Wednesday, June 18, 2014

What Events Could Lead to a Crisis?

With IMF reforms stalled and major monetary system change seemingly "a long way off" as Paul Volkcer recently said in his speech to the Bretton Woods Committee, we have noted that it would take a major global crisis to spark change more quickly. What are some events are out there that we should keep an eye on?

We will list a few that are in the news right now that have potential to lead to global financial crisis (but have not so far).

1- The situation in the Ukraine - this has just been a regional issue thus far and the sanctions issued have not had any major impact. But there is still potential lurking here for things to escalate. See this article in Voice of Russia with a couple of quotes from it below.

"Sergey Glazyev, the economic aide of Vladimir Putin, published an article outlining a plan for "undermining the economic strength of the US" in order to force Washington to stop the civil war in Ukraine. Glazyev believes that the only way of making the US give up its plans on starting a new cold war is to crash the dollar system."

"Glazyev's set of countermeasures specifically targets the core strength of the US war machine, i.e. the Fed's printing press. Putin's advisor proposes the creation of a "broad anti-dollar alliance" of countries willing and able to drop the dollar from their international trade. Members of the alliance would also refrain from keeping the currency reserves in dollar-denominated instruments. Glazyev advocates treating positions in dollar-denominated instruments like holdings of junk securities and believes that regulators should require full collateralization of such holdings. An anti-dollar coalition would be the first step for the creation of an anti-war coalition that can help stop the US' aggression."

Of course we know the above is already underway around the world now on a slow and steady pace. But here Russia seems to want to ramp up things so we should watch that.

2- Civil War in Iraq - Again this is a regional issue right now. But if it were to expand and threaten energy supplies in the Middle East, that could be significant. Already oil prices have reacted. A sharp rise in oil like Jim Rickards mentioned on CNBC the other day to $200 could easily trigger derivatives problems on a global scale. For that matter any event which could set off a derivatives problem could become a trigger (sharp rise in interest rates for example).


Along with the above we have a couple of items related to Central Banks that hint that things may not be as well off as we are told.

First we have the ECB implementing a new policy to actually impose negative interest rates. Christine Lagarde at the IMF has continued to warn that deflation is a concern for the EU area. This historic action taken by the ECB makes it pretty clear there is deep concern over deflation. For now it is viewed as just a minor adjustment by the ECB, but it may be a hint that bigger trouble is ahead. We need to keep an eye on it.

Next we have the US FED announcing they are looking at imposing exit fees on bond funds. Now this is interesting. This CNBC article says this about it:

"Federal Reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors, underlining concern about the vulnerability of the $10 trillion corporate bond market."

"Officials are concerned that bond funds are becoming "shadow banks", because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter."

Obviously, you would not consider exit fees if you were not concerned about a "run by investors" or how hard bonds might be to "sell in a crisis". And your concern obviously makes it clear that you consider such a crisis a possibility. If you didn't think it was possible, you wouldn't be concerned about it.

So we have plenty of potential triggers around the world that could lead to sudden crisis. Because the global financial system is highly interconnected and loaded with enormous derivative positions, a "black swan" event setting things off is always possible.

Right now things seem fairly calm and conflicts appear to be regional (even as major powers lurk in the background). But things can change quickly at any time. So we should stay informed and watchful. We will do our best to do so.

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