It’s been nearly 9 months since the $ started to show signs of meltdown fever. Except the meltdown was the rush to buy $ as a hedge against collapsing markets and disappearing credit lines.

In the last few months we have seen markets bottom and even recover some poise, aided and abetted by the action of nearly last resort, quantitative easing. There was nothing left in the toolbox really.

So far so good in some respects. The S+P has rallied 37% off its lows…….mind you its lows were 57% down from the highs and the index still stands 42% off the highs of the last few years. Not that the numbers really matter. The main news is that markets are functioning…still.

And the $ balloon has finally burst with QE signaling a chance to sell the $ without worrying what the equity markets were doing. The Kiwi$ has rallied 32% from its March low even outpacing the hammered Pound, up 21% from its low of $1.35.

Markets can do very strange things. Even whilst the $ was rallying to extreme highs against all currencies, no one really wanted to own it. Now people really really don’t want to own it.

This is all very well but this type of volatility is impossible to manage. How can any investment manager talk about average returns of 10% a year when markets are moving at this rate. How can any business hedge currency risk when currencies are moving like this.

The bigger problem for the US is trying to stop the snowball effect that may happen if markets really decide to dump the $. The noises coming from China may be regarded as monetary brinksmanship but with Russia, looking very wolflike these days, nibbling in behind, it’s becoming a more serious issue.

There’s a lot of politics involved in this but the positioning is clear: the US is weak not just economically but militarily. The exhausting foray into Iraq has stretched the US war machine as well as seriously impacting on its reputation. Historically the ability to create coin or currency was usually backed up by military power. One of the first actions by invading nations was to replace the local currency with its own.

This makes currency both a political and economic issue. So whilst there is unlikely to be any immediate change in the $ role as global reserve currency, there is no doubt that the dance of change is underway.

The short term problem for China is its huge ownership of US bonds and other paper. So they wouldn’t be happy with a complete collapse right now but it seems like less money will be staying in $ and more will be finding a new home whilst they work out how a new global currency system might operate.

But with GM falling apart and US unemployment rising to severe levels, concerns over the health of the $ will only continue to mount.

Not wanting to bve left out of the party, China announced a huge stimulus package over the weekend. $600bln or thereabouts is not be to sneezed at. The Chinese are taking no chances with collapsing global trade and economic activity. They have an large domestic economy and plenty of headroom to generate homegrown action.

They also have the money to do it.

As Yves notes the sums involved are getting to the point where a trillion doesn’t raise eyebrows. The Fed’s balance sheet is expanding quicker than a fast food muncher’s waistline. $2trln or will it be 3? Who knows? Who cares anymore? It’s like the end of a Monopoly game where the deals come thick and fast and the rent for landing on Mayfair (or Park Avenue) breaks your bank.

At the same time one continues to hear, in the background, that ecosystem stress is alive and well. As I noted last week there are some major concerns about the level of ecological debt. In a report by the WWF, called The Living Planet, they estimate some $4-5trln worth of ecological damage is occuring on an annual basis.

Deflation, stagflation, hyperinflation, ecological breakdown and over population.

Your cash losing its value every day as the printing presses run wild.

Time for a pause and a lie down.

I mentioned Wokai briefly in the previous post but after closer examination they deserve the full monty. Developed by 2 smart ladies (Courtney McColgan and Casey Wilson) from the US who met studying advanced Chinese at Tsinghua University.

Wokai means “I start” in Chinese and represents the entreprenuerial spirit of microfinance. It looks an amazing undertaking. With over a sixth of the world’s population the potential for domestic economic activity is enormous.

With 300,000,000 living below the poverty line and the Rural Credit Bank only servicing 25% of demand, there is clearly a large market here for small, flexible lending which is the hallmark of microfinance.

It’s another exciting addition to the microfinance and P2P stable of companies. As long term readers will know I believe strongly that P2P financing will replace traditonal banking systems within 20 years.

Who knows it may be sooner with organisations like Wokai springing forth.

The recent rush for the $ has exposed a global currency crisis that seems to be gathering momentum.

So far we have seen Iceland bankrupted, South Korea facing a huge run on the Won, Argentina seizing private pensions, Hungary and Denmark raising rates and general deleveraging in emerging markets.

At the same time even the majors have taken a pounding. In the last 3 months against the $ the Euro has fallen 22%, the Pound 22%, the Aussie 38%, the Kiwi 29% and the Canadian 28%. The latter 3 suffering more because of their links to commodity markets which have also collapsed.Against the Yen just add another 10%.

Those falls are enormous.

The major factors here are:

- Credit issues.

- Current Account position.

- Commodities.

- Interest Rates.

If you have a large current account deficit and huge overseas borrowing (like Australia and New Zealand) then you will struggle given the problems with credit availability. At the same time lower currencies provide an opportunity to reduce those deficits. No more cheap imports for the Antipodeans.

This poses real problems for the US. Although the Yen is taking some of the slack with a major appreciation, a strong $ is hardly what the US are looking for at the moment given their huge current account problems. However we are entering into a situation where there are bigger issues at play.

