The Vital Signs Are Good, Even Though Patient Is In ICU

There are signs that the financial regulators and leaders know what is troubling the global capital markets. If they know, then we are on the way to properly restoring calm and sensibility. More importantly, it will ensure a properly functioning capital markets - which is still not evident now as many stocks have dipped below way past what is considered as fair value. Its pointless to point out which stocks are worth buying as there are too many to mention. You would be better off to try and see the road signs that say that the root problems are being addressed. If they are not doing that, then we will be in the doldrums for a while. However, I can see two major signs which say we should be on the right path. Treasury Secretary Henry Paulson’s comments that signaled he wouldn’t let another large bank fail, large institutional traders began doubling down on bets that large banks would skyrocket. At a time when almost everyone is deleveraging, several funds were in essence doubling their leverage on one trade. This is essential as the statement indicates that Paulson now knows what a catastrophe it was to let Lehman Brother fail (please read recent posting on Lehman Brother, The Rosetta Stone). That will be as close you can get to an admission of grave fault by Paulson.

The major hedge fund Citadel had a conference call over the weekend and agreed with my take on Lehman Brothers:

3:55 p.m.: “One effect we’ve all seen is about the diversity of counterparties. Given the diversity of counterparties around the world, clearly the diversity isn’t enough to deal with some of what we’ve seen in the past few weeks.”

3:54 p.m.: Lehman’s bankruptcy caused “the greatest dislocation we’ve seen in money market history”

The second major issue is the flight to safe currencies such as yen and USD. But, this is not a currency crisis. This is a liquidity crisis, a growth crisis, a confidence crisis. As such, probably the first step should not be to intervene to save currencies. People calling for their central bankers to protect their currencies are calling for the wrong antidote. At a time like this, you don't need or rather you don't want a strong currency. Look at the OZ dollar, there is no way the Reserve Bank of Australia can do much to stem the reversal of the massive yen carry trade effects. The RBA can only do one thing to protect the OZ dollar and that is to raise the interest rates, which is already crippling in light of the over speculated property market there. What good is it to bump up rates and protect your currency and then find your economy in tatters with property markets there compounding. You would have a graver, and longer term disaster in the works. Better to allow the currency to find its own footing. At current levels, the OZ should start attracting some FDI into property for sure and should see a strong boost to tourism. I mean the OZ dollar is even cheaper than the Singapore dollar now by nearly 10%.

The source of aggressive capital flows into the dollar and yen is emerging markets, and it is the emerging market central banks, flush with dollar reserves, who could take action to stem the market frenzy. Naturally this cannot be allowed to continue, especially for Japan, which needs a weaker currency to prevent a more severe deflation in its economy. Emerging markets “need to act the same way the U.S. and European Union has acted. That will address the root of the problem. However, those governments’ assertiveness is limited by their experience.

Ahead of the Asia Europe Meeting, which began Friday, Japan and other East Asian leaders agreed to establish an $80-billion joint fund aimed at fighting the global financial crisis. Much of the movement into yen and USD can be said to be coming from emerging markets themselves, and that needed to be reversed. The setting up of the "fund" is a good start. More collaboration will go some way to slowly unwind the weakness in emerging markets' currencies.

p/s photos: Deepika Padukone