Trend: Interdependencies in global markets often cause unanticipated ripple effects that can make or break investors.
Cesar Zambrano at Forexfraud.com describes the playing field in globalized markets below.
The turbulence in our global trading markets witnessed in May appears to be abating. Volatility measures have dropped nearly 50%. Traders, forced to delay their vacations to oil-stained sandy beaches on the Gulf, are staring at their screens pondering their next medium-term moves. It’s time to catch our collective breath.
A financial crisis in the not too distant past could generally be confined to the economic region of its origin. However, in today’s interdependent world of globalization, a debt problem in Greece can immediately send shockwaves through every trading market around the globe. Technology and innovation have compressed reaction times from months to mere seconds. An idea in Hong Kong appears the same day in London. News travels in nanoseconds, now aided by the Internet and “24X7” cable news channel services. The trend is pervasive and offers opportunity for the savvy investor.
No where is this butterfly effect more apparent than in the world of foreign exchange, the global barometer of economic weather changes. Besides being the largest trading market on the planet, forex trading is sensitive to basic fundamental information on every global economy, and when chaos strikes as it did in May and in late 2008, the system absorbs the shock and gradually returns to its initial set of conditions, a property referred to as “recurrence” in chaos theory literature.
Our global economy is a unique mix of interdependence and non-homogeneity. As complex as the variables may seem, a simple currency chart can often tell the story for the interested observer. A case in point is the chart for Australia and the United States, or “AUD/USD”:
The 5-year chart presents a gradual strengthening of the Aussie Dollar towards parity with the greenback, but interrupted on two occasions in the process. The global recession and shockwave produced by the Lehman Brothers failure in late 2008 caused the first interruption. The crisis in Greece produced the second.The Australian economy has been a real success story since 2006. While other G10 countries were struggling with deficits and debt, Australia was in the forefront as one of the few economies capable of resisting the rest of the world’s woes. There were no “asset bubbles” to fear, and GDP grew at 2.7% in 2009 when most others in the developed world were negative. The strong Aussie Dollar reflected the country’s economic strength and its ability to insulate itself from the world’s problems.
Despite good “insulation”, the Aussie Dollar could not withstand the storms on the other side of the globe. It was quickly pounded after each crisis in 2008 and 2010. The reason relates to the “carry trade”, one of the most popular forex investment strategies. An investor sells a “base” currency where interest rates are low, and then invests in a growth market where rates of return are high. However, if the “base” currency strengthens as the U.S. Dollar did in both cases, then Australian assets must be sold to buy back expensive greenbacks. U.S. Treasuries and gold become the preferred “safe havens” in times of crisis. The rush to buy them puts demand pressure on the U.S. Dollar, thus creating temporary strength. These capital flows affect nearly every dependent currency around the world. No one escapes the carnage.
Globalization has brought prosperity, innovation and instant awareness of how quickly our interdependencies can influence our perceived insular world. Crisis induced capital flows in our currency markets are but one example of how quickly interdependencies can effect change. Keen investors should be prepared before a crisis strikes, and then short currencies offering the best profit opportunities.
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