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     Aug 11, 2012


CHAN AKYA
Death of the dollar
By Chan Akya

There is an old joke from Israel at the time of the first Gulf War, after national radio announced that the chances of any Israeli being hit by a Scud missile launched by Saddam Hussein was about the same as the probability of winning the national lottery. "Oh yeah," deadpanned a comic, "but they didn't tell us there would be three draws daily".

Amidst all the hoopla of the Olympic games, bankers in London will probably be thinking something similar after the scandals around Barclays and HSBC (see my previous articles "Who put the lie in Libor", Asia Times Online, July 7, 2012, and "Laundry of your choice", Asia Times Online, July 21, 2012) have now led to a scathing report about London-based bank Standard Chartered

 
involving alleged violations of United States sanctions on Iran. The Department of Financial Services (DFS) in New York, one of the alphabet soup of banking regulators in the US, went so far to declare the bank a "rogue institution".

This is sensational stuff, but unfortunately also sensationalist in my opinion. Firstly, Standard Chartered is a well-run bank with an excellent top cadre of managers most of whom have been promoted from within the ranks of what is essentially an emerging markets bank with a strong focus on Asia and Africa. In that respect the bank is very similar (but arguably not as solid) to the core management principles of HSBC, another London-based giant.

Secondly, the amounts involved in these alleged breaches are miniscule: some US$14 million in remittances that were not fully compliant with the US rules and "may" have violated sanctions, according to the bank. The DFS statement of course claims much larger sums - up to $250 billion (casting aspersions on the entire gamut of a type of remittance from the Middle East) - and alleges other irregularities such as in "know your customer" policies and (perhaps most damaging) that the bank wailfully attempted to circumvent US sanctions.

Thirdly, I personally find it distasteful that US regulators are able to make allegations public without having to subject their suspicions to rigorous court processes. While a number of such allegations do end up with convictions, there is also growing evidence that banks in particular simply choose to settle the issues with the regulators albeit without admitting guilt while paying financial penalties (Goldman Sachs and Citibank are two US-based banks that certainly appear to have a history of such settlements).

The problem with such settlements of course is that we as members of the public never really know if the settlement was intended by the banks to repair potential reputational damage from a long-drawn out court trial, or was guilt actually involved. More troubling, once you have one bank or company agreeing to such a settlement, regulators are usually incentivized to pursue the same strategy with other targets even when the body of actual evidence is quite small and inconclusive.

As an example, the DFS has cited the outburst of a particular employee of Standard Chartered from their London office who abused Americans, and questioned the need for the rest of the world following US sanctions. This is an entirely logical point of view for non-Americans to have and by itself doesn't mean that a "crime" is being committed against the US. More importantly, the fact that the DFS played up this particular juicy titbit appears (to me) to suggest a strategy to sensationalize a case where actual evidence on the ground may be sparse.

I don't know much more about the details of the case, nor do I wish to speculate on how it may all turn out for a pretty good bank that seems to find itself in the cross-hairs of the US regulators.

Doubts about London
There are a number of questions now confronting London's status as a financial center: firstly, it is clear that politicians in continental Europe would like nothing better than destroying the city's pre-eminent position in financial services. Partly this effort is so that European politicians could push through certain anti-market principles such as the financial transactions tax (the so-called Tobin tax being promulgated by the French) and a ban on certain types of financial transactions such as sovereign credit default swaps that they believe are centered in London.

There is of course the deep envy that German regulators feel about the sheer irrelevance of Frankfurt as a global financial center, not to mention the deep resentment felt in France that even banks that survive due to government bailouts end up having significant operations, particularly those involving higher-paying jobs out of London.

Then there is the whole question of how financial regulators have operated in the UK, essentially being accused by their colleagues elsewhere in the world (Switzerland, the US, Germany, Italy to mention a few) of allowing roguish behavior from bankers peddling fairly dangerous financial instruments (collateralized debt obligations, or CDOs, structured investment vehicles - SIVs - and whatever else have you) to unsuspecting investors elsewhere in the world. I have personally heard a couple of central bankers echoing those very thoughts about the UK's Financial Supervisory Authority.

More recently, US regulators have taken to blaming lax supervision in London for the travails of JP Morgan and its multi-billion losses on bets taken by the chief investment officer.

So, on paper at least, a number of points can be made that appear to highlight a systemic collapse of regulatory oversight in London - at least that's where the non-UK financial media appear to be pointing in their summary of the Standard Chartered case.

This is a tempting conclusion but also an intellectually lazy one.

