Worried over H1N1 swine flu? Forget about it (at least for now). A new epidemic, P1N1 Forex Flu, is sweeping the globe as you read this. Symptoms are breaking out all over the place. It's hard to say who will be infected next.
And what does "P1N1" stand for, you ask? It's a little term your editor has coined from his outpost here at CDC headquarters (the Center for Delusion Control).
The P stands for "paper." N stands for "Null Value." Symptoms include a knee-jerk embrace of debt and toxic assets... a compulsive tendency to babble nonsense phrases like "government-created jobs" and "inflation is contained"... and, most alarmingly, heaving convulsions of excess bank reserves.
Your central banking system may already be infected. It's a particularly virulent strain.
Origins Unknown
Origins of the fiscally deadly P1N1 are more or less unknown. Some trace the bug back to a charmingly promiscuous economist named John Maynard Keynes. Others believe the DNA signature of Forex Flu to be much, much older, dating all the way back to coin clippers of ancient Roman times.
The connection at this time is hard to verify, but we do have evidence that Keynes is responsible (at the very least) for a new and aggressive mutation of P1N1. As Keynes' ideas spread in years past, so too did early hints of infection. (A truly noxious trait of P1N1 is the way it can go dormant, appearing to be in remission for decades at a time.)
This remission is only an illusion though. After a long period of dormancy, the outbreaks wind up being that much stronger...
"Patient Zero"
One thing we do know for certain is that, as official printer of the world's reserve currency, the U.S. Federal Reserve is "Patient Zero."
Thanks to its love of travel and gregarious nature, the $USD has proven to be the most effective "carrier" (transmission device) the world has ever seen. Malaria-bearing mosquitoes have nothing on the greenback.
The nature of P1N1 is widely misunderstood though. While many have recognized that the U.S. central banking system (and thus the dollar) is sick, they fail to see the manner in which P1N1 makes
other currencies sick. The transmission works something like this:
• "Patient Zero" (the United States) floods a country's banking system with paper U.S. dollars.
• As U.S. customers buy "stuff" with dollars, the sellers of "stuff"--exporters and the like--then deposit the dollars in their local bank accounts, changing them over to local currency in the process.
• The central bank receiving the flood of fresh dollars (via the local banks, who in turn forward them on) then has to print up local currency in order to soak up all the supply.
• If the receiving central bank does not do this--print more of its own currency to soak up incoming dollars that is--then the value of the local currency quickly rises, due to supply and demand mechanics. That, in turn, chokes off exports and angers the bankers' political masters.
• By this mechanism, the bad habits of "Patient Zero" are transmitted. Such habits further include an alarmingly relaxed attitude towards government stimulus, government intervention and government debt. (These latter symptoms are undoubtedly tied to the Keynesian strain.)
Exploding Debt Dynamics
As mentioned, P1N1 can go dormant for quite a long time. The critical stages, however, can be explosive. This pattern was most visible in Latin America in recent years, and spectacularly so in Zimbabwe.
Just as more traditional viruses work by shutting down the host's immune system, P1N1 attacks the host country's ability to finance growing levels of government debt.
As debt levels expand beyond a certain point, the realistic ability to repay that debt slowly recedes. At the terminal velocity stage--the point at which "exploding debt dynamics" well and truly kick in, to use an old IMF term--the heft of interest payments and the political pain of forced fiscal austerity become too much for the host country to bear.
The growing probability of debt default then mutates into a self-fulfilling prophecy, as creditors flee and local currency holders empty out their bank accounts. The debt problem thus "explodes," like a hapless scientist's chest in Ridley Scott's
Alien.
Others Getting Sicker
There has been a lot of table-pounding about the dollar in recent days. Some pundits--particularly one fellow who plans to run for Senate--have argued vociferously that the value of the U.S. dollar is about to fall straight to the center of the Earth.
From your humble editor's point of view, this relentless bearishness on the greenback is the result of a fundamental miscalculation. Such table-pounders do not understand the
transmission effects of P1N1.
Even though the $USD is the carrier, and the U.S. central banking system is "Patient Zero," America has a sort of built-in immune system defense (by virtue of its still unchallenged world reserve currency status).
What many dollar permabears thus do not realize is that, as a P1N1 carrier with a one-off immune system defense,
"Patient Zero" is making other patients even sicker.
"Patient Zero" is also stronger than average. Even now, the U.S. economy is large, powerful and diverse relative to most others. Again, the U.S. is the keeper of the world's reserve currency. Its government debt is the most desirable. It is home base for the most liquid capital markets in the world.
These superlatives may eventually slip away, but they have not done so yet. The above traits make the U.S. like a big, burly individual who can handle being sick better than others.
Think of the lumberjack with a hardy constitution who laughs at the prospect of a nasty cold. What happens when that cold is passed on to someone smaller... frailer... weaker? Perhaps the lumberjack shrugs and goes back to work--while the weaker individual finds himself in a hospital bed.
Countries like Iceland and Latvia have already learned this lesson the hard way...
Visible Signs of Outbreak
As you well know if you've been following along, the U.S. dollar surged recently. Perversely, "Patient Zero's" strength is an indicator of systemic weakness (as the other sick patients hack and cough).
