Excerpts from:

Global System Instability

by Doug Noland
March 16, 2001

One can certainly get a feel for the global nature of the current crisis by scanning today’s headlines
from Bloomberg News:"Canadian Dollar Drops Near Record Amid Concern about Stocks and
Economy";"Australian Dollar Falls on Concern Government Set to Lose Parliament Seat";
"Korean Won, Taiwan Dollar Decline as Weak Yen Curbs Demand for Exports";"Thai Baht Falls to
Three-Month Low as Central Bank Says It’s Not Worried";"Venezuela Unemployment Rate Surges
to 15.8% in January From December’s 10%";"Philippine Unemployment Rate Rises in January to
11.4%, a Nine-Month High""Argentine Bonds Plunge on Concern Economy Plan Won’t Get
Political Support";"Turkish Economic Program Hinges on Lenders Providing Up to $25 Billion"; and
"Euro Suffers Worst Weekly Drop Against the Dollar." In the US, a disconcerting headline has
"Edison, PG&E Stocks and Bonds Drop on Fear of Bankruptcy." With significant exposure to a
California utility bankruptcy in money market funds, this situation should be monitored closely. At
the same time, American credit data turns more ominous by the week.

Yesterday, the Mortgage Bankers Association reported a sharp and broad based increase in
mortgage delinquencies. The delinquency rate for"one-to-four unit residential properties" jumped
50 basis points to 4.54% during the fourth quarter…

I have made the case repeatedly that while there are spectacular examples of regional real estate
bubbles, the critical aspect of this boom cycle has been the pervasive nationwide character of this
bubble fueled by a national real estate financial superstructure and unprecedented mortgage lending
excess….

And while consumer debt problems are in the very early stages, the unfolding corporate debt debacle
seems to worsen by the month. It is worth mentioning an article yesterday from BusinessWire:
"Fitch: One For History Books; 1st Qtr Defaults To Exceed $20B. On the heels of a record setting
$27.9 billion in default volume for the year 2000, high yield defaults soared to $12.8 billion for the
first two months of 2001. February produced $9.4 billion in defaults, driving the LTM high yield
default rate to 6.7% compared to 5.3% in January……

With huge foreign bound outflows and a truly massive current account deficit, the offsetting foreign
source inflows have grown to simply unimaginable proportions."Foreign-owned assets in the United
States" increased $952 billion during the year 2000, up 26% from 1999’s increase of $754 billion.
And while"foreign official assets in the United States" increased about $30 billion (compared to
1999’s $33 billion),"other foreign assets in the United States" ballooned a stunning $917 billion (up
29% from 1999’s $711 billion). During the fourth quarter alone,"other foreign assets in the US"
increased $280 billion (up almost 80% from 1999’s Q4 increase of $157 billion)……

This data is evidence of unprecedented financial credit excess. Further, capital movements of this
magnitude and character are almost certainly"hot money" speculative flows emanating from credit
excess at home, in Europe and, increasingly, from the UK and off-shore banking centers. With this
in mind, the unfolding global financial crisis should come, unfortunately, as little surprise to serious
analysts.

My work to this point has heavily focused on the Great US Credit Bubble. However, there is
absolutely no doubt that the past few years have witnessed the most outrageous and reckless credit
and speculative excess throughout the global financial system. The multinational investment
banking houses, international money center banks and the ballooning hedge fund industry - the
"leveraged speculating community" - have led this financial rampage……

As George Soros so brilliantly articulated in his book"The Crisis of Global Capitalism," when the
current global system comes under significant stress, countries at the periphery are the first to
falter. Well, globally the"wheels are coming off" the system, and the currencies of the periphery
countries are getting hammered. Sure, politician, pundits, and citizens of countries such as Canada,
Australia, Brazil, South Korea, Taiwan, Argentina, Singapore, Thailand, and elsewhere can easily
come up with domestic explanations for their currency and financial woes, but the root of the
problem lies outside, with a dysfunctional global financial system. The earthquake (the"Big One")
has now begun and, alarmingly, the foundation of the system is beginning to buckle after only the
initial minor tremors……

We also have little doubt that derivative players are and will continue to play a prominent role in the
unfolding crisis. They have willingly become"receptacles" of enormous market risk - equity,
currency, interest-rate, credit - in what will prove a great failed experiment with sophisticated"risk
management" techniques and vehicles. If the true story is ever told about these derivative markets,
the storyline will be much more about reckless leverage and speculations than managing risk. And
with global positions surpassing $100 trillion, the derivative marketplace is very much a"weak
link" in the acutely fragile global financial"daisy chain." If one major derivative player falters,
perhaps a Japanese institution, then the entire frail system is in jeopardy….

( Midas insert - this is why gold was trashed this week )

So far, the US dollar wins by default, with the periphery currencies under intense liquidation. For
now, this is much more about market dynamics than underlying fundamentals. Still, there remains
the strong but erroneous marketplace perception as to the soundness of the U.S. financial system….

So, especially with a faltering yen and the Japanese financial system in tatters, the great global
leveraged speculating community is even more comfortable with the US credit market as the"place
to play." Moreover, a confluence of factors including the crowd behavior of the speculators,
heightened global risk aversion leading to a liquidation of"periphery" assets, and a massive
derivative position overhang exacerbating market direction - whatever that direction might be, finds
us today in the midst of a severe global currency market dislocation. It’s a dollar"meltup." …..

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