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When The Tide Goes Out, Weaker Currencies Are Naked

The unfolding of the Fed tapering is making its effect on world markets. The initial assumption is that tapering would reduce the amount of U.S. money in circulation, would eventually raise U.S. interest rates, strengthen the U.S. dollar and put stress on the economy due to less monetary support. What has not discussed was the effect it would have on the world stage. Emerging markets currencies are more reliant on the Fed policy that people believe, judging by the volatile reactions of currencies like Argentina, Turkey, South Africa and China. While it is true that the problems brewing with these currencies may have existed for years, the Fed easy money policy has allowed these issues to fester undisturbed. Once the support is removed, the weaknesses get tested, and stress will ensue in places that are not strengthened. When the tide goes out, these currencies are naked. The problems are being exposed that were under the surface.

What is more interesting is the reaction of the governments that are controlling these currencies. Argentina has issues paying its debt and high inflation. They let their currency devalue quickly and this is causing fear. (4)(5) What is ironic is that Japan and the U.S. have been letting their currencies devalue more slowly, and this was greeted with optimism by the market. Turkey also had a large currency decline due to low foreign currency reserves. Turkey raised their interest rates in a massive way and the effect remains to be seen. (2)(3) In China, the issue is a liquidity restriction, and they began freezing access to money, much the way the U.S. did in 2008. This is very different that letting the currency devalue. China is known to have large U.S. currency reserves, but it is now being revealed that there is also a lot of Chinese debt. (1) This sounds similar to what the U.S. issues are. The reliance on U.S. economic indicators will continue to increase, and as these indicators sputter, volatility will increase in the market. Will the Fed taper continue or will it be reversed under the pressure of sinking markets?

Sources:

1) http://www.kitco.com/ind/Brecht/2014-01-24-Will-Worries-Over-China-Banking-Sector-Spark-Increased-Gold-Buying.html

2) http://www.reuters.com/article/2014/01/29/us-turkey-centralbank-rates-idUSBREA0R1W420140129

3) http://www.shanghaidaily.com/Business/economy/Manufacturing-profit-growth-slows-though-strong-for-year/shdaily.shtml

4) http://www.laht.com/article.asp?ArticleId=1517692&CategoryId=14093

5) http://www.reuters.com/article/2014/01/25/us-markets-emerging-idUSBREA0N1M120140125

6) http://www.forbes.com/sites/panosmourdoukoutas/2014/01/26/global-market-selloff-a-worrisome-chart-for-wall-street/2/

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.