Americans Sway the Currency Framework

Huge movements of capital: The Americans withdraw their money from all over the world. The action could trigger a dangerous recession.

Well, OK, vacation in the United States is becoming a bit more expensive. And maybe gasoline, too. But for the German economy overall, the sinking euro rate seems to come at the right point in time. It went down to $1.31 per euro at the beginning of the week.

On Friday it stood at just $1.34; however, four weeks ago $1.45 had to be paid — a deep reduction in the shortest time. That makes German exports 10 percent cheaper in one fell swoop, provides for more orders, raises profits. And that ultimately benefits everyone: the companies, their employees and their investors. One would think.

Unfortunately, it is not that simple because a huge diversion of global capital lies behind the movements on the currency market. Until now, this has only been visible for investors and consumers in the slight decline in the euro rate; however, just like in nature, such a stream can also quickly become a raging river, which can pull the economy along down as in a whirlpool. That would be a debacle for companies, their employees and their investors.

Financial markets move billions around the world daily. Sometimes the trend goes in one direction, sometimes in the other. In the past two years it was the order of the day to invest money outside the U.S., because the nation was incessantly piling up more new debt, and the Federal Reserve was printing money like wild. “The euro on the other hand was a sort of anti-dollar,” says Hans Redeker of the investment bank Morgan Stanley.

Investors brought their money to Europe, primarily to Germany; however, the mood has shifted since a few weeks ago. One reason for this is the never-ending debt crisis in Europe. Yet that alone is not enough because debt was already swelling. Added to this, the world economy as a whole is weakening, and such developments drive America’s investors home every time. They are bringing their money home.

Initially they got out of their German stocks, which caused the German stock index (DAX) to collapse in August, because America’s investors had made especially high profits with them. Then they liquidated further investments little by little.

Stock Markets in Asia Tumble

Finally, for example, stocks from Indonesia and Thailand were next in line, which had still held up well for a long time. During the past four weeks, in which the DAX ran more or less sideways, the stock markets in Jakarta and Bangkok dropped roughly 20 percent.

So it has gone for weeks: As stock market after stock market tumbles, U.S. investors sell and bring their money home. In the process, it is a matter of huge sums. So, in the last week of September alone, roughly $3 billion were withdrawn from funds that invest in stocks in emerging countries, as data from the fund data provider EPFR show. That is the highest value that was ever measured. Funds that invest in bonds from these nations sold a further $3 billion, totaling $6 billion in one week. And the sell wave continues.

But where is the money going? That is also shown in the data of EPFR. Since the end of September, funds that invest in U.S. bonds enjoyed the highest influx ever measured; in so-called American municipal bonds, it was at a 54-week high. The Americans are bringing their money home from all over the world and placing it in U.S. bonds because for them, these are the only safe harbor in the stormy times that currently prevail.

This in turn has let the dollar rate drastically rise for weeks; conversely, the euro rate, and also the rates of other currencies in comparison to the dollar, are drastically sinking. The Russian ruble dropped over 10 percent, the South African rand roughly 15 percent, the Brazilian real 20 percent — and all of this inside of no more than four weeks. The only currency that can presently still stand up to the trend is the Japanese yen.

This is due to the fact that Japan has a relatively broad base of domestic investors and is not as dependent on dollar investors. Quite different, on the other hand, are the emerging countries, who have therefore been especially hard hit.

Capital Is Withdrawn World-Wide

As comprehensible as this development is from the view of an American investor, the herd, which is trotting collectively in one direction, is also threatening to trample some valuable things in the process. Thus the International Monetary Fund showed in a study a few months ago how the influx of capital from foreign countries leads to raised lending by banks in emerging countries and so promotes growth. At that time the focus was directed mainly on the fact that the enormous capital influx overheated the economy and fueled inflation.

But now it is going exactly in the opposite direction. Now the withdrawal of the capital threatens to let lending collapse, which will in turn negatively impact the growth of these countries. At the same time, the economy in the emerging countries is the last hope for the stalled economy of the industrialized nations. If, however, growth in these countries also collapses, then this would lead to even stronger outward flow of capital and let the dollar rise even further — a vicious cycle would get started.

The only county that is considerably less dependent on this in and out flow is China. Peking can order its banks to give credit or withhold it. Here no danger threatens the economy of the country. It comes, however, from another direction, because the strong American dollar has also influenced the exchange rate with the Chinese yuan.

For years, Americans have complained that China was artificially keeping its currency weak. In the past two years the Middle Kingdom allowed the yuan to appreciate slowly but steadily, by roughly 7 percent in the past 12 months alone. However, since the dollar was recently strengthened, this development has come to a standstill.

Does a New Trade War Threaten?

The U.S. Senate promptly launched a legislative initiative in the past week that is supposed to garnish China’s exports with penalties. Peking in turn reacted with harsh tones. The United States is risking a trade war, the central bank announced promptly along with various ministries. The simultaneous reaction in several governmental places shows how concerned one is in the Middle Kingdom.

Stalled bank lending, a new trade war: In this way the world economy could ultimately be driven into recession. And all of this caused by the multibillion dollar sums that the large American investors are moving back and forth. It is therefore within their hands to prevent these consequences.

At the end of the past week, it looked as if they were perhaps gradually coming to their senses. The euro exchange rate stabilized again. The most recent figures from the EPFR showed that “only” an additional $4.8 billion had been withdrawn from emerging countries, somewhat less than in the previous week.

However, that is by far not a trend change. German investors should therefore remain on the sidelines and avoid investments in emerging countries, whether in stocks or bonds, because they would be downright overrun by the herds of large investors when they once again begin to stampede.