look.

Everyone knows the multiplier effect from Econ 101. Banks need deposits to make loans, even if they were willing to make loans in the first place. Deposits are the raw material of banking. We do not yet have the rising unemployment that will contract deposits naturally, but we already have hoarding of cash. This is not healthy for GDP. We get the preliminary Q3 GDP on Thursday, probably a contraction of 0.5% (like the UK). This is going to scare people even more.

But for once the US dollar exchange rate is not suffering from the grim outlook because conditions are worse elsewhere. Bloomberg reports that the deleveraging that already began in the US and Europe is now spreading to emerging markets. "Banks have extended about $2.5 trillion in foreign currency loans to emerging markets, according to Barclays, which cited data compiled by the Bank for International Settlements in Basel, Switzerland. Some 70% of the claims on developing nations in Asia mature in less than one year, while the amount for emerging European countries is 43%."

Barclays says “The increasing difficulty facing developing countries to roll over their foreign currency loans may set the stage for even greater strengthening of the US dollar.'' A sum like $2.5 trillion is not trivial. We need to start thinking of failed states. So far we have Iceland and Argentina, but soon we will be getting the list of the others from the experts. We will be surprised by some of the names-we always are. The Ukraine, the Baltic states-and who else?

Back in the US, we have unreasoning panic starting to develop. We don’t need the government to say "Liquidate! Liquidate everything!" as the Treasury Secretary said during the Hoover years—we have individuals and the private sector doing that on their own. Pretty soon we will hear another round of blame laid at the doorstep of hedge funds, which will be unfair. Some 10,000 hedge funds hold some $1.7 trillion in assets and will have to contract to only a few hundred funds holding perhaps $300 billion in assets, but hedge funds are only the visible part of the contraction. Regular banks, regular pension funds and regular mutual funds are dumping assets, too. Again, as we wrote before, we don’t know who has the credibility and stature to bring this to a halt. Maybe Obama? But when?

Until we get leadership, the only thing to do is buy dollars and buy Treasuries.

Buy for Now

Barbara Rockefeller
Forex Trading Reports

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