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Which Currency Will Crash First?

Currencies / Euro Feb 08, 2011 - 11:24 AM GMT

By: Rosanne_Lim


Best Financial Markets Analysis Article2010 was an exciting year for currencies. The dollar, euro, the yen, and the yuan all went under the spotlight. Except for the yuan, each experienced drastic swings wrought about by internal or external factors. But overall, these events underwhelmed confidence in paper money. The main reason is because of the sovereign debt crisis that swept the world.

Most of the developed nations including the United States, Japan, and a number of European countries have unsustainable debt. The US and Japan, for example, are heading towards insolvency. Meanwhile, the only reason why several countries in the EU haven’t defaulted is the bail-out by stronger EU members.

This year presents more challenges for the world’s major currencies. While the markets are not as nervous at this point, problems remain just beneath the surface. The truth is that the world has not seen a sovereign debt crisis of the magnitude seen last year. With much of the developed world on the red, this has brought the market at the brink of disaster. We’ll analyze some of the major currencies in this article including the yen, the euro, and the dollar. Developments in China regarding the yuan will also be discussed.

The Euro

It was all over the news in the later part of 2010. Several weaker members of the Eurozone would have defaulted already if they weren’t helped out by stronger members. As it stands right now, Greece, Portugal, Spain, Italy, Ireland, and Belgium are on shaky grounds. A number of countries have had their credit rating slashed, resulting to soaring bond yields that are unsustainable. Taking on new debt has become very expensive.

Greece, the country who was most at risk of default at one point in 2010, saw their yields go up from 6 percent to 13 percent in a single month. Even countries that are not in danger are feeling the effects of the crisis. For instance, the French debt hit a record high on December 20.

Right now, there are rumblings that more European countries may need bailouts to stay afloat. According to Professor Willem Buiter, a chief economist at Citibank, a few EU countries can face financial collapse in the next few months. “The market is not going to wait until March for the EU authorities to get their act together…they are being far too casual.”

Where did the bailout money come from? A lot of it comes from Germany but most people don’t realize that a significant portion actually came from the United States. But the real question is, are these countries willing to pour in more money to nations on the verge of default? For the German public, they want bailout to weaker neighbors to stop. There are other reasons why continuous bailouts will not work.

Right now, some politicians in Europe are asking for the European “bailout fund” to be doubled to $2 trillion. There are analysts who think that it will require $4 to 5 trillion to help all European nations that need it. Even a country as wealthy as Germany cannot give away billions of euros to its neighbors indefinitely. When the bailout to financial black holes stop, the defaults are likely to begin. 

Let’s look at the short-term chart (courtesy of for euro:

In the Euro Index chart this week, there are a number of bearish signals which can lead to bullish sentiment for the USD index. We have observed that the right shoulder of the bearish formation was invalidated by the buying that occurred at the beginning of this week. However, the price then moved to the rising dashed ling, invalidating the breakout. As a result, the head-and-shoulder formation is still underway, which has bearish implications for the following weeks.

Still, that formation alone doesn’t mean that euro will be the first major currency to crash. There are also other candidates…

Japanese Yen

Although Japan has the third largest economy, they are swamped with debt. The Japanese government has the highest debt to GDP ratio at 200% of all major industrialized countries. It is estimated that with this amount of debt, every person living in Japan right now owes around 7.5 million yen. Any other country would have defaulted. The main reason why Japan hasn’t yet is the high amount of personal savings rate of its citizens. The Japanese citizens are buying massive amounts of government debt at very low interest rates.

Despite this, the debt level is worrying. Standard & Poor has said they will slash the country’s credit rating if the debt gets any bigger. If confidence starts to falter, Japan has to pay significantly higher interest rates. At some point, Japan will have to face the threat of a meltdown unless drastic actions are taken.

The US Dollar

No one can argue that the United States is indeed in trouble. It has the largest national debt of all. With its national debt at $14 trillion, it is just $300 billion away from the $14.294 debt ceiling. If Congress fails to raise the debt ceiling, the US government will begin to default. While everyone fully expects this to be increased, the US cannot continue raising this threshold forever.

The US national debt is now 14 times higher than 30 years ago. Everyone is realizing that this level of debt is not sustainable. The Federal Reserve has already stepped in and “bought” more debt for the US government. Treasury yields have been moving up, potentially starting a massive problem in the future. This is mainly because the United States is increasingly relying on short-term debt.

Average maturity for US government bonds is now 4.4 years. As a comparison, the maturity of UK government debt is around 13 years. The situation can be dire if interest rates continue to climb. But there is one thing going for the United States: The Federal Reserve. It can keep on printing money and because the dollar is a global reserve currency, there is demand for it. But this can change quickly – and the consequences will be seen all around the Globe.

The Chinese Yuan

China is increasing its gold and silver reserves in line with its plan to globalize the yuan. The report published by the Economic Information Daily, the People’s Bank of China – the country’s central bank – is chalking up plans to buy gold and silver reserves when the prices are down.

A number of analysts predict that the Chinese yuan might overtake the US dollar as the global currency in a few years; one of them is global commodities expert Jim Rogers. He believes that the Chinese yuan will eventually dominate the currency market. China is already the largest producer of gold.

Last year, officials have announced that they will increase reserves to the tune of 10,000 tons over the next decade; the country’s reserves currently stands at 1,200 tons. Chinese central bank adviser Xia Bin has confirmed that China must increase its gold and silver reserves. According to the report, “increasing gold reserve at the time of prices dip is the strategy of internationalizing the yuan.”

There were rumors that the People’s Bank of China will bid for IMF gold reserves but this did not happen in 2010. The main reason may be that bullion prices climbed by 30% last year aided by the depreciation of the US dollar against other major currencies, the European debt crisis, and strong demand from India due to festivals and other occasions. The investment appeal of precious metals also surged as investors sought to protect their wealth in an uncertain environment.

In essence, what China wants to happen is to stabilize its currency. By making the yuan internationally tradable, its dependence on the dollar will be dramatically reduced. Hwang Il Doo of the Korean Exchange Bank Futures Co. said that while “the report is a positive factor for gold prices in the mid-and-long term”, it won’t have an “immediate impact on prices as gold’s gain has more to do with the unrest in Egypt at the moment.”

Can this be the Start of a Global Currency?

Concerns about the stability of currencies have improved the appeal of a united global currency. The same groups and individuals who thought up the WTO, IMF, OECD, and World Bank believe that the uncertainty produced by shaky world economy presents the perfect “opportunity” to introduce a world currency. Chinese President Hu Jintao has said that the “current international system is the product of the past.”

Whether this comes to fruition or not remains to be seen. The United States has the most to lose if this happens. Certainly, American policymakers will certainly try to find a remedy. However, the problem is, the country might eventually be too deep in debt to do something about it.

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Thank you for reading.

Thank you for reading.

Rosanne Lim
Sunshine Profits Contributing Author

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