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.

Forget about government bailouts, now its investors that are bailing out. It’s a case of salvaging whatever is left of portfolios now. Hedge funds are unloading anything with liquidity and currencies are taking the strain,

The horrendous spike in LIBOR rates has seen a reverse run on the $. From global pariah to this week’s must have the $ has risen at a rate of knots in the last month against all currencies except the yen, which has been used to fund most of the speculative investment activity. The Aus$/Yen cross rate is down over 40% in 3 months. The Eur/$ rates has fallen 20%. Eur/yen around 25%. These are not emerging markets, these are the main conduits for global trade and when added to stock market moves of between 25-50% one is faced with the realisation that the whole global financial system is at risk.

I wrote recently that at some point global markets will need to be frozen. That may well happen as not just stocks but currencies go into complete meltdown making any form of economic activity almost pointless.

The recent wholesale and blanket guarantees of bank deposits and lending in many countries have just added to the general lack of confidence in the global financial system.

Added to this commodities have collapsed in price also as that speculative bubble is popped. Even gold, something one would consider in the current situation, has fallen, over 20% in the last few weeks.

Nothing makes much sense at the moment except that the unwinding of years of excess is both savage and yet unpredictable.

One can only hope that somehow the markets can stabilise but the lower it goes the worse it gets as the spiral of margin calls increases and investors seek to recoup whatever they can. It’s probably not the time to sell but at the moment cash is king.

And surprisingly the king of cash is the $…….for now.

I had heard that some Euros were better than others and this story confirms the rumours.

Germans are refuisng to accept Euros which have originated from the Latin Bloc, especially Italy. They want “hard” Euros issued by the almighty Bundesbank, that inflation fighting automaton. You can hardly blame them given the fiscal history of Italy, never mind Greece, Spain or Portugal.

But what this shows is the lengths to which people will go to mitigate risk. It seems a waste of time really given that the Euro is universal in its value and acceptance. But its a bit like English and Scottish Pounds. No one ever wanted a Scottish one even though they were both accepted as legal tender by the Bank of England.

Perception is everything and the Germans have long memories of inflationary times.

The sad fact is that if the financial system falls apart nothing will save you. Having a nice pile of gold soveriegns might but the reality is that there wouldn’t be enough to create a reasonable market for exchange. Now a nice veggie garden is more of a goer in times of monetary distress. This is where NZ has a major comparative advantage. Nearly everyone has a patch of dirt in which to grow stuff.

Our central banks have a lot to answer for but promoting home grown veggies is one good thing to come out of this debacle.

The P2P phenomenon which started with online communities and has now spread to lending money, couch surfing and music swapping has another possible application: currency exchange.

The reason I mention this is because of the highway robbery some currency exchange outlets are carrying out. To give you an example:

Last week I took a trip to Sydney. I bought some A$ at Christchurch airport through the BNZ. Their rates are always very good usually a spread of around 2-2.5%. Now that’s still pretty big but remember these rates are change maybe once a day max and the markets can be moving as much as that. I bought some US$ at 0.7929 knowing the market was actually trading at 0.7945 so i was getting an almost at market rate.

But when I arrived in Sydney I checked out the rates available at Travelex. These guys are offering outrageous prices (unfortunately they are at Auckland airport also).

Their spreads on A$ to NZ$, US$ and GBP were 20%, 15.6% and 22.4%.

Who are these guys kidding. In market vernacular I could drive a bus through that spread (more like a fleet of them).

So what to do? Well we have P2P lending now established in many commonwealth countries. So how about extending that to provide a currency service within the new distributed network.

It’s food for thought.

The G7 communique from the current meeting makes for interesting reading. Their focus has been wide ranging and, for a change, not just on currencies though the headline statement does make a clear reference to recent moves.

What I took note of was their concerns around bank capital. This is really where the crunch point is located. They call for the Basel Committee to review liquidity risk management guidelines and a quick disclosure of write downs ands revaluations (or in reality devaluations).

The accounting for off balance sheet items was also raised, particularly the valuation of assets in a time of financial stress. That should cause palpitations amongst traders of credit default swaps. Quite frankly some of this stuff can only be valued when its traded. The idea that there is some kind of two way market is really a myth. That in itself should make regulators, as well as bank shareholders, sit up and think about some of the toxic trades sitting around on the books.

They also call for a speedy implementation of Basel II. I think they should tear up Basel II and move straight onto Basel III but more on that another time.

They realise the game is up and the time has come for a thorough overhaul of the system itself. It will be interesting to see how this plays out as more and more unwinding takes place. As far as currencies go, China was gently reminded to hurry up and revalue the Yuan and the market was reminded that G7 wasn’t happy about some of the moves we had in March.  Whether that helps the $ is anyone’s guess but they better have an intervention plan up their sleeves before the $ takes another big dump.

The markets had a nice rally but reality is never too far away in markets and the last couple of weeks may have just been a pause for thought.

After a chaotic few days the market has calmed as it awaits the next round of soothing medicine from the Fed. 100bps is expected now and anything less could see a major sell 0ff. So perhaps its time to recap on what’s happened:

- Global expansion of the money supply by the banking system abetted by loose regulation.

- Financial assets treated as investments.

- Trading on a leverage basis whether in the markets or in property.

- Reliance on capital gain to pay off debts.

- Creation of an asset bubble in property and stocks.

- New financial products promising spectacular gains.

A quick recap:

- Asset prices can go no higher as the mathematics of compound interest and cashflow catches up.

- The first domino falls as the sub-prime market starts to fall.

- Property finally turns and heads south in the US.

- Debts over run equity in houses.

- Spirals into derivative products causing a more widespread reaction.

- First reaction from Fed.

- Banks start to revalue (mark to market) loans.

- First run on a bank: Northern Rock fails.

- UK nationalises Northern Rock.

- General deleveraging starts as contagion spreads.

- Banks review lending and fringe financing companies fail.

- Rogue traders appear.

- Central banks provide copious amounts of liquidity.

- Fed cuts rates heavily and provides open lending to all.

- $ collapses and commodities explode as safe haven.

- Second run on an investment bank: Bear Stearns fails.

- Fed sort of nationalises Bear Stearns but gives it to JP Morgan under guarantee.

- Financial system on the verge of complete collapse.

So what now?

Well the Fed has studied the 1930s depression very carefully and realises that systemic bank failure is simply not an option. Yes shareholders will lose most of their money but that’s the risk with equity. The lines of credit and liquidity must be kept open and depositors must be kept afloat. If necessary banks in trouble will be taken over or have to merge.

It’s safe to say they will do whatever it takes, regardless of the cost. The clean up can come later but for now this is mainly about preserving confidence in the system.

How it pans out is impossible to predict but i wouldn’t want to own any banking stocks.