The global financial markets are going through a spasm. Emerging markets, long the flavour of the month as poor countries got richer, have seen money flow out of their economies at historical rates.
Russia’s currency is in free-fall and there’s very little that the Russian authorities can do about it, proving that these days it is easier to invade Ukraine than to defend the Rouble.
The price of oil is collapsing, so too is the price of coal, steel and copper.
But what is happening in global financial markets right now, and how will it affect you? Is it something far away that you need not worry about? Or is it something that will affect all of us in 2015?
To understand what is happening, you have to appreciate the extent to which financial markets panic, regularly. Once there is leverage, once traders borrow someone else’s money to buy stuff, there will always be the potential for panic.
This panic can become self-propelling where the panic itself makes the panic legitimate. As things get more fragile, good assets are sold to pay for the losses incurred in bad assets and the selling can become widespread.
The contagious nature of financial markets became clear to me many years ago – in 1997 to be precise – when I worked in the financial markets.
In October 1997, I pulled up a chair in the enormous foyer of the Grand Hyatt overlooking the harbour in Hong Kong.
There was a good view of the Star ferry as it shuttled thousands of workers to and from Kowloon.
The investor I was meeting explained that he was busy selling his assets in Russia and Eastern Europe because of the events in Asia. This puzzled me. I’d thought Russia did little trade with the Asian Tigers. Why would the crisis in Asia affect it?
The answer lay in the dynamics of financial globalisation, which I, an economist in a global bank, had not yet fully grasped.
Many investment banks have proprietary trading desks. These desks use bank depositors’ money to gamble on the markets. Their objective is to dramatically increase the return on the bank’s money.
In order to have some level of security, each bank sets a limit on the trading desk: the amount of the bank’s capital that can be put at risk. The bank I was working for, BNP, was using French deposits to speculate in Asia and Russia. Many traders, who believe themselves to be infallible, view such limits as a nuisance that restricts their genius and become adept at finding ways to circumvent them.
Trading desks can also leverage the bank’s reputation to get additional credit facilities from other banks.
The trader using other banks’ money in this way will normally be required to lodge a deposit of perhaps 10pc of the value of the investment with the bank from which he’s borrowing. This deposit is known as the ‘margin’. So let’s say the bank lends him €1,000: this gives him €900 of a stock, over which the bank has a charge; and he deposits €100 at the bank. As long as the end-day position equals the €1,000 lent, everything is fine.
What happens if the value of the stock falls to €800? This triggers a margin call: the margin between the value of the shares and the value of the loan has grown, and the trader now has to make up the difference by adding another €100 in cash to the €100 already on deposit.
The trader now probably has to sell something in his portfolio to get the cash to pay the margin call. This, in microcosm, is contagion: it illustrates the way a crisis in one market can provoke selling in another, perhaps entirely unconnected, market. One trader selling one asset to make one margin call is no big deal; but when a crisis causes heavy falls in asset prices in a certain area, and when the markets are dominated by heavily leveraged traders operating in a wide range of sectors, it’s not hard to see how a panic in Thailand can spread across Asia and thence to faraway places like Russia.
This is what causes small crises to blow up into much bigger ones – and it is why the financial world has become less stable in the era of globalisation and easy credit.
When asset prices are rising, everything is fine. But when asset prices are falling, everyone suddenly needs cash to pay for the margin calls coming at them from all angles. Banks find themselves forced into the interbank market by the need to borrow from each other, in the hope of shoring up their balance sheets.
If central banks don’t step in and inject as much liquidity as possible, a short-term cash-flow problem rapidly becomes a credit crunch.
In the foyer of the Hong Kong hotel that day, the trader’s position had nothing to do with economics, trade, investment, the stuff you learn in textbooks.
The arithmetic of the trader’s position was simple: he had just lost money in Indonesia, so he had to raise it elsewhere to cover his losses.
This was a classic ‘Minsky moment’ – the moment when investors must sell assets to cover their obligations – and it was being played out here in the vertiginous lobby of the Grand Hyatt in Hong Kong.
The same thing is happening now in various corners of the globe, in banks, hotels and other financial institutions.
Billions of euros, dollars or sterling of borrowed money has been used to gamble on assets in the past five years. As central banks cut interest rates and made cheap money available to boost growth, the financial markets used this money to place bets on oil, commodities and IOUs from governments.
