Today the ECB has reduced its main refinancing rate (which is quivalent to the Fed funds rate)  by 75 percent points, the biggest amount in its short history. The Bank of England also cut its key rate by one percentage point to 2 percent and Sweden’s Riksbank lowered the same by the most since 1992. My attitude toward the ECB has been the same throughout this crisis. They’re more disciplined, because the financial state of the governments and citizens who they regulate is much better than that of their counterparts in the US. M. Trichet today showed some willingness to purchase some troubled paper directly, but whatever, and whenever this happens, its size and scope is likely to be far smaller than the Fed’s operations.

European Central Bank President Jean- Claude Trichet signaled he’s reluctant to cut interest rates so low that policy makers are “trapped” with few options to respond to a deepening recession.

“We have to beware of being trapped at nominal levels that would be much too low,” Trichet said at a press conference in Brussels today. The ECB earlier lowered its benchmark by three quarters of a percentage point to 2.5 percent, the biggest cut in its ten-year history.

Some of the ECB’s 21 policy makers have advocated a steady- hand approach to tackling the recession.

Council Split?

Luxembourg’s Yves Mersch told Luxembourg’s Tageblatt newspaper today that the bank is “entering calmer waters” with future rate changes more likely to be in the order of 25 basis points. Executive Board member Lorenzo Bini Smaghi said on Oct. 31 that “the present crisis is partially due to interest rates that remained at low levels for too long.”

“The council is split between those wanting to cut rates by only 50 basis points and those who wanted a more aggressive 100 basis-point cut,” said Juergen Michels, chief European economist at Citigroup Inc. in London. “So 75 basis points was a compromise and policy makers can keep their powder dry until February.”

Trichet said today’s decision was reached by “consensus,” and declined to divulge if there were calls for smaller or bigger cuts. ECB has reduced rates by 1.75 percentage points since October after the financial-market crisis intensified.

ECB forecasts published today show the euro-region economy will shrink about 0.5 percent next year, which would be its first full-year contraction since 1993. Inflation will average about 1.4 percent in 2009 and 1.8 percent in 2010, the new projections show, meeting the ECB’s price-stability goal of keeping the rate just below 2 percent.

“European policy makers, as we’ve seen in past global crises, continue to underestimate both the degree of the problem and their own part in its creation and solution,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in a Bloomberg Television interview. “I prayed that the ECB would do 100. At least they didn’t do 50.”

Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October.


While “global and euro-area demand are likely to be dampened for a protracted period of time,” lower commodity prices may support a gradual recovery from the second half of next year, Trichet said.

As well as cutting rates, the bank has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the ECB to purchase assets and securities outright, while declining to say if it would.

With those who don’t receive unemployment payouts included, the total joblessnumber is close to 6 million now:

The number of people on unemployment benefit rolls rose to 4.09 million in the week ended Nov. 22, the most since December 1982. A separate report showed orders at U.S. factories tumbled in October by the most in eight years as demand collapsed at home and abroad.

AT&T Inc., DuPont Co. and Viacom Inc. today announced plans to eliminate more than 15,000 jobs as consumer spending falters and the recession deepens.

Figures from the Commerce Department showed factory orders dropped 5.1 percent, the biggest decline since July 2000. Excluding transportation gear, bookings decreased for a third consecutive month.

Fed Perspective

Dennis Lockhart, president of the Fed Bank of Atlanta, told a conference in New Orleans the economy was “in the midst of a long and very painful adjustment process.” Chicago Fed President Charles Evans, speaking in Dearborn, Michigan, said the U.S. faced a “very substantial downturn.”

Trending Up

The four-week moving average of initial claims, a less volatile measure, climbed to 524,500, the highest since 1982, from 518,250, today’s report showed.

The unemployment rate among people eligible for benefits, which tends to track the jobless rate, increased to 3.1 percent, the highest since 1992, from 3 percent. These data are reported with a one-week lag.

Forty-nine states and territories reported an increase in new claims, while 4 reported a decrease. The biggest increases were reported by California, Ohio and Michigan.

Longer Slump

What started as a housing slump has spread to manufacturing and services. The Institute for Supply Management’s factory index dropped last month to the lowest level since 1982, and its services gauge, which accounts for almost 90 percent of the economy, fell to the lowest level since records began in 1997.

