Tuesday, February 24, 2009

Eastern European Currencies & Soros

Per Financial Times report (here): CBs of Eastern Europe are issuing coordinated statements calling recent currency weakness unjustified and raising the possibility of intervention on foreign exchange markets. Take this, in line with George Soros' weekend cry to arms for state-led socialism to replace liberal financial markets regulation (as if such really does exist in any developed country today). Recall the classic lesson taught by Soros in the case of British experience with ERM: Central Banks interventions in Forex markets impoverish taxpayers and enrich George Soros.

So what should the strategy be for anyone with a position in Poland’s zloty, Hungary’s forint, the Czech koruna and the Romania’s leu? These currencies rallied after the statement. Three scenarios are thus possible:
Scenario 1: CBs mount a spirited defense driving currency valuations up for ca 1 month before all currencies come down again on the back of excessive fiscal deficits, private economy contractions and implosions of housing bubbles (in some countries), with private banking continuous deterioration (in other). Foreign banks and domestic banks use the opportunity to aggressively expatriate capital at higher currency valuations, driving down demand for domestic paper. Shorting now is a 'win' proposition.
Scenario 2: CBs do not mount a serious/credible defense and instead preside over further devaluation to bring currencies down to longer term recessionary equilibrium levels. Foreign banks, suffering their own crisis at home continue to expatriate capital, further contributing to devaluation pressures. Shorting now is a 'win' proposition.
Scenario 3: George Soros gets his wish and EU-styled over-regulation reigns supreme over the Forex markets in which case we get stiffening of the ERM mechanism and a coordinated effort on behalf of the EU to drive down the Euro over a period of time. No Eastern European country would enter an ERM band at a peril to its exporters, so Poland (and potentially at a later date - Hungary, Romania and Czech) will devalue their currencies before the ERM accession to boost the chances of economic recovery. Shorting now is a 'win' proposition.

As with the 1990s ERM crisis, this is a one-way bet assuming you have a stomach for being open in the Eastern European currencies in the first place. (All usual caveats apply of course, plus a disclosure: I hold no open position in the above currencies.)

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