As these leveraged bets turn sour, the traders have to sell good assets to shore up cash losses on bad assets.
Already developed markets in Europe and the United Kingdom are wobbling. If this goes on it will have a material impact on our economy.
Also, the impact of a deeply unstable Russia for both the Ukraine and for European business confidence is obvious.
That’s the nature of contagion; you never know where it will stop.
Good morning all in wind and rain swept.
Yes margin calls are in the billions and trillions. Leverage is in the 100’s not tens to one and the markets are all deranged and not working anymore.
Cental banks create all the extra reserves all right but every bit is an added debt thus adding to the “contagion”. We are going down big time and most economists will “not see it coming”
Perhaps it’s a good time to put our pensions into cash for a few months, just until it blows over.
Buy land and solid assets with no debt. Interest rates will spike as the currencies fail> See Russia at 17%.
This article is a statement of the bleedin’ obvious. The disturbing bit is that David got a degree in economics and a job with a global bank without understanding all this. No wonder economists get things wrong so often – they’re not taught the basics!
What’s interesting is that this broad fall in asset prices implies that there’s been a significant fall in demand for the the assets, which implies that there is already a very significant global slowdown in demand for the goods that the assets are used for.
This seems to contradict the ‘recovery’ and ‘interest rate tightening’ stories.
The consensus across the handful of credible and independent commentators that I subscribe to is 2015 will be the year of the ‘great collapse’. Which particular ‘snowflake’ causes that inevitable ‘avalanche’ is the remaining question open to speculation.
My stamp collection
I am holding WW2 Postal Stamp marked Deutschland Reich DM 5million
Part of my hoard collected when I was 7/8 years old .
Cigarette buts were more valuable then
CAD is a commodity currency and is currently falling
Hi all, Since we are approaching Christmas and especially with all that has been happening in Russia there has never been a better time to revisit the story of the Nativity. No one has ever asked the obvious; Why was Mary when so heavily pregnant wandering around in the middle of the desert in the middle of the night in the middle of winter on the back of a donkey? Ans; Joseph was talking the two of them to complete a census call by the casear who needed to catch more citizens in his tax net after blowing a whole… Read more »
Disappointing to see David goes along with the fiction or lie that Russia is invading Ukraine. If Russia was invading Ukraine there would be no Ukraine today. This myth is so clearly an illogical and impossible fiction and a lie that I am appalled David has swallowed it. In fact it is the USA and the EU and NATO that is invading Ukraine; and is tearing that country apart as a consequence. The USA and the EU and NATO have determined to take Ukraine away from the Russian sphere and have designated any Ukrainians who do not want or accept… Read more »
For me, the interesting thing with the financial markets is that it seems to be full of people who try to make money by understanding the real economy. They get this wrong and then the effect is that they damage the real economy. There is a couple of things about primary commodity prices that are accepted by economists. One is that exporters of these commodities are faced with issues around the terms of trade. These are usually the developing countries. Low relative income elasticity of demand against manufactured goods is a problem. Also a low price elasticity of demand. So… Read more »
“”Look at it this way, the U.S. (the West) is facing the greatest potential margin call of all time. The entire system is a margin call waiting to happen. Less than 50% of the population supports a majority of the population. Some ungodly number of people in the U.S. live paycheck to paycheck and have no savings whatsoever. Real estate is completely levered, banks and brokers levered with all sorts of derivatives. State and local government finances are in disarray while the federal government is in debt beyond 100% of GDP …with admitted debt, 10 times over with future obligations.… Read more »
http://www.alt-market.com/articles/2444-imf-now-ready-to-slam-the-door-on-the-us-and-the-dollar
MF Now Ready To Slam The Door On The U.S. And The Dollar
Wednesday, 17 December 2014 06:29 Brandon Smith
May the housing boom continue!!!! Ireland: Irish central bank urged to ease mortgage restrictions: The FT reported that think-tank Economic and Social Research Institute was the latest and most influential critic of the central bank’s move to curb a mini house price bubble. It noted that the central bank said in October it would introduce macroprudential measures to cap the size of a mortgage to 3.5 times a borrowers’ income and up to 80% of the value of the property. The results are due to take effect from 1-Jan, but the central bank had indicated that it may delay the… Read more »
David is right in that margin calls act as a brake on the markets but it only applies to a small section of the market. Most of the activity now takes place in the derivatives market where the concept of margin call does not apply. This is why Warren Buffet called them weapons of mass destruction. Until the markets find a way of reining in derivatives we will remain in the shadow of a financial mushroom cloud.