Let us take the issue of the CDOs and SIVs that proliferated out of London but ended up damaging investors in the US, Germany, Switzerland and elsewhere. The suggestion behind the train of thought of course is that the British exported a financial opium that the rest of the world got pulled into without realizing the full costs. This is nonsensical, firstly because UK banks also suffered from the fallout - Northern Rock, RBS, Halifax - to name but a few. Even the ones that survived - Barclays, HSBC - did so mainly because of their global strength, even as their specific operations out of London were damaged massively.

More importantly, the investors in SIVs and CDOs were themselves lazy - by depending purely on a rating agency assessment of quality rather than doing their own homework, these investors simply failed to observe and follow the core principles of investing. If it hadn't been CDOs that blew them up, it could well have been something else.

The discussion around the role of London in promoting such exotic financial products also masks the regulatory and supervisory failures in the US, Germany and Switzerland to name but a few countries that were damaged. The central banks of these countries simply failed to monitor their "wards" and allowed reckless gambling on financial instruments that was eventually to fell many hundreds of thousand jobs.

Similarly, on the JP Morgan case it is clear that US regulators had nothing but praise for the London-based chief investment officer when they were making outsize profits (over 15% of the bank's total profits in some quarters) - indeed the sheer size of such profits should have invited intense scrutiny but did not because US regulators were and still are in awe of the bank and its senior management.

The case against London is weak. That doesn't of course mean that it won't succeed - if anything, I would say that chances of a knee jerk reaction from UK regulators to protect their global reputation may be quite high, with the resulting regulatory over-reach helping to destroy the city's financial services business rather effectively.

Status of the US dollar
The decline of London though may actually end up hurting the US and particularly the position of the US dollar as the global currency of choice.

There are a number of structural and geopolitical reasons for the dollar to lose its position, not the least of which is the country's yawning budget deficit and its lost wars in Iraq and Afghanistan. The effect of the George W Bush / Dick Cheney "War on Terror" is such that Muslims around the world feel rather inclined to avoid the US currency entirely. Poor Muslims may prefer the US dollar to their own currencies controlled by tottering dotards; however, there is enough evidence that rich Muslims have simply diversified from US dollar bank accounts into British pound and euro accounts not to mention physical gold.

Among exporters of oil, the dichotomy is increasing: Russia, Iran and Venezuela all prefer to avoid oil payments in US dollars entirely; getting paid in Chinese yuan through bilateral currency swaps for example. As other countries such as Libya and Iraq re-emerge as oil exporters, it is quite possible that the influence of Islamists would help to initiate similar anti-US dollar policies.

A second set of reasons for the decline of the US dollar is the diminishing influence, globally, of US financial institutions. A number of household institutions - Lehman Brothers, Bear Stearns, Citibank, Wachovia, Merrill Lynch - all have fallen by the wayside while amongst the survivors such as Bank of America and Wells Fargo there is a clear tendency to go "back to basics", ie the core US business, while eschewing their non-US presence. A number of financially strong institutions such as Morgan Stanley and Goldman Sachs no longer have the same access to global deals (and dealmakers) as in the days before the crisis.

As a financial center, London actually has been a gateway for a huge number of transactions that pump capital into the US economy. Bond, currency and rate markets essentially operate out of London - hence the recent fracas about the London Interbank Offered Rate, or Libor - while key segments of global financial services including insurance and hedge funds are based in the city. Reduce the role of London and it is very likely that the worst affected will be US financial markets as a number of market participants who are shut out of the market end up trading in other currencies such as the pound or euro, far from the prying eyes of US regulators.

A large number of Chinese, Russian and Middle Eastern banks operate out of London and evidence suggests that a large portion of this business ends up touching the US markets either through trade finance or capital transfers to US companies. Shut down their London operations and those banks will simply start using currencies other than the US dollar; they will simply not risk moving those businesses directly under the nose of US regulators.

Meanwhile the US stock market is itself in bubble territory, with underlying economic weakness being masked by one-off gains in profits and remittances that have helped to flatter results. Weakness in Asia and Europe has not been fully factored into US earnings; I therefore expect a significant downturn in equity valuations over the next six months or so.

Political rhetoric in the US isn't helping matters either, as the upcoming presidential election appears to cast further aspersions on US attitudes towards China. Already, there is clear evidence that China has been selling its US dollar furiously; any move towards trade wars (candidate Mitt Romney promises to label China a "currency manipulator" on the first day of his Presidency) only makes matters worse for the US dollar.

I wrote on the subject a long time ago (see "Dead Dollar Sketch", Asia Times Online, March 4, 2008). In the intervening years, the decline of the euro has helped to increase global acceptance of the US dollar as the next easy choice. History reminds us though that, time and again, the lack of alternatives is never a sufficient reason for the status quo to remain intact.

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