Undeterred by the global currency war being waged through the foreign exchange market, or the speculative bets against its own currency, the Treasury has proposed to exempt the multi-trillion dollar forex swap market from regulatory scrutiny:
The Treasury Department Friday announced that, as expected, it is proposing to exempt the $30 trillion foreign exchange swaps and forwards market from central clearing and exchange trading requirements that will apply to the other 95% of over-the-counter derivatives transactions.
Rather than formally telling the U.S. Commodity Futures Trading Commission of the exemption immediately, as allowed under the Dodd-Frank law, the Department is calling for another 30 days of comments and, officials said, not speculating as to whether any final modifications could be applied because of those comments.
Failing to regulate the enormous currency exchange market will leave the U.S. economy in an extremely perilous position. The combination of monetary stimulus and record-low interest rates have made the U.S. dollar an easy target for a bear raid:
The sell-off in the US dollar continues apace. Bearish bets by investors against both the economy and credit standing of the world’s reserve currency are pushing the dollar to within sight of record lows.
The latest losing streak has run for the past seven days, a small chapter in a broader sell-off that has flowed since last summer when the first inklings of further quantitative easing, or QE2, by the Federal Reserve emerged.
Bernanke's cheap money spigot has been a gold mine for Wall Street while the real economy is crushed under the weight of rising assets:
For investors, he offered further encouragement to keep borrowing in dollars, paying virtually nothing and then swapping those dollars into higher-yielding currencies or using them to buy oil, metals and food futures and options.
This so-called "carry trade" has become the trade du jour, particularly with the dollar's precipitous drop of around 10 percent from its peak in January.
The danger lies in the inevitable unwind of the carry trade, which has already caused the total collapse of one nation's currency during the financial crisis:
Iceland is getting used to this. Over the past six months its currency has collapsed, its largest banks have all failed and been nationalized, and its economy has imploded. Today the tiny (pop: 320,000) nation became the first to lose its government to the global financial crisis. Addressing the press, Iceland's Prime Minister Geir Haarde announced the resignation of his cabinet and the collapse of the current coalition government.
What happened in Iceland can take place here. In 2008, it nearly did. The massively leveraged FX swaps market suffered a nearly catastrophic loss, exacerbating the severity of the meltdown and facilitating a multi-trillion dollar bailout:
The recently released data by the Federal Reserve Bank (“Fed”) prove that the foreign exchange markets were on the verge of collapse days after the financial crisis began in September of 2008. The new data also prove that only massive, emergency and unlimited Fed intervention in the foreign exchange markets prevented the collapse. The Fed's actions to save the foreign exchange markets were an essential part of its overall plan to stop the uncontrolled run on and prevent the failure of the entire shadow banking system. Thus, the data refute the claim that the foreign exchange markets performed well during the financial crisis and should be exempt from regulation.
The new data show that the foreign exchange markets in the fall of 2008 froze and were likely to collapse, just like the repurchase (“repo”), money market, commercial paper, and the other parts of the shadow banking system. The same counterparty distrust that threatened those other markets also froze the foreign exchange markets and liquidity quickly evaporated. As in those markets, the Fed had to bail out the foreign exchange markets with more than $2.9 trillion in October 2008 alone and with more than $5.4 trillion of foreign exchange swaps in the three months following the Lehman Brothers bankruptcy.