A full scale unwind of the global currency net position would see surplus countries holding the upper hand. China with its vast $ reserves has plenty of options on the table. There is an interesting analysis on Naked Capitalism with some good links.

The most interesting proposal from Brad Setser at the CFR is for China (and other large $ holders) to diversify their $ holdings and buy assets from other deficit countries. Although its hard to see China doing this it makes sense as part of the eventual rebalancing of currencies and capital that must happen if we are not to see a huge race to the bottom in currency land.

This would help out the US in taking the heat over a resurgent $ and it would take the heat out of the impending meltdown of cross border capital flows. It may even help avert a potential meltdown in the Euro which grows closer by the day.

The era of running big deficits thanks to leveraged debt finance and derivative products is over. The November 15th War Council will certainly push to reform and regulate markets though that bolted years ago and the stable has burnt down.

Other suggestions proposed are:

- A return to a gold backed global currency. This is just fiat in a different form. It has some merit as a stable, hard store of value in which supply is reasonably easy to manage but it has already failed several times in recent memory.

- A commodity/energy back currency. The EBCU proposal by Richard Douthwaite still is a favourite of mine because it links natural resources, climate change and money together. It’s real unlike gold as it connects energy to money and energy is what we are concerned with, in terms of transforming it and using it in our daily lives.

Hopefully all of these approaches will be on the table when our financial “wizards” meet shortly.

In the meantime it will be a case of holding one’s breath and hoping for the best with possible intervention ahead.

At worst expect markets to close and capital controls to be applied.

It is of passing interest to those interested in karmic events that both Burma and China have experienced cataclysmic disasters within a week of each other. Does repression carry its own energy?

I’ve talked about Burma but for China this is becoming a very difficult year. It was supposed to be a huge celebration, the coming out party for the slightly post-communist leviathan and a party to show the world what an amazing country it was. Alas the Tibet demonstrations rained on that parade and now the earthquake has really taken away the focus. Indeed many Chinese were unhappy that the Olympic torch procession was carrying on as normal and this saw an immediate response by the authorities who scaled back the daily relay.

This shows that the Chinese government is very senstive to public feeling within China and is keen to always be on the right side of its citizens if not those who live outisde its borders. This sensitivity has been increasing over the last 10 years and with the Olympics putting China centre stage, the rallying call for a strong sense of nationhood has been blasted out from all points. From all accounts it seems to be working.

It’s nearly 20 years since the Tiananmen Square massacre. It holds memories for me because I was in Northern Pakistan at the time, coming to the end of nearly 2 years away backpacking and working during my OE from London, and getting ready to cross the Khunjerab Pass into Western China. The idea was to head across China and catch the Trans Siberian home. It didn’t happen. I was with my Kiwi girlfriend (now my wife!) and we met an English guy who had just crossed over from China and told us the news. We were completely cut off and had no idea what ws going on. This was from the days of getting your post from the GPO Poste Restante service. Oh for an internet cafe. It was clear then that it wasn’t a good idea to cross over so we abandoned that idea and headed back down.

China has come a long way in 20 years. Sure it still is pretty ruthless when it comes to repressing dissent or “dangerous groups” like Falun Gong. And yes it still executes a lot of criminals though they say that rate is falling. It has built an enormous economy with a massive trade surplus which has enabled it to move overseas to secure resources and assets. It is however still unsure of its rightful place in the world. It’s military continues to expand posing a threat to Taiwan as well as giving itself plenty of muscle in the worlds’ oceans historically the preserve of the US Navy and before that the Royal Navy.

2008 is a big year for China. How it handles it should give us some idea of how it will turn out in the years ahead. Can it open itself up and with that accept the good and the bad, the praise and the criticism or will it revert to control and repression. Let’s hope its the former.

The Olympic Torch continues to trip and stumble its way to Beijing. That there would be protests along the way was never in doubt but what has been a surprise is the mobilization of Chinese citizens along the way. In Australia there were clashes between Chinese supporters and pro-Tibet protesters. The same thing happened in Japan yesterday.

This is a new phenomenon and one that should be taken note of carefully. There are a lot Chinese living overseas, many of whom were glad to get way in the bad old days of communism and repression. Now things have changed. China is open for business and the most dynamic economy in the world. Suddenly its cool to be Chinese (well sort of) but just as India was “in” a few years ago, China is now all the rage. With this has come a new sense of purpose and national identity both in China and overseas. It certainly gives rise to a lot of comment and opinion.

Where this ends up is anyone’s guess but a resurgent China will be a shock for many people used to browbeating and looking down on China as simply a repressive regime with super cheap labour.

The Chinese vice commerce minister said on Friday “Chinese enterprise should transform themselves from purely from being exporters and importers to being multinational companies through overseas acquisition and production”. That’s a big statement. We’ve already seen this approach with  stakes being taken in US banks and industries but these guys are not messing around. With $1.6trln in reserves they can pretty much buy anything.

They are smart. Why buy US treasuries when you can buy US companies? They can spread influence using economic rather than military means and of course secure a constant supply of the resources required.

It’s a fascinating developmental process to watch and the ramifications are bewildering to imagine.

We certainly do live in interesting times.