The Cypriot fallout – European capital flight, Asia’s plight?

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The threat of capital flight out of Europe is becoming more real with each passing day that Cyprus stays on holiday. And all of a sudden, the talk in town now is that the Europeans have no where to go but Asia. Consequently we saw this morning how Asian currencies are holding up and even strengthening against the USD despite the EUR’s collapse. Indeed, at least one British friend who recently moved to Singapore for work is enquiring which is the best Singapore bank to park his cash. Mind you – the guy is from Britain holding GBP, not EUR.

But does it make sense? No. What you should be doing if the above scenario really pans out is a. short EUR, b. long USD and gold, c. long USD/Asia and d. stay out of short EUR/Asia. Here are my thoughts.

  • Capital controls in Asia. Have people forgotten Asia’s track record on capital controls – full controls in MYR from September 1998 to July 2005 and THB from December 2006 to March 2008? The rest have imposed various soft controls at different points in time. And other than SGD and THB, all Asian currencies are non-deliverable. True that you can put your money in Asian banks but you do not need to keep it in the local currencies – hence the non-deliverable nature of these Asian currencies does not matter. But it’s best not to forget the era of capital controls in the region – in bad times, we don’t want money to leave; in good times, we don’t want money to enter.
  • Asia currencies are fair weather currencies. At the rate that the hardline Eurozone leaders (read, German and Dutch) are going, EUR at parity to USD cannot be ruled out. In case, readers haven’t already heard from the Dutch Finance Minister Jeroen Dijsselbloem calling for the Cyrpriot bank depositors bail-in model to be adopted as a template for the rest of the European banks http://www.forexlive.com/blog/2013/03/25/dijsselbloem-says-cyprus-bank-restructuring-plan-a-template-for-rest-of-euro/. Where was USDSGD when EURUSD was at 0.84 in 2011? 1.82. There’s a reason for this – the region is very export-oriented. If Europe decides that it needs to shrink its banking sector, it means it is ready for another recession, our exports won’t do well.

10:37 25Mar13 RTRS-EUROGROUP’S DIJSSELBLOEM SAYS CYPRUS BANK RESTRUCTURING PLAN SHOULD BE SEEN AS TEMPLATE FOR REST OF EURO ZONE

10:37 25Mar13 RTRS-EURO ZONE COUNTRIES WITH LARGE BANKING SECTORS MUST LOOK TO RESTRUCTURE, REDUCE OVERALL SIZE – DIJSSELBLOEM

10:37 25Mar13 RTRS-AIM IS TO SHIFT RISKS AWAY FROM PUBLIC SECTOR, IF UNINSURED DEPOSITORS NEED TO BE ‘BAILED-IN’, THEY WILL BE – DIJSSELBLOEM

10:37 25Mar13 RTRS-IF BAIL-IN PROCESS WORKS, DIRECT RECAPITALISATION OF BANKS BY ESM MAY NEVER HAVE TO HAPPEN – DIJSSELBLOEM

  • BOJ QE. This has only just begun. And there is a reason for it – Japan runs a current account deficits – in addition to its chronic fiscal account deficit, it has made it much easier these days for the BOJ to engineer a weak yen by simplying printing more and more. While it is true that Asian currencies have de-linked from the JPY over the years, especially since 2008 after the US adopted QE, there is recent semblance of a re-connect to the JPY. Recall that during the weak EUR era, Asian currencies’ correlation to the JPY was higher than now and higher than that to the EUR. So if BOJ is on QE and EU is indirectly flushing out its own money, there is really no way out for the Asian currencies. Hence, short EUR/Asia is not the strategy – might even be a bad strategy for certain currencies – vulnerable ones being the ones holding current account deficits i.e. IDR and INR.
  • As a counter-defence to global QE, Asian central banks’ best – perhaps only – strategy is to intervene in the FX markets to hold down their own currencies. There is a limit to cutting rates without jeopardizing inflation. Capital controls are tempting – yes and that gets back to my first point above.

So watch Cyprus – the tiny nation in the Mediterranea Sea, trapped between Turkey and Greece, with EUR68bn of bank deposits, 8x its GDP. The government has extended its public holiday to Thursday – started from two Mondays ago on 18 March. That has already made them one of the longest off-calendar bank holidays ever – longer than Argentina, Ecuador, and Uruguay read, “As Cyprus Delays Reopening Banks Again, Here Are The Longest Bank Closures Ever” http://www.zerohedge.com/news/2013-03-25/cyprus-delays-reopening-banks-again-here-are-longest-bank-closures-ever

There are various reasons the Euro Group put up for giving Cyrprus such a “different” deal from others – the foremost being that the Cypriot banks relied heavily on bank deposits and not debt – hence there is not enough debt papers to be restructured the way the Greek banks, Irish banks, Icelandic banks had done to rescue themselves. In truth, as Dijsselbloem said, they want this to be the model for overbanking in the Eurozone. Never forget – the ECB is conducting QE – it’s doing so within the Eurozone such that the euro never leaked out of the zone – i.e. from one European bank to another. Now is it really ready to open the floodgate?