In his latest GREED & Fear letter, CLSA’s gloomy Chris Wood discusses the ramifications of the Greek crisis on the global currency system.
Specifically, he sees a vicious demand for good ol’ US dollars if Greece defaults/restructures/whatever, and European banks holding the book must scramble for liquidity.
On this point, there was an interesting article by BIS Economic Adviser and Head of the Monetary and Economic Department, Stephen Cecchetti, published in June last year (“Current efforts to enhance global financial supervision”, 7-8 June 2010). The author noted that the financial crisis exposed currency mismatches “created on the balance sheets of non-US holders of the dollar-denominated assets” which were “financed by a combination of wholesale borrowing, where a non-US bank would simply borrow dollars from a bank that had them, and foreign exchange swap arrangements, where the bank would swap its domestic currency liabilities into dollars”.
The author also estimated that Canadian, Dutch, German, Swiss, UK and Japanese banks required an aggregate of US$1.2tn (net) in US dollars during the crisis. These obligations ultimately could only be met through international swap arrangements among central banks. Cecchetti also noted that in the subsequent three years the dollar funding number had not fallen, adding that this was why the foreign exchange swap arrangements between central banks were re-instated in May last year.
In a real disaster, with anything approaching Lehman, the latest rumblings of the dollar bulls would be just the beginning.
In case you had forgotten, this dollar chart should remind you what the Greenback did post-Lehman, at the end of 2008.
Because of the dollar scramble that European banks would face, Wood’s favourite trade is not on the dollar, but on FRENCH and GERMAN CDS (protection against a sovereign default), which you virtually never hear anything about.
The above is why GREED & fear still believes the best macro trade on Euroland is what can be termed the “core infection” trade. This is betting on rising German and French. Meanwhile, it is clear that there are no easy answers for the core as to how to deal with this situation. This is, obviously, why the politicians continue to defer the pain.