Financial firms are among those making the biggest job cuts. JPMorgan Chase & Co., the largest U.S. bank by assets, said this week it will cut 9,200 jobs nationwide at Washington Mutual Inc. as it acquires the Seattle-based lender.

“We have seen a fairly significant dropoff in demand, starting in October,” Delta Airlines Inc. President Ed Bastian said on a Webcast of a Credit Suisse Group AG airline conference in New York this week. “The revenue environment is as cloudy as it’s ever been. We’ve never seen the level of demand destruction that some are forecasting for our business.”

Delta, the world’s largest carrier, said it will cut seating capacity by as much as 8 percent in 2009 and eliminate an unspecified number of jobs.

The SIV story is not entirely over yet, and Bloomberg today reports that the creditors of the failed SIV “Sigma” may not paid “in full or in part”. In other words, they may get zero cent(s) on the dollar…

Sigma, which held securities with a face value of $2 billion, according to Moody’s Investors Service, raised a total $306 million from a Dec. 2 auction as part of its liquidation, the SIV’s receivers Ernst & Young LLP said in a statement today. Sigma has $6.2 billion of secured debt outstanding, the receivers said.

“Short-term liabilities which fell due for payment after Oct. 23, 2008 will not be met either in full or in part out of these assets,” the statement said. The liquidation follows a judgment by the U.K. Court of Appeal and the receivers said their estimate may change should the case go before the House of Lords.

Sigma, created by London-based Gordian Knot Ltd., survived longer than other SIVs that defaulted after money markets shut down by borrowing from banks through collateralized loans known as repurchase agreements. Sigma stopped paying creditors at the end of September after failing margin calls, according to court documents.

Sigma pledged $25 billion of its assets to banks to cover $17.4 billion of borrowings, according to Moody’s, leaving just $2 billion of unencumbered assets to repay about $6 billion of outstanding bonds.

Senior creditors in Cheyne Finance Plc, the first SIV to collapse, recovered about 61 percent after the company was reorganized, according to an Aug. 12 statement.

Not only hedge funds suffer redemptios. Mutual funds are also facing something of a run by worried investors nowadays. One positive development is the return of investors to money market funds, which is for now preventing some investment grade companies from falling apart:

Investors fled from stock and bond mutual funds for the third straight month in November, removing $86.4 billion as signs of a worsening economy drove them out from all but the safest investments.

Shareholders removed $52 billion from stock funds and $34.4 billion from bond funds last month, said Conrad Gann, chief operating officer of TrimTabs Investment Research, citing preliminary data compiled by the Sausalito, California-based firm. While outflows were less than a record $111 billion in October, investors are still scared, he said.

“There’s still plenty of fear out there,” Gann said. “It’s more of a continuing drumbeat.”

Stock and bond mutual funds have lost $270 billion to investor withdrawals since September. Every bond-fund category has lost ground in 2008 except those that invest in U.S. Treasuries.

Cash has poured into money-market funds, considered the safest investments outside of bank deposits and government-backed bonds. Taxable money-market mutual fund assets surged to a record of $3.657 trillion in the week ended Dec. 2, according to IMoneyNet of Westborough, Massachusetts.

Drop Since May

Mutual funds had $9.6 trillion in assets as of Oct. 31, a 22 percent drop since May, according to data compiled by Washington, D.C.-based Investment Company Institute.

Merril Lynch says that oil may fall to $25 per barrel if China falls into a recession:

Crude oil fell below $44 a barrel to the lowest since January 2005 and gasoline dropped below $1 a gallon as the deepening recession in the U.S., Europe and Japan cuts fuel consumption.

Prices may dip below $25 a barrel next year if the recession spreads to China, Merrill Lynch & Co. said in a report today. “We’ve got the U.S, U.K., Europe and Japan all in recession for the first time since World War II, and the oil market is reacting,” said Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $5 billion energy-company bond portfolio.

Oil prices have tumbled 70 percent since reaching a record $147.27 on July 11.

 “There is no sign where it will stop,” said Tom Bentz, senior energy analyst at BNP Paribas in New York. “We are now looking at $41.15, which was the pre-Gulf-War high and after that at the $40 and $37 level.”

Oil reached a then-record $41.15 in October 10, 1990, when Iraqi troops were occupying Kuwait. The milestone held until May 2004. Prices were last below $40 a barrel in July 2004.

