Greek tragedies, in their various artistic forms, have enthralled and mesmerized readers and audiences for many centuries. The current Greek tragedy, which is being played out in financial markets throughout the world for the last one and a half years, has been completely different in that sense.
Rather than enthralling and mesmerizing readers and audiences alike, this tragedy has been one of the major reasons of worry for bankers, money managers and investors in general. During the last two months, with Greece more and more likely to default on its debt, that worry has transformed into fear and uncertainty in the global financial market.
Along with the fear of Greek default, other global and regional economic problems, from debt problems in other European economies to economic woes in the US, have created a vicious cycle of fear and uncertainty. The World Economic Outlook (WEO), which was released recently by the International Monetary Fund (IMF) and which signalled that traditional economic powerhouses (such as the US, Japan and other Western European economies) are headed for a long period of economic downturn, has raised alarm bells about the direction of the global economy. (The executive summary of the WEO, which has a tag line of Slowing Growth, Rising Risks, begins with the line, “The global economy is in a dangerous new phase.”)
Given such a perilous economic state, policymakers are scrambling for rescue plans (such as “Operation Twist” in the US) and investors are looking for safety, whereby they are fleeing riskier assets and moving into relatively safer ones. This “flight to safety”, especially during the last two months, gives an idea of how investors perceive risks and how assets are priced in an environment of fear and uncertainty. For example, when the rating agency Standard & Poor (S&P) downgraded the US sovereign credit rating from the highest rated AAA to a notch below to AA positive — the first such downgrade in US history — interest rates on five-year and 10-year US treasury bonds actually dropped following the announcement, when, in normal circumstances, it would have gone up as lending to the US would have been “riskier”.
The rise of the US dollar (USD) against other major currencies during the last few months has also taken many by surprise. Many have rightly predicted doom and gloom for the greenback, but the current crisis has once against showed the resilience of the USD during times of uncertainty. Normal economic theory would suggest that as emerging economies (read India, China and so forth) grow bigger in size, their currency will appreciate against the USD. Why then this sudden reversal of the trend especially given the economic woes in the US?
Well, the current economic scenario belies normal economic theory. The recent appreciation of the USD (and for that matter the Japanese yen and the Swiss franc) against other currencies doesn’t have to do with any change in fundamental economic factors. In fact, they are even discounting fundamental economic factors: What else then explains the massive appreciation of the USD against the Indian rupee (INR) despite the Reserve Bank of India’s (RBI) hiking key interest rates.
The key thing in today’s time is that, with a lot of uncertainity, investors, when investments are increasingly becoming fungible, don’t want to put their money where risks are “perceived” to be higher. Hence, they are taking their money out from countries such as India and putting it in US treasury bonds. (See the inverse relationship between the yield on 10-year US treasury bonds and the INR/USD exchange rate, which gets accetunated during times of crisis.) There is no doubt that in the long term (the extent of the global economic problem will determine the length of the period), currencies such as the INR will appreciate against the USD. But today’s time is no normal time.
Rather than enthralling and mesmerizing readers and audiences alike, this tragedy has been one of the major reasons of worry for bankers, money managers and investors in general. During the last two months, with Greece more and more likely to default on its debt, that worry has transformed into fear and uncertainty in the global financial market.
Along with the fear of Greek default, other global and regional economic problems, from debt problems in other European economies to economic woes in the US, have created a vicious cycle of fear and uncertainty. The World Economic Outlook (WEO), which was released recently by the International Monetary Fund (IMF) and which signalled that traditional economic powerhouses (such as the US, Japan and other Western European economies) are headed for a long period of economic downturn, has raised alarm bells about the direction of the global economy. (The executive summary of the WEO, which has a tag line of Slowing Growth, Rising Risks, begins with the line, “The global economy is in a dangerous new phase.”)
Given such a perilous economic state, policymakers are scrambling for rescue plans (such as “Operation Twist” in the US) and investors are looking for safety, whereby they are fleeing riskier assets and moving into relatively safer ones. This “flight to safety”, especially during the last two months, gives an idea of how investors perceive risks and how assets are priced in an environment of fear and uncertainty. For example, when the rating agency Standard & Poor (S&P) downgraded the US sovereign credit rating from the highest rated AAA to a notch below to AA positive — the first such downgrade in US history — interest rates on five-year and 10-year US treasury bonds actually dropped following the announcement, when, in normal circumstances, it would have gone up as lending to the US would have been “riskier”.
The rise of the US dollar (USD) against other major currencies during the last few months has also taken many by surprise. Many have rightly predicted doom and gloom for the greenback, but the current crisis has once against showed the resilience of the USD during times of uncertainty. Normal economic theory would suggest that as emerging economies (read India, China and so forth) grow bigger in size, their currency will appreciate against the USD. Why then this sudden reversal of the trend especially given the economic woes in the US?
Well, the current economic scenario belies normal economic theory. The recent appreciation of the USD (and for that matter the Japanese yen and the Swiss franc) against other currencies doesn’t have to do with any change in fundamental economic factors. In fact, they are even discounting fundamental economic factors: What else then explains the massive appreciation of the USD against the Indian rupee (INR) despite the Reserve Bank of India’s (RBI) hiking key interest rates.
The key thing in today’s time is that, with a lot of uncertainity, investors, when investments are increasingly becoming fungible, don’t want to put their money where risks are “perceived” to be higher. Hence, they are taking their money out from countries such as India and putting it in US treasury bonds. (See the inverse relationship between the yield on 10-year US treasury bonds and the INR/USD exchange rate, which gets accetunated during times of crisis.) There is no doubt that in the long term (the extent of the global economic problem will determine the length of the period), currencies such as the INR will appreciate against the USD. But today’s time is no normal time.
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