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A Butterfly’s Hurricane?

Original post made by Tom Cushing on Oct 11, 2011

As the saying goes, when a butterfly flaps its wings in Thailand, the wind blows in Michigan. In other words, everything is connected to everything else in the natural world. The same holds true increasingly in the social and financial worlds of the 21st century.

Today's butterfly is a vote in the Slovakian National Council to approve or reject an expansion of the provisional plan to bail out several troubled European economies – Greece, Portugal, Spain and Ireland among them. How many of us have heard of Slovakia? Can name its capital? Find it on a map? Of Europe? A bit of digging reveals that it is a nation of some 5 million souls, most recently formed in 1993, and about the size of Vermont and New Hampshire, combined. It is a member of the EU and, crucially it turns out, the Eurozone currency union. (capital: Bratislava).

We need to care about Slovakia because jaws flapped and votes cast there will be felt on Wall Street. Everything is connected.
The Rube-Goldberg sequence begins with the fact that Slovakia's Council comprises 150 seats populated by several political parties -- a minor, 21-seat player in which holds the crucial votes needed to compose a majority. They are dubious on the bail-out. Eurozone members manage important elements of their finances in common, and each member has a veto over the expansion of the bailout fund. If the bailout plan is vetoed, then Greece, with a restive population unused to austerity measures imposed on it by others, might well default -- renouncing its debts, including those held by various major European banks. And as Greece goes, others may follow.

Still with me? While US banks have lent modestly to Greece, they have strong ties to those major European banks that ARE heavily exposed to a Greek default. Those ties are denominated in low trillions of dollars. Lots of zeros. If those Eurobanks fail, a strong breeze blows toward Wall Street.

It can get worse. Recall those too-clever derivatives and other shenanigan investment vehicles that brought us all to the brink in 2008 – leading to Bankbail 1? Wall Street has bets in various forms on such securities of European origin. We don't hear much about them in financial reports because, after all, they're "insured." But as we learned a few years back, insurance is only as good as the underwriter. The initials AIG ring a bell? If issuer stress collapses those markets, the breeze goes gale, and we may be looking at Bankbail 2: economic boogaloo.

Expansion of the Eurozone bailout fund can help contain the damage and its remedy mostly to the Continent, to be worked-out over time. That it all hangs on the slender whim of a libertarian minority party in a teenaged former Eastern bloc nation demonstrates that the interconnections of the global economy are terribly fragile, poorly understood, and woefully under-regulated.

Hang onto your hats.

Comments (3)

Posted by Harald A. Bailey, a resident of another community
on Oct 12, 2011 at 8:54 am

Great Start, Tom,

Now define the potential results of the China currency bill just passed in WDC? How will the balance of monetary values be impacted and what will be the final balance of values among world currencies? How will more expensive goods from China impact our domestic spending and our economy overall?

Hal


Posted by Tom Cushing, a resident of Danville
on Oct 12, 2011 at 12:55 pm

Harald: the floor is yours (and that really is a topic worth looking-at).

Please feel free to steal my thunder!


Posted by Hal, a resident of another community
on Oct 12, 2011 at 3:58 pm

Tom,

The Reuters, NYT and other coverage of this topic is exhaustive. Currency markets always find balance is the general point and any change in an individual currency will impact all other currencies. What is most unique in that discussion is the dollar as a global currency without role for its value in our domestic economy. The dollar in most of these articles simply finds its value in world markets and its use in global trade.

What hasn't been defined is how the global value of the dollar will change with any change in the value of China's currency and what will be the domestic result, and impact, of a change in the dollar's global value.

As you can see, I am searching for answers from reliable sources and cannot offer an opinion beyond there will be a change in the value of the dollar's buying power here at home and likely negative.

As that applies to your subject of considering Europe's impact, we can imagine multiple factions impacting the dollar in comparison to the Euro and other currencies.


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