David,
I remember once before when you told us that you do not write the headline for the article. That is provided by the newspaper editorial team.
In this particular situation, the headline is completely in contradiction to the article.
I am losing any remaining confidence in the Irish media, as I write this.
Money makes the instructions in our world. And this has been particularly the since sine Reagan and Thatcher ponzified the economic system in their countries.
Surely the central bankers in Tokyo must be looking on this with massive envy. The BoJ has been trying for years to depreciate the value of the Japanese currency, and cannot do it. Even Venezuela can do something that seems to be beyond the capability of the Japanese authorities.
[ written with a plentiful supply of irony ].
Here is the defense of the Ruble.
Best form of defense is to attack.
Russia can destroy NATO without firing a shot.
http://kingworldnews.com/paul-craig-roberts-russia-unleash-ultimate-black-swan-west/
US AND Saudis play Russian roulette with the oil derivative daisy chain.
http://ellenbrown.com/2014/12/19/russian-roulette-taxpayers-could-be-on-the-hook-for-trillions-in-oil-derivatives/
Tony check out Nassim Nicholas Taleb a Quant and former Wall Street trader. His risk management strategy is to hedge against a “black swan event” which is a totally unpredictable event(to rational minds) like 9/11 or the oil price collapsing. Anyone who has sold oil options without balanced hedging is facing wipeout. It’s this simple. You’re in a lottery syndicate that pools 100 Euro every week. You trust one person in the group to buy the tickets for each draw and hand over the cash. They calculate the odds and decide to trouser the cash instead of buying the ticket.… Read more »
Tony check out Nassim Nicholas Taleb a Quant and former Wall Street trader. His risk management strategy is to hedge against a “black swan event” which is a totally unpredictable event(to rational minds) like 9/11 or the oil price collapsing. Anyone who has sold oil options without balanced hedging is facing wipeout. It’s this simple. You’re in a lottery syndicate that pools 100 Euro every week. You trust one person in the group to buy the tickets for each draw and hand over the cash. They calculate the odds and decide to trouser the cash instead of buying the ticket.… Read more »
http://investmentresearchdynamics.com/can-we-believe-anything-coming-from-the-u-s-government/
http://www.telegraph.co.uk/finance/comment/11305686/Volatile-Russia-could-be-bad-news-for-everyone.html
EU destroys personal choice and insists you have no rights to do as you wish. Food cannot be labeled as GM. Local government cannot stop GM food production. All gm crops are sprayed with herbicide. That is the reason they are modified, to resist the herbicide. That means all food will contain residue of the herbicide. Crops eaten by animals will contaminate the flesh. In turn the eaters of that flesh will be contaminated, or poisoned. Glycophate is the poison and known as Roundup. The diseases and illnesses attributed to Roundup are legion. Humanity is being steadily poisoned, disabled and… Read more »
I appreciate the symbolic value of gold but it doesn’t heat homes, or fuel planes trains and cars. In relation to markets being manipulated something is definitely amiss. Governments would normally use the fall in fuel prices as an opportunity to ramp up taxation levels on petrol and diesel and they haven’t. The price of gold and oil is usually the canary in the coalmine in relation to world events and it’s heading South. Given the tensions in the world the normal reaction would be for gold and oil to spike upwards.Strange times.
“Why it’s easier to invade Ukraine than defend the Rouble!”
Since it’s unlikely that the USA would want to defend the Rouble e -easy or otherwise -you then must mean that Russia intends to invade “the Ukraine“instead of saving the Rouble.
I just can’t see Russia invading “the Ukraine” – easy or otherwise…I expect they will “defend” the Rouble against this economic war perpetrated by “the west”
Hello! Thank you for your article. I’d like to try to compare it to my previous experience of learning Ukrainian through Skype on online classes. I did around ten conversations over Skype with a native speaker from http://preply.com/en/ukrainian-by-skype. And I was pretty satisfied with their Quality. I think they have a strong teaching quality, practicing their course curriculum now I can speak Ukrainian easily like a native they also provide personal tutors, but I Want to try another option.