Portfolio

Get ready for upheaval in the currency markets

D. Murali | Updated on February 19, 2011

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The short message of Matthew Lynn in Bust: Greece, the euro, and the sovereign debt crisis ( www.wiley.com) is that the euro is finished. Stating that the fault-lines exposed during the Greek crisis were too severe to be fixed and certainly not by the ramshackle rescue package cooked up in Brussels over the trillion-dollar weekend, he adds that it would be better for the system to be broken up wholesale rather than just for Germany to leave. The author foresees that there will be no more talk of further schemes for European integration. “The euro was meant to be a step toward the closer integration of the continent. It now looks more like a full stop than a stepping stone.” In his view, the EU (European Union) for the next decade will be an introverted, inward-looking organisation mainly preoccupied with sorting out the catastrophic mess it has made of the single currency, and retreating from the rest of the world.

Search for an alternative

What can be worrying is the grim prediction in the book that there will be a period of intense upheaval in the currency markets, with investors starting to cast around for an alternative. Tracing back, the author notes that the euro really was a contender to become a globally prominent currency and perhaps even supplant the dollar. That was partly because it was the money of one of the world's biggest economic blocs, and because investors were increasingly disillusioned with the dollar, he reasons. While, therefore, the money markets are expected to flee back to the dollar as the euro is laid to rest, Lynn cautions, however, that all the doubts about the dollar will still be there, and that they will be just as valid as ever. He avers that a return to a global economy dominated by the dollar as the world's strongest currency simply is not possible.

Among the possible alternatives mentioned in the book are gold, a basket of global currencies proposed by the International Monetary Fund (IMF), the yuan, some combination of commodities, and ‘even something that no one has really thought of yet.' Once the answer emerges the currency markets will start to calm down; but there will be an intense period of uncertainty, characterised by wild swings of prices and sentiment, before that point is reached, warns Lynn.

Root of the crisis

The author explains how, at its root, the crisis was not really about Greece. It was about the massive build-up of government debt and the addiction of most of the developed world to spending more than they could afford, he observes.

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Drawing a comparison with the credit crunch, Lynn highlights that the problems may have started with the collapse of Lehman Brothers, but that it would be a mistake to think it was just about one investment bank taking on too much risk and collapsing under the weight of its own stupidity. He underlines that it was about a whole financial system that was drowning under too much debt. “Lehman was a symptom, not a cause, and saving the bank would not have averted the crisis. It would have simply exploded somewhere else.”



Similarly, in the case of Greece, it would be wrong to imagine that there would have been no sovereign debt crisis if the Greeks had stuck to the rules of the euro and done more to encourage genuine growth, the author reminds. “Like Lehman, it was the flashpoint, but the crisis would have simply exploded somewhere else.”



An apt quote in the book is of George Soros — that we have just entered ‘‘Act II of the drama.'' For, the sovereign debt crisis is an extension of the credit crunch, as Lynn lays out. “If that crisis was about too much consumer debt recycled through the banking system, this one was about too much government debt recycled through the bond markets.”

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Published on February 19, 2011

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