“A temporary drop below $25 a barrel is possible if the global recession extends to China and significant non-OPEC cuts are required,” Merrill commodity strategist Francisco Blanch said in today’s report. “In the short run, global oil-demand growth will likely take a further beating as banks continue to cut credit to consumers and corporations.”

OPEC oil ministers agreed on Oct. 24 in Vienna that the 11 members with quotas would cut supply by 1.5 million barrels a day starting in November.

“Prices won’t rebound until either the financial crisis is fixed or oil-market fundamentals tighten,” said Michael Lynch, president of Strategic Energy & Economic Research, in Winchester, Massachusetts. “We will have to see substantial inventory reductions and OPEC cuts.”


Russia is now likely to enter a prolonged period of hardship as the financial structure of the nation collapses under the impulse of falling commodity prices, and the heavy-handed ineptitude of the Medvedev-Putin administration.  These two appear to have believed that initiating a geopolitical gamble in the middle of a global economic crisis was a wise move, or rather, that they would be able to bully the economics of the country into submission, as they did with its people. Their scheming has failed. But I believe that the economic problems will make the government even more despotic, as they will attempt to prevent social disorder by instituting stricter controls on the country’s political and economic system, and its media. They certainly have the power to do so, and there doesn’t appear to be any alternative other than chaos, given the turbulent situation of this nation in almost every aspect.

In any case, the troubles of Russia are only a prelude to the next phase of this crisis which will severely test the resilience of emerging markets worldwide. Many of these nations owed their prospertity to the low risk-aversion of developed world investors, and as this source of funding evaporates, with global trade, and global economic activity slowing down significantly, and possibly contracting, the underlying inefficiencies and weaknesses of these nations will place them under very difficult conditions.

How much has changed in seven years! Many nations, such as Brazil, Argentina, and Turkey are ruled by individuals whose culture of governance has very little difference to that of their corrupt and bankrupt predecessors. I know for a fact that neither in Turkey, nor in Brazil the fundamental problems of the past years which used to cause periodical crashes and high inflation have been resolved. And the main characteristic of the leaders of all three nations is populism, not any particular management skill, nor understanding of the workings of the global economy. But the dreamy state of mind of investors in the developed world, their low home bias, and speculative herding, have allowed all these nations to live in false prosperity, often financed through borrowing, and supplemented through the boon of high commodity prices.

Now those bubbles are collapsing, and the return to reality will be very painful, I’m afraid.

Russia’s erratic stock market closures and the central bank’s policy of seeking to manage the ruble’s value are deepening the effects of the global crisis as the price of oil, the country’s biggest export earner, tumbles.

Slumping commodities prices, state-backed corporate probes and the war with Georgia have combined with frozen global capital markets to spook investors. The Micex Index is down more than 60 percent since Aug. 1 and holders of Russian assets have withdrawn about $158 billion, BNP Paribas SA estimates.

Goldman Sachs Group Inc. predicts the ruble may weaken 18 percent versus the central bank’s dollar-euro basket in the next 12 months as Bank Rossii continues to sell foreign-currency reserves to stave off the flight of capital.

“Russia has moved at least a decade away from becoming a real financial center,” says James Fenkner, managing partner at Red Star Asset Management in Moscow, which holds about $100 million in Russian stocks. “The government’s incompetence is making this crisis worse for anyone stuck on the Micex and RTS,” bourses.

The Micex closed and reopened for the 29th time since Sept. 16 today, having announced it would remain shut until after the weekend.

No Advert

Stocks have been further hurt after the government reopened an investigation into a 2006 mine flood at OAO Uralkali, Russia’s second biggest potash producer. The announcement on Nov. 7 knocked its shares down 10 percent and brought back memories of recent probes against steelmaker OAO Mechel and oil companies TNK-BP and Yukos, which made investors nervous about state interference in the country’s natural-resources industry.

Those cases contributed to “an environment that is not an advertisement for a country you want to place your money in. It’s the opposite,” said Andrew Bosomworth, who helps manage more than $50 billion of emerging market debt in Munich at PIMCO.

Compounding the economic woes, Bank Rossii let the ruble weaken 1 percent versus the basket on Nov. 11, a move that may spur capital flight. The central bank manages the currency against the basket to minimize the effect of currency swings on Russian exporters.

The devaluation was “clumsy,” and has “triggered a new speculative attack on the ruble,” analysts at Renaissance Capital including Kayta Malofeeva and Nikolay Podguzov said in report e-mailed today.