In numerous other central banking systems, signs of Forex Flu "outbreak" are mounting rapidly. Consider the following catalogue of semi-alarming symptoms:
• JAPAN: Like the U.S., Japan has shown a remarkable resistance to P1N1 over an extended period of time. But with debt levels approaching 200% of GDP, Japan's seemingly infinite capacity for wealth destruction is close to hitting a wall. In honor of that sober realization, Japanese authorities have now decided to re-underscore Einstein's definition of insanity--doing the same thing over and over while expecting different results.
Japan has unveiled a new $81 billion "economic stimulus package" (Because the previous trillions worked so well, perhaps?) and at the end of last month previewed central bank plans to fire up a new "quantitative easing" (QE) program. Here comes the flood... again.
• GREECE: As a faltering member of the eurozone, Greece makes for an interesting test case. If it were a stand-alone country, though, the drachma (Greek currency unit prior to the euro) would be toast. Standard & Poor's, a major ratings agency, recently put Greek sovereign debt on "creditwatch negative," causing local bond and equity prices to plummet.
Adoption of the euro seems to have been something of a free pass for Greece... an excuse to load up on ever more leverage and debt over the years by way of borrowing sober Germany's credit rating. Now we get to see if this clear-cut example of exploding debt dynamics transfers P1N1 to the whole of Europe.
• VENEZUELA: As the WSJ reported, "Worries grew... that Venezuela is on the verge of a banking crisis, causing a run on smaller lenders, sinking the country's currency and bond prices, and stoking fears that president Hugo Ch√°vez could nationalize the banking system."
El Máximo Líder looked smug not all that long ago in his decision to issue U.S. dollar-denominated bonds. (Countries can and do go "short" the dollar by borrowing in greenbacks.) Now the fiery leftist just looks like a jackass as the bolivar craters and the cost of $USD repayments skyrocket. Other countries with significant $USD debt exposure could soon be forced to rein in their exchange-related losses too (by way of purchasing U.S. dollars).
• VIETNAM: The Asian tiger both raised interest rates and devalued its currency, in an effort to combat inflation and boost exports at the same time. This is a bit like stepping on the brake and the gas pedal simultaneously, but no one said central bank policy has to make sense. The hope is that things will cool off a bit at home even as a weaker dong (Vietnam's unit of exchange) keeps exports humming.
If we head into a period of post-stimulus economic slump in 2010, the P1N1 Forex Flu problem could grow markedly worse. Vietnam gives a hint as to why... in the event of meaningful further slowdown in exports, more countries will deliberately devalue their currencies--a sort of "race to the bottom"--in an effort to stay competitive.
• BRITAIN: If you haven't noticed in recent days, the value of the British pound is plummeting alongside the euro. "Britain may finally be emerging from recession," The New York Times reports, "but many analysts warn that it is a false dawn... the economy here is so ravaged by growing debts and ruined banks that it could well be following in the steps of Japan's lost decade of the 1990s."
As with the Yanks (Americans), the Brits most certainly do not want to "turn Japanese." This means ever greater willingness to fire up the printing press... "stimulate" in the name of government job creation... revisit "quantitative easing" as necessary... and all around embrace the full-blown effects of P1N1 Forex Flu in myriad other ways. "Sound as a Pound," once a phrase with credibility and meaning, has thus now become a sick joke.
• NORTH KOREA: Even the Hermit Kingdom, normally so isolated from the rest of the world, has somehow been gripped by P1N1 Forex Flu. "North Korea redenominated its currency for the first time in 50 years," the WSJ reports, "and limited how much old money could be traded for new, likely wiping out millions of residents' savings..."
What North Korea does blatantly, the West does surreptitiously. Printing up large amounts of paper currency is a form of theft by alternative means. There is no need to directly siphon grandma's savings account when the currency itself can be debased. (In the direct issuance of controls, the Kim Jong Il regime seems to have been making a political point.)
Preventative Measures
Such is the sickness of P1N1. Not only does it fill up the fiscal lungs (with debt), it creates a dangerous swelling in central bankers' brains. This swelling, in turn, leads to impossible visions and delusions of grandeur, stirring the belief that "
If only we do it BIGGER this time... if we just do MORE of the same... then perhaps we shall be saved!"
And how to guard against Forex Flu? Unfortunately, if your country catches it there is very little you can do. Be aware, though, that the cause-and-effect relationships of P1N1 Forex Flu are far from cut-and-dried. The U.S. dollar and the U.S. financial system are both very sick... but other systems show sign of being even sicker, at least for the interim. You may wish to take this into consideration (and invest and trade accordingly).
How to Protect Yourself Against this Forex Flu
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Adam Lass is the editor of Taipan Publishing Group’s WaveStrength Options Weekly and a contributing editor to Taipan Daily . He has written numerous articles and special investment reports for several major financial publications, including Taipan, Fleet Street Letter (US), Strategic Investment and Penny Stock Fortunes, on topics ranging from long-term market forecasting, crude oil pricing, and currency speculation to precious metals investing.
Adam appears on national television and radio, and has been quoted on The Wall Street Journal Web site. His last turn on CNBC’s Squawk Box on July 18, 2007 was marked by controversy when he predicted that the Dow would fall from 13,965 to below 8,000. He was never invited back.
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