It's Beginning To Look A Lot Like 1998

Includes: FCA, OIL, RSX, TBT, TLT
by: Mercenary Trader


If Russia defaults on its debt, foreign lenders could be exposed to $670 BILLION in losses.

We are in full-on “1998 mode” now. Various emerging market currencies are also hitting 16-year-lows versus the greenback.

Putin has no way out of this. But if Russia defaults, neither do global investors.

"I couldn't imagine even a year ago that such a thing could happen - even in my worst nightmares."

~ Sergey Shvetsov, Deputy Governor of Russia's Central Bank

If Russia defaults on its debt, foreign lenders could be exposed to $670 BILLION in losses.

That is the estimate of Carl Weinberg, Chief Economist of High Frequency Economics.

Think about that number for a moment - $670 billion.

Will Russia default? We don't know of course.

The point is that odds of a default are now non-trivial. They may even be 50/50.

Even just a 25 to 33% chance would be mind-bending… because probability gets multiplied by severity of consequence.

We're talking full-blown financial catastrophe here.

On Tuesday, the ruble bounced 10 percent against the dollar.

Then it went back into panic freefall, for a full decline of 11 percent on the day.

We are in full-on "1998 mode" now. Various emerging market currencies are also hitting 16-year-lows versus the greenback.

Source: FT, Thomson Reuters

If Russia's central bank spends $10 billion per day, they will run out of money in less than six weeks.

The "shock and awe" attempt of Russia's central bank was a complete failure.

Russian citizens are panicking to get their money out of the country. This is full-on capital flight.

The below snapshot shows Russia's estimated foreign reserves, liquid and illiquid.

The promise to spend five billion per day didn't do anything. Nor did a huge hike in interest rates.

Thing is, if they decided to spend $10 billion per day, they would blow through all their cash in forty days.

source: Economist

The situation gets worse: Russia may need hundreds of billions in corporate bailout money.

Many Russian corporations have large volumes of dollar-denominated debt. Those debts could be suffocating in the coming months.

Russia may have to bail these companies out to avoid economic collapse on the local level. But how? With what?

The reserves they have left need to go towards defending the ruble…

…And the Russian economy is headed for deep recession or even depression.

At the same time, the Russian economy itself is under dire threat of collapse.

Double-digit interest rates can kill a healthy economy. So imagine what they do to a weak and sick one.

Speaking of which, the interest rate on Venezuela's two-year-note just topped seventy-five percent. Yep, they are toast.

Putin has no way out of this. But if Russia defaults, neither do global investors.

This is the really, REALLY scary thing:

  • Vladimir Putin may be finished.
  • There is no conceivable way out of this.
  • But if Russia elects to default on its debt…
  • At least the pain gets spread around.
  • Potentially $670 BILLION worth of pain.
  • What is stopping Putin from doing this?
  • The risk of train-wrecking his legacy?
  • Nope. That's already done.

Russia defaulted in 1998 because of huge external debts NOT denominated in rubles.

There is a lot of confusion surrounding what happened in 1998.

Many investors couldn't believe Russia was so stupid to destroy its currency and default on its debt at the same time.

Why in the world do both? Why not just run the printing presses to pay off the debt?

Because if the debt is payable in a currency OTHER THAN YOUR OWN, you can't do that.

The Soviet Union had accumulated staggering amounts of foreign denominated debt.

The collapsing economy, and falling ruble, made this debt impossible to pay off in the late 90′s.

That same scenario may be happening again.

Wells Fargo estimates $38 billion of USD government debt… but HUNDREDS OF BILLIONS on the private side.

Russia can handle $38 billion in dollar-denominated government debt, given its $400 billion in reserves.

(Unless it starts plowing through those reserves at $10 billion per day to defend the currency…)

Meanwhile, Wells Fargo estimates Russian banks have $200 billion worth of external debt. And other sectors have roughly $300 billion.

There is also "$160 billion in intercompany debt to overseas parents and subsidiaries, likely mostly to Western European companies."

Yeah, that's a lot.

A Russian default would be Putin's most powerful means of defying his enemies in the West.

Let's be clear about this: Putin hates the West at this point.

It's like in the Godfather. They keep saying, "it's not personal." But at the end of the day, it's always personal.

The West continues to taunt Putin. President Obama authorized a new round of sanctions on Tuesday.

This is like giving a guy a paper cut after he just came through a knife fight, but still… it's the principle of the thing.

Were Russia to default on its debt, Putin knows the global financial community could implode.

It likely won't come to that. But it truly could.

Fear reactions also heighten default and blow-up risk in other markets.

Remember it's not just Russia on the edge of meltdown.

Many other emerging market countries are experiencing the pain of currency freefall… and the potential need to hike interest rates to fight off inflation… which in turn slams the brakes on local economies, making dollar-denominated debts harder to pay.

The dominoes are falling.

As Russia looks into the dark abyss, China shows inevitable sign of slowdown.

It's not just Russia. Nor is it just fragile emerging markets.

The dragon is slowing. And we don't know what the fallout will be from China's bad debt tsunami.

China may contain the fallout through "zombie" measures - throwing cash at the multi-trillion wave of bad debts and implosion threats.

But China's marginal demand will contract painfully if this happens.

Recent estimates of China manufacturing activity show more contraction.

Domestic demand has "fallen considerably" says Hu Hongbin, Chief China Economist at HSBC.

At the same time, consumer prices in China have fallen to a five-year low.

And producer prices in China have fallen for 33 months in a row.

It doesn't matter that China's stock market is being directly manipulated higher. The China growth miracle is slow-motion imploding.

source: Daily Shot

If things get really bad, long bonds will go vertical.

We maintain a sizable long treasury bond position (via short TBT).

You can see from the chart below, long bonds are already going vertical.

"Risk off" concerns are rampant, and justifiably so. This move could just be getting started.

If Russia threatens default or institutes capital controls… or more cracks in the high yield debt market appear… or a major emerging market blow-up occurs… or if a COMBINATION of these things occur…

Then the sun will move two inches from the earth, and long-dated US treasury bonds will be the ultimate zinc ointment.

And as for icing on the cake… nobody knows what the Fed will do, or how markets will react.

The piece de resistance:

  • The Federal Reserve meets today (Wednesday).
  • We don't know what they will say.
  • They may change their statement.
  • Or they may not…

There is increasing speculation the Fed will drop "considerable time" language from its policy statement.

This would be a big, BIG signal that rate hikes are coming in mid-2015.

The Fed might play dovish given obvious concern for global turmoil.

But they might ALSO decide they can't afford to back down… and that markets will simply need to "take their medicine," because the Fed is focused on the US economy and not the rest of the world.

Bottom line: Be prepared for ANYTHING… including TOTAL BLOODBATH.

We could see a sigh-of-relief rally on Wednesday.

We could see the Fed come out dovish, and global financial markets could calm down, and all could be nice and calm come Christmas.

But we could ALSO see pure, unmitigated carnage. White-knuckle total-panic freakout.

And US equities, that bastion of strength, might not be spared.

The embedded risk at this juncture is crazy, crazy high. We're talking 1998 and 2008 high.

Be careful out there.

The above is excerpted from our December 17th Live Feed commentary.

Disclosure: The author is short TBT. Also long the US dollar vs. a basket of currencies.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.