Oil Price

Oil’s fall is undermining the currency of the world’s biggest energy producer and it sends the $91.2 billion current- account surplus toward a deficit. Urals crude oil fell for a third day today, losing 1.8 percent to $48.80 per barrel, the lowest since January 2007 and more than $20 per barrel lower than the level needed to balance next year’s budget.

The $50 level, which Urals broke yesterday, is “psychologically important” and will increase pressure on the ruble, Chris Weafer, UralSib Financial Corp.’s chief strategist, said on Nov. 11.

“By opening the door 1 percent when nobody believes that’s the full magnitude of the fall, that just attracts speculators to short it,” said Bosomworth. “Anybody doubting before that it was going to weaken, they now know that it is going to weaken.”

The central bank should devalue the ruble in several, larger steps of as much as 7 percent, interspersed with occasional movements strengthening the currency to increase volatility and shake out speculators, the Renaissance Capital analysts wrote.

That could leave it as much as 20 percent lower against the dollar at 32 by the end of the year and would make speculative bets on the ruble dropping further “minimal,” they said.


To be sure, an overly aggressive devaluation could panic a population still smarting from the ruble’s 71 percent devaluation against the dollar in 1998.

Russians have purchased more than $3.4 billion of foreign cash in September, or almost twice as much as they bought per month throughout the year, Alfa Bank said today, citing the central bank’s figures.

Any sharp devaluation may exacerbate that trend, Anna Zadornova, an economist in London at Goldman Sachs, wrote in a note today.

“The central bank of Russia is wary to allow a large step devaluation, fearing that it could encourage capital flight and increase uncertainty about the economic stability in the population,” she said.

RBC Capital has a new target for the century-old Nortel Networks; it’s zero, predicting that Nortel will go bankrupt. It is by now a story with which we’re becoming more familiar by the day:

Nortel Networks Corp., North America’s largest maker of telephone equipment, may go bankrupt by 2011 without a cash injection from the government or financial backers, RBC Capital Markets said.

The company is “overwhelmed with debt and burning cash,” Mark Sue, an RBC analyst in New York, said today in a note. He cut his price target on the stock to $0 from $1.50.

Nortel, founded more than a century ago, has lost about 95 percent of its market value this year as customers reined in spending and switched to newer technology from Cisco Systems Inc. Nortel may be forced to sell its Metro Ethernet unit, used to deliver Internet, TV and telephone service, at a fraction of the intended price, RBC said.

“Assets sales couldn’t have come at a worse time,” Sue said. “The world moved on while Nortel was stuck in restructuring mode.”

The company may finish 2009 with $1.6 billion in cash, about the amount it needs to run its business for 12 months, Sue said. Nortel has $1 billion of debt due in 2011.

Nortel’s U.S. stock reached a split-adjusted high of almost $900 in 2000.

Bonds Fall

This week, Nortel announced plans to cut 1,300 jobs. Chief Executive Officer Mike Zafirovski has eliminated 18 percent of the workforce since taking over three years ago. Nortel has lost $3.66 billion so far this year.

The problems of hedge funds keep growing. I think that it’s a simple fact of economic cycles that there are times when one shouldn’t borrow, and isn’t this one of those times? Is a leveraged model feasible in this environment? Does the risk-reward paradigm suit the expectations of a prudent investor? The answer to these questions, obviously, is no. But hedge funds don’t seem so worried about all these for now, and it seems, despite being burned many times already, they are still willing to gamble. Greed is good, but only when tempered by fear. These people have little fear, because the money they gamble with is not their own. (Update: Hedge funds are now much more cautious about what they do)

Fortress Investment Group LLC’s hedge-fund clients have asked to pull more than $4.5 billion, or 25 percent of their money, over the next few months as the company reported its first quarterly loss since going public.

The redemption requests poured in as Fortress’s Drawbridge Global Macro funds lost 13.5 percent this year through Sept. 30 and its Special Opportunities funds declined as much as 7.2 percent, the New York-based company said in a statement today. Hedge funds fell an average of 11.6 percent in the same period, according to the HFRX Global Hedge Fund Index.

The worst financial crisis since the 1930s is battering Fortress’s primary businesses of taking companies private and running hedge funds. The company was forced to write down $50 million of private-equity holdings. Investors withdrew an estimated $60 billion from the $1.7 trillion hedge-fund industry in October, Singapore-based Eurekahedge Pte said today.

