Updated August 22, 2105: Causes of Market Turmoil

Threat is greatest to emerging-market economies, where the China effect looms largest

  • While the short-term outlook for the U.S. and most of the rich world is still relatively benign, it also is fragile. One reason: Long-term underlying growth is being undermined by an aging population, slowing growth of the workforce and a puzzling slump in the growth of productivity—how much output each worker produces.
  • A second reason the rich world’s outlook is fragile is that inflation is stubbornly stuck below the 2% level that the Fed, ECB and Bank of Japan all target. The recent slump in oil prices and China’s devaluation, which will push down prices of everything that it sells, will nudge inflation even lower. When inflation is low, so are interest rates, which gives central banks less ammunition to bolster growth. That lack of ammunition worries policy makers, and it should worry investors who have often assumed central banks would help put an end to bear markets.
  • But in a world of low inflation and tepid underlying growth, even a modest increase in (interest) rates could pose headwinds. » The Wall Street Journal Analysis

China moves to devalue the Yuan and factories contracted

  • Given that China’s currency, the yuan, is linked to the dollar’s value, it has risen as well against the euro and many emerging market currencies, weighing on Chinese exports.
  • Analysts don’t see China’s move as sparking a wider currency war, but rather as an indication that exchange rates will continue to play a central role in efforts by policy makers to protect fragile economies.
  • Links between trade and currency values (Jupiter images)

  • Analysts said they would be eyeing other Asian economies to see whether China’s move has ripple effects. If policy makers in these countries take steps to weaken their currencies to maintain competitiveness with China, it could spark a more global trend toward easier monetary policies. » The WSJ article – By Brian Blackstone – August 11, 2015…. Updated August 19, 2015: Vietnam devalues its currency by 1% » The AP article.

Global banks admit guilt in forex probe, fined nearly $6 billion

  • Four major banks pleaded guilty .. to trying to manipulate foreign exchange rates and, with two others, were fined nearly $6 billion in another settlement in a global probe into the $5 trillion-­a-­day market.
  • The settlements .. stood out in part because the U.S. Department of Justice forced Citigroup’s main banking unit Citicorp, and the parents of JPMorgan, Barclays and Royal Bank of Scotland to plead guilty to U.S. criminal charges.
  • The investigations are far from over. Prosecutors could bring cases against individuals, using the banks’ cooperation pledged as part of their agreements. Probes by federal and state authorities are ongoing over how banks used electronic forex trading to favor their own interests at the expense of clients.
  • Citicorp will pay $925 million, the highest criminal fine, as well as $342 million to the U.S. Federal Reserve. Its traders participated in the conspiracy from as early as December 2007 until at least January 2013, according to the plea agreement.
  • Traders at Citi, JPMorgan and other banks were part of a group known as “The Cartel” or “The Mafia,” participating in almost daily conversations in an exclusive chat room and coordinating trades and otherwise fixing rates. » The Reuters article – BY Karen Freifeld, David Henry and Steve Slater – May 21, 2015.

Stricter Regulation of Foreign banking in the the U.S.

  • Federal Reserve Governor Daniel Tarullo defended the central bank’s rules requiring stricter supervision of foreign banking companies operating in the U.S., saying the global financial crisis made it clear that regulation needed to be expanded.
  • “The most important contribution the United States can make to global financial stability is to ensure the stability of our own financial system,” Tarullo said in a speech today to a Harvard Law School symposium in Armonk, New York.
  • Foreign bank reliance on short-term wholesale liabilities such as commercial paper to fund longer-term securities created instability in 2008 as sources of cash grew tight. The Fed provided backstop loans to both domestic and foreign bond dealers through the Primary Dealer Credit Facility, and to foreign banks directly through the discount window.
  • The Fed “provided substantial liquidity to the broker-dealer affiliates of the bank holding companies, as well as to the primary dealer subsidiaries of foreign banks,” Tarullo said.
  • The biggest borrowers from the discount window as the program reached its crisis-era peak were foreign banks, accounting for at least 70 percent of the $110.7 billion borrowed during the week in October 2008 when use of the program surged to a record.
  • Under the rule issued in February, foreign banks with non-branch assets of $50 billion or more must hold their subsidiaries in holding companies that are subject to capital and liquidity standards applied to U.S. banks, and meet special risk management standards. » The full Bloomberg article – By Craig Torres and Susanne Walker – March 28, 2014

News from Wall Street

Image source – The Globe and Mail
    “Laws, like sausages, cease to inspire respect in proportion as we know how they are made.”
    John Godfrey Saxe, American poet and lawyer, 1869

  • Add bond ratings to that list. » More in this New York Times article – By Floyd Norris November 8, 2012.

S&P found guilty of misleading investors

  • Standard & Poor’s misled investors by awarding its highest rating to a complex derivative product that collapsed in value less than two years after it was created by ABN Amro, an Australian judge has ruled, in a landmark case that paves the way for legal action in Europe.
  • In a damning verdict the Federal Court of Australia ruled S&P and ABN Amro, now owned by RBS, had “deceived” and “misled” local councils that bought triple-­A rated constant proportion debt obligations (CPDOs) from an intermediary in 2006. » The full Financial Times article – By Neil Hume in Sydney – November 5, 2012.

  • Bank Investors Dismiss Moody’s Cuts as Years Too Late

    • Moody’s Investors Service suffered a downgrade of its own as markets responded to the company’s rating cuts of 15 of the world’s largest banks by bidding up the value of their stocks and bonds.
    • “We view the Moody’s downgrade as another overhyped story of 2012,” David Trone, analyst at JMP Securities LLC, wrote to his clients. “The corporate market thinks for itself and credit rating agencies are often lagging indicators.” » The full Bloomberg article – By Dakin Campbell and Michael J. Moore on June 22, 2012.
    • Looking back
    • A report by the Senate’s Permanent Subcommittee on Investigations said that S&P, Moody’s and Fitch Ratings helped trigger the financial crisis when they cut thousands of mortgage securities they rated AAA to junk status. The raters had engaged in a “race to the bottom” to win business, lawmakers said.
    • Even after Congress included rules in the Dodd-Frank Act last year designed to cut reliance on ratings, S&P and its competitors remain a key part of the financial markets. Pension and mutual funds often require minimum ratings to buy debt securities. Banks are generally required to hold less capital to back higher rated bonds as regulators including the Federal Reserve have yet to find an alternative. » The full Bloomberg background article – By Zeke Faux and Jody Shenn – Sep 1, 2011

    • The New York Times – Learning Network – Examining Key World Economies and Comparing Their Current Volatility
      Overview: Students review key economic terms and ideas necessary for understanding world economies. They then research the economies of countries in the Group of 10 and present how their economies have changed over the past five years and how the relationships among these countries affect each other in light of world events.  Go to this Economy and Society Lesson.
    • The New York Times – Learning Network – Understanding Credit Cards and Credit Card Debt
      Overview: Students examine and learn the basics about credit cards and credit card debt, then create an informational brochure for young students. Go to this Economy and ESL Lesson.

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