What will be the next market panic?

November 17th, 2009

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It is an open secret that the zero interest rate policy (ZIRP) by the Federal Reserve is fuelling a carry trade bubble as described in Return (and potential crash) of the great Aussie carry trade. In fact, the Chinese are seething with anger as they blasted the Americans as the root cause of blowing asset price bubbles all over the world. As this article wrote,

The US Federal Reserve is fuelling ?speculative investments? and endangering global recovery through loose monetary policy, a senior Chinese official warned on Sunday just hours before President Barack Obama arrived in China for his first visit.

As far as Wall Street and their buddies in the US government is concerned, an orderly decline of the US dollar is not their problem. It is the problem of

  1. The American people because a depreciating US dollar means a lower standard of living for them via price inflation
  2. Export-oriented economies because it makes their wares more expensive to Americans
  3. Countries who more or less peg their currencies to the US dollar because lose American monetary policy implies a lose domestic monetary policy, which helps to ignite asset price bubbles.

Right now, there are two possibilities for the US dollar: a short-term rebound or a Black Swan trigger that turns an orderly decline into a disorderly rout.

The first possibility should be familiar to you- it will probably look similar to the Panic of 2008. Based on technical analysis, the USD is extremely oversold and ought to be very vulnerable to a rebound. Most likely, it will turn out that way: a ‘surprise’ deflationary event (e.g. see Looming Black Swan that can bring the market back into panic) triggers a USD short covering (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar), which will result in a return of fear and panic and then followed by more money printing, stimulus and bailouts.

The second possibility is the really unpredictable one. The flight away from the US dollar may not necessarily be towards the non-US currencies (e.g. AUD)- instead it could be towards precious metals. In that case, we can see some strengthening of the US dollar plus the soaring gold prices in all currencies. Our hunch is that the next big move in the markets is not going to follow the familiar deflationary script of the first possibility- it is just too predictable. Because it is too predictable, Wall Street, Bernanke and the authorities must have already anticipated them and manipulated the markets to prevent it from happening. Hence, perhaps the much anticipated correction will not happen in the conventional form that we expect? Perhaps the deflationists have severely underestimated the cunning of the gang?

But there is a limit to how far that gang can manipulate the markets. When they have a rival nation (China) that follows different set of rules, different forms of governments and whose national interests are incompatible, things are much trickier. We have no doubt that the Chinese, in the quest of their own national interests, are undermining the national interests of the US, whether as an deliberative active policy or as a consequence of their mercantilist pursuits. The intersection between this clash of interests is where miscalculations and loss of control of the markets happen. This is where economics and politics collide.

Our hunch is that the next panic may have something to do with currencies. Should this occur, the only safe haven we can think of is precious metals. As to when and how the panic will look like, we do not know.

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