“The problems at Fortress have shifted from private equity to hedge funds,” said Jackson Turner, an analyst at Argus Research in New York. Turner, who anticipated hedge-fund redemptions of less than 10 percent, recommends investors sell Fortress shares. “Investors have lost faith in the franchise.” .


Fortress said it received $2.6 billion in withdrawal requests payable through the end of January for its liquid hedge funds, which manage $9.1 billion in assets between the Drawbridge Global Funds and the Fortress Commodities Fund.

Investors asked to pull $1.9 billion, effective Dec. 31, from its hybrid hedge funds. The Drawbridge Special Opportunities Funds and Fortress Partners Funds managed $8.2 billion as of Sept. 30. Those redemptions will be paid out over time as investments are liquidated, the company said.

Revenue Falls

Revenue dropped by 25 percent to $185.1 million. The company reported a net loss of $57.4 million, or 66 cents a share, wider than a loss of $37.6 million, or 52 cents a share a year ago. That included $298 million in compensation to the firm’s founders tied to the IPO. Fortress expects net losses for the next three and a half years because of the payments.

Earlier this week, Sparx, Asia’s biggest hedge-fund manager, with $8.5 billion in assets, posted a first-half loss on redemptions and falling stock prices. Its assets under management on a preliminary basis were 839.1 billion yen ($8.8 billion) as of Oct. 31, compared with a peak of 2 trillion yen in August 2006.

Fortress joins rivals Blackstone Group LP and KKR & Co. LP in cutting the value of assets to match a global decline in prices. Blackstone, the world’s largest private-equity firm, posted the biggest quarterly loss in 18 months as a public company on Nov. 6 as the financial crisis eroded the value of the businesses and real estate it has acquired.

Fortress said in September it wouldn’t pay a third-quarter dividend to shareholders, saying the money can be better spent by investing in financial companies.

And there’s ever more trouble with commercial real estate. Naturally the vicious cycle of tightening standards, more defaults, and more tightening will continue, until life is sucked out of the economic system, and the remaining core offers a very positive risk profile to lenders, or rather what will remain of them. Bankruptcies are the only solution to the gigantic crisis that we are going through.  

CIT Group Inc., the largest independent U.S. commercial lender, applied to become a bank holding company and requested an investment from the U.S. Treasury after six straight quarterly losses drained capital.

CIT joins American Express Co. Goldman Sachs, and Morgan Stanley in seeking to reorganize as a bank.

CIT may need cash after $2.9 billion in net losses since the second quarter of last year. Chief Executive Officer Jeffrey Peek is making fewer loans, tightening lending standards and raising borrowing costs for customers amid the worldwide credit crisis.

From Haaretz, 14th September:

                  “Despite reservations in Washington regarding a possible
                  Israeli strike on Iran, the American administration will
                  supply Israel with sophisticated weapons for heavily fortified
                  targets, the U.S. administration announced.

                  The U.S. Department of Defense announced it would sell the
                  Israel Air Force 1,000 new smart bombs, rumored to
                  significantly enhance the IAF’s military capabilities. The
                  deal was approved amid public and secret messages from
                  Washington, with the Americans expressing their reservations
                  about a possible Israeli strike against the Islamic Republic’s
                  suspected nuclear sites.

                  The Pentagon’s announcement, which came on Friday, said the
                  U.S. will provide Israel with 1,000 units of Guided Bomb
                  Unit-39 (GBU-39) – a special weapon developed for penetrating
                  fortified facilities located deep underground.

                  The $77 million shipment, which includes launchers and
                  appurtenances, will allow the IAF to hit many more bunkers
                  than currently possible. Although each bomb weighs 113
                  kilograms, its penetration capabilities equal those of a one
                  ton bomb, according to professional literature.

                  Most U.S. Air Force aircraft are able to carry a pack of four
                  of these bombs in place of a single one-ton bomb. The bomb’s
                  small size allows a single-strike aircraft to carry more of
                  the munitions than is possible utilizing currently available
                  bomb units, thus increasing firepower, or, alternatively,
                  allowing the aircraft to fly longer distances to deliver a
                  single bomb.

                  During demonstrations, the GBU-39 – labeled by the
                  manufacturer, Boeing, as a Small Diameter Bomb (SDB) – has
                  successfully penetrated more than 1.8 meters of thick
                  reinforced concrete with a 23-kilogram warhead. The GPS-guided
                  weapon is said to have a 50-percent probability of hitting its
                  intended target within 5-8 meters, which should minimize
                  collateral damage.

