World’s End Close, Edinburgh
The events in the past week may be telling us that we could be one step closer to the end of the world. Ok, that’s a bit of an exaggeration, but these were significant events. US just lost its AAA rating for the first time. That means a loss of confidence in the US in their ability to repay their debt, and more so, a loss of confidence in the governance of the country. This has major repercussions on the financial system, especially the currency.
At the core of the currency system is trust. A currency note is only worth how much you believe it says it’s worth. If you believe a dollar note is only worth half its supposed value, and everyone thinks likewise, then it becomes so. It’s evident that the general perception of the value of the US Dollar has been on a downward trend. This spells trouble to a lot of people, especially to those holding a lot of US financial assets, since wealth held in such forms are now in greater danger of being wiped out, which happens on the day when they cannot be converted into any other forms of wealth.
The doomsday scenario that could happen is, the currency/monetary system breaks down. Everything you have in the form of cash turns into vapour. This may sound far fetched but it has literally happened before, in the Weimar Republic, where banknotes were burned for warmth.
In the near term, by logical deduction, what should happen is, as US treasuries loses its appeal, its value drops and the the yield goes up in tandem (the opposite is happening right now because there seems to be no safer alternative for parking money). There is no choice but to print more money to salvage the economy (i.e. QE3). Deflation could set in due to the slowing economy, but there is a likelihood of inflation as well, as the availability of physical resources diminish.
For SIBOR and SOR, the factors involved are the competing forces of the falling USD and rising interest rates. For now, the guidance on the Fed rates remains as to be kept at record low for “an extended period”. The current low treasuries yield is probably helping to keep SIBOR and SOR low as well. For the time being, it is looking good for SIBOR or SOR pegged mortgagees.