In parva molestia Sina!
“Big Trouble In Little China!”
Hang Sang Ain’t Hangin’ Today… It’s a Fallin’
The fallout of the Swiss Central Bank’s action to lift its currency peg (or allowable trading range) against the cross rate of the Swiss Franc to the Euro has made the Chinese quite worried. In the last 24 hours, during early Monday morning in the China (Sunday night in the USA) when the U.S. markets were shut, China’s Shanghai Composite Index (SSEC) fell from approximately from 3,400 to roughly 3,100 before it closed around 3,115, a drop of approximately 8 to 10 percent on one trading session.
Monday, the U.S. stock and bond trading was on Federal Holiday, for Rev. Martin Luther King Day, the markets were shut. Meanwhile, investors in China were worried about their own hasty lawmakers and their actions in response to losses of currency and commodity trading firms, and of their clients, in the aftermath of the Swiss Franc surging after it lifted its peg to the Euro.
Chinese investors were worried about future regulatory changes associated with currency and commodity trading and the use of leverage and borrowing to do such trading and investing. Foreigners can currently employ about 100:1 to 400:1 leverage, by borrowing, to increase their exposure to currency and commodity trades. This isn’t the case in the USA where the CFTC regulates margin on currency and commodities and futures trading and investing. In the USA we also have Reg T for securities trading (which includes the regulation of stocks, bonds, and options) and as investors of these actual securities (very different from futures and commodities) we’re not allowed to have 400:1 leverage and borrowing.
If regulatory action is taken by legislatures worldwide in the fallout and aftermath of the Swiss Franc surging by lifting its peg, then I’m sure you can imagine what’s going to happen to commodities prices which may be supported by, in my mind, extreme leverage (aka extreme borrowing). If the magic carpet of margin, of 400:1 lending is pulled out from underneath commodity prices, then their prices will (or may) collapse!!! Everything from cattle, to corn, to soybeans, to coffee, sugar, orange juice, milk, rice, cattle, hogs, to even lumber, and precious metals (gold, silver, platinum, and palladium, and copper) could all plummet in prices! [Click here for current commodities prices]
In my mind, the world would then experience an environment of disflation (lower and lower inflation rates), leading to outright deflation (actual lower and lower prices).
Deflation is when price levels decline, or even plummet (perhaps that would be “hyper deflation”). At first glance this seems great; I mean who doesn’t want a cheap Starbucks coffee right?! But it’s actually a total disaster! Deflation is paralyzing, if not total paralysis, and is crippling to the people and to their economies and society. If prices are falling what would or may you or people do? You might wait for lower prices later right? Well, if everyone waits for lower prices, then people aren’t buying things, if they’re not buying, no one is earning money, if no one is earning money there are layoffs, lower demand, lower wages, lower productivity, and layoffs which exacerbates the entire issue, of people being less willing to purchase anything. The whole deflationary spiral would get alarmingly out of hand! Prices would or could plummet, through regulation of margin. When margin regulations on the stock market were put into place after the Great Depression, surely that took some “hot air” out of the stock market, leading to lower stock prices. In a deflationary environment growth would slow, the economy could contract and shrink, spending would or could cease, savings and investment would dwindle, layoffs would increase, and prices would continue to plummet. Sounds like economic Armageddon… It’s because it is, or would be!
I hope the CFTC in the USA doesn’t even look into or examine the regulatory structure of excessive leverage of currencies and commodities investors and traders. It would probably prove to be enough to cause a stir and incite a panic, before you know it, deflation would materialize, along with a recession.
Don’t worry, it doesn’t seem to be affecting the market psychology and behavioral finance of American and U.S. investors. Currently as of 11:50pmCT stocks are mostly trading higher in Asia, and S&P Futures vs. Fair value are indicating an implied open of +27 points on the DJIA for Tuesday trading.
By Andrew G. Bernhardt
Bernhardt Capital Management LLC 