                  The estimated value for the bomb’s GPS version, which military
                  experts have called the latest development in the
                  bunker-buster line, is around $70,000 to $90,000 for each
                  individual bomb.

                  The U.S. has already supplied Israel with earlier versions of
                  bunker busters. In 2005, the Pentagon authorized the sale of
                  GBU-28 to Israel, in a move that commentators construed as a
                  hinted threat aimed at Iran. Haaretz reported earlier this
                  month that the U.S. was hesitant about selling Israel heavier

With the leadership vacuum in Israel now eliminated by the election of Tzipi Livni, one wonders what the meaning of this development is. There was lots of speculation that the administration’s refusal to sell these munitions was a sign of their unwillingness to support military action against Iran. Why have they changed their decision? Did Israel give the US any assurance that they will not use these munitions for a surprise attack? Or is the administration finally conceding that it’s not possible to restrain Iran when Russia is threatening to veto any meaningful sanctions? We can only speculate, but the developments deserve attention.

The dollar is rising, and while reappraisal of the global economy may lead to further strength for the dollar in the coming 6-12 months, it’s important that we put the macro picture into perspective when analysing the direction in the forex markets.


When there is no excessive divergence in interest rates or central bank policies, one should expect currencies to perform according to the underlying fundamental strength of the respective economies.


Such is the case between Europe and the US, where the rate differential is too small to override macroeconomic concerns. Since the introduction of the Euro, and except for a brief period during the global stock market bubble, the behaviour of the euro-dollar pair has beem based on fundamentals. The overextended finances of both the public and private sectors in the US contrasts unfavorably with the balanced current account situation of Europe, the relatively less leverage of its citizens, and the much better fiscal discipline of the governments. Until recently even Spain’s government could boast of a singnificant fiscal surplus, and on the whole the stringent requirements of the euro area treaties, and continuous urging by the ECB for fiscal responsibility allowed Europe better fundamentals than those of the overextended, overleveraged US. There’s, in short, every reason to be negative on the dollar versus the euro, based on the fundamentals of the two economies: The dollar is just another word for leverage and indiscipline.


When the Fed began reducing rates in September 2007, in spite of external financing concerns, and fears of inflation, investors and speculators around the world reacted by buying commodities and selling dollars, partly in anticipation of decoupling, and partly to profit from the dollar-negative momentum. And they were justified in their pessimism for the US dollar, except for one difficulty:


The USD is the world’s currency for trade: it’s supply will be ample during times of increased economic activity, as the supply of USD from exporters to the US, and also from global players such as hedge funds and mutual funds widely exceed the USD demand for imports such as oil, copper, and finished goods. Thus, as greed, and the quest for yield cause ever greater amounts of US dollars to be exchanged for other currencies, the buoyancy of the global economy will also draw down the value of the dollar, especially when the medium term fundamentals of the US economy are as weak as detailed in the previous paragraph.


When however, the opposite happens, and global demand contracts, as the growth of demand for commodities, the volume of international trade is in danger of declining, there will be less circulation of the dollar, and the currency of international trade will also see increasing demand, just as the supply of dollars from international economic actors contracts as a result of the same reasons: the prospect of weaker economic activity will cause repatriation flows, extracting dollars from the global financial system, and in the worst cases, as we’re witnessing now, a shortage of the US currency.


This then explains why the discrepancy between the value of oil and the euro versus the dollar created an arbitrage opportunity, provided that the investor sees them as different faces of the same investment paradigm. Indeed until recently the fluctuations of euro-dollar parity, and the oil price showed a close correlation even of intraday movements. It was only natural that one would follow the other.


Now, if rising dollar means less global economic activity, at a time when internal demand in the US is likely to shrink as a consequence of deleveraging, and rising unemployment, then how do we explain the recent rise in stock prices? Rising dollar and rising yen are the hallmarks of pessimism and fear; if US and Japanese investors are withdrawing funds from overseas, putting it in bonds and cash, is it possible to interprete this phenomenon as being positive for financial markets?


While the disinflationary effect of the rising dollar is welcome, one must remember that even before the recent turmoil, there were significant inflationary pressures in the world economy. The era of cheap Chinese labour is already over – inflation is now a structural problem, not a temporary one.


We’re likely to see continued falls in the stock markets in the next few weeks, and months.