October 6, 2009
Submitted to The Daily Bail by Janet Tavakoli
China Defaults, Currency Basket Threatens Dollar
Robert Fisk exposed revived discussions by the Gulf States, China, France, Japan, Brazil, and Russia to replace the dollar as the benchmark oil trading currency with a basket of currencies including gold within 10 years. This proposal is not new and discussions have been ongoing for decades. But other extraordinary moves in the capital markets suggest we should take this threat to the dollar’s position very seriously. For example, China has $2.3 trillion in currency reserves (about 70% in dollars), and China knows how to get its way.
In November 2008, Chinese banks said they would no longer play by our rules. Top tier banks (Bank of China and Industrial and Commercial Bank of China) reneged on derivatives contracts. They failed to come up with billions in collateral on dollar/yen FX trades, which were out of the money after the yen’s October appreciation. This should have been headline news in every financial newspaper, but it wasn’t.
Chinese banks defaulted. They may have been partially motivated by U.S. malfeasance in the capital markets that caused losses in Asia. The U.S. squandered its credibility and our cover-ups have done nothing to restore it.
Most credit support annex agreements would say that closing out these trades would be an event of default, and then the cross default on all the trades would kick in with the same counterparty. But the credit of the Chinese banks was better than many of their counterparties. Everyone was forced to renegotiate contracts with the Chinese banks.
From the perspective of the derivatives markets, this is earth shattering. What would have happened if AIG had done the same thing? (Hey, Goldman, UBS, and others…you want your collateral? Well…Stuff It!)
At the end of August 2009, China signaled that state owned oil consumers: Air China, COSCO, and China Eastern could default on money-losing commodities derivatives contracts.
If we had been paying attention, the U.S. should have done everything in its power to correct our mistakes, clean up the mess in our financial system—instead of sweeping it under the carpet—and turned our efforts to maintaining the credibility of the capital markets and the credibility of the dollar.
Janet Tavakoli Article Collection
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Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).
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