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Don’t Get Caught in Ecuador Without Cash.

I have been caught in a foreign country without cash twice… so please read this message carefully.

First time was in Singapore… 1971. The US dollar was unhinged from gold for the first time and devalued.  I had plenty of cash… greenbacks but nobody would take them.  That only lasted a day but scared the heck out of me.

Then this happened again in Ecuador… 2000. All the banks went bust!  Everything financial shut down and for a week one could not get a penny.  This can be scary… even dangerous… and this is why I say do not leave all your money in Ecuador banks.  Don’t do it!

This is the year to take extra care because most investors could be 54 days from disaster.

See why and what to do about it below.

Fed charts

The peak in this chart… shows a risk that could come this year… by May 2012… 16 weeks from now.

This chart shows how in May 2009 global banking liquidity provisions rose to such a high level that they created an unintended consequence that has the potential to wipe out many investors while it enriches just a few.  The next time of great risk will be October 2012. See why below.

This note explains why this chart represents a financial overhang that like a rock trap will ravage the finances of millions who are caught when it falls… but it will also also be a bellwether of fortunes for investors in the know.

That chart by the way is totally accurate…  pulled directly and unaltered from an article entitled “International Liquidity Provision During the Financial Crisis: A View from Switzerland” in the recently issued December 2011 Federal Reserve Review.  This is the Fed’s warning of potential upcoming economic disaster.  This is a warning which is hidden in plain sight.

There is a link below so you can read the entire Fed’s report yourself… but you may find the Federalese daunting and obscured in obtuse language (I spent two days studying just two pages to try and unravel all the implications), so let me outline here why these liquidity provisions could rip the guts out of many safe investment portfolios who follow tradition.

This outline will also unveil why huge returns will come to just the contrarians who see the risk and bet again the norm.

The fact that this danger is openly outlined is unusual but the extra quirk is that this chart was published by the US Federal Reserve Bank yet shows liquidity provisions provided not by the Fed, but by the Swiss National Bank in Swiss Francs!

To understand how this creates a problem and the investing risks that may affect us all,  let’s look first to the past.

Then we’ll see where and how the future hides the risk.

In a small way I was partly responsible for starting the problem… clear back in 1986.  Having spotted how my bankers in Europe would lend me one currency at a low rate so I could deposit it in another currency at a higher rate, we published our first version of our report “Borrow Low – Deposit High”.  The report mainly featured how to borrow low interest rate Swiss francs and Japanese yen to invest in high yielding currencies like the US dollar, British pound. French franc (this was pre-euro) Mexican peso, Brazilian real.

Before this time there were certainly big banks and institutional investors already using the tactic… later called the “Carry Trade.”   I did not invent it, not even close… but I spotted its potential early on and our reports were among the first to reach tens of thousands of investors and open this idea for the little guy… smaller, individual investors  like myself.

Investors caught on and this trend of borrowing Swiss francs to invest in higher yielding deals grew so much so that in June 1999 a mechanism was created called the Swiss Repo Market to expand the ability for banks to borrow Swiss francs so they could lend them on.

The Federal Reserve acknowledges this fact in the report “International Liquidity Provision During the Financial Crisis: A View from Switzerland” and points to the problem when it says:  The authors document the provision of liquidity in Swiss francs (CHF) by the Swiss National Bank (SNB) to banks located outside Switzerland during the recent financial crisis. What makes the Swiss case special is the size of this liquidity provision—at times, 80 percent of all short-term CHF liquidity provided by the SNB—and the measures adopted to distribute this liquidity.

In the years leading up to 2007, banks across the globe dramatically increased their balance sheet exposure to foreign currencies. This led to increased trading between banks with a need to refinance in the foreign currency and domestic banks with deposits and consequently sufficient funds to lend in that currency (i.e., extensive cross-border trading).

This idea described in the report worked well for almost a decade. Investors would come to their bank and borrow Swiss Francs.  The bank would lend the low interest francs… even if it did not have them to lend… knowing that it could cover its loan in the Swiss Repo Market.

Then came the crunch.  The Fed describes it in its report like this: With the onset of the financial crisis and the successive drying-up of the repurchase agreement (repo) market and especially the unsecured interbank money market, the private sector no longer provided this liquidity, thus requiring a coordinated action by the world’s major central banks.

This was the easy part… describing the problem.  This demand to get Swiss francs to cover loan positions was a huge financial crack that made all the other complicated economic issues worse as financial systems structures and banks crashed around the world.

The Feds report: CHF-denominated loans obtained by non – banks outside Switzerland are typically granted by non-Swiss banks that, in turn, finance themselves by borrowing from financial institutions in Switzerland.  As in all bank business, these non- Swiss banks provide long-term loans yet finance themselves on a short-term basis. Their ability to roll over maturing CHF positions became stressed when the interbank money market progressively dried up following the onset of the financial crisis in August 2007, particularly after the collapse of Lehman Brothers in September 2008.  The CHF-specific spike in the cost of obtaining unsecured funds was caused by a combination of the need by banks outside Switzerland to continuously roll over maturing interbank loans and the shrinking supply for these funds. Most Swiss banks and a considerable number of non-Swiss banks have access to the Swiss repo system—the prevailing secured money market in Swiss francs. In a calm market environment, these banks would  have immediately exploited this profit opportunity and provided unsecured funds to banks without access to the Swiss repo system.

A key ingredient of the crunch was that… most borrowers borrowed short and invested long… exactly the opposite of what they should have done.  Now they had to repay Swiss francs and the non franc assets they held were crashing.  Losses were enormous and growing.

The Fed report continues (bolds are mine): In international currency markets, any bank can potentially obtain financing in any foreign currency either by going directly to the interbank money market or by obtaining funds from its central bank and swapping the received funds into the desired foreign currency. In principle, these two methods should ensure the rate at which a currency is funded is the same.  

During the recent financial crisis, however, interbank money markets temporarily faltered.

Without access to the Swiss repo system, even banks with ample collateral could not obtain secured funding from the SNB or the secured interbank market.

There you have the crux of the problem.  The system that gave access to Swiss francs melted down. This created huge additional potential losses that could have destroyed the already weakened European (with threads back to the USA) banking system. This could have added to the downwards crush in the global economy.

Here is the Fed’s explanation in the report: The lower cross-border trading could have posed a substantial danger to the stability of the financial sector at large.  If banks across the euro zone and CEE were unable to obtain CHF in the money market, then non-Swiss banks, in turn, could try to reduce their exposure by liquidating CHF loans they had made to their clients.  Given the banking tensions at the time, this move would have driven many debtors into default and could have started a disorderly winding-down of CHF loans, with increasing default rates implying the need for additional loan-loss provisions, thereby increasing pressure to liquidate CHF exposure.  This vicious cycle could have had dire consequences for the banking system and the real economy.

The Fed and other central banks had to find a stopgap for this problem which was a bigger problem for every country because of the Swiss Franc angle.  This is also explained in the Federal Reserve report:  The drying-up of liquidity distribution in foreign currency posed a problem more challenging than the breakdown of the domestic interbank money market: No central bank, on its own, can provide a large amount of liquidity in a foreign currency in a timely manner.

So what could the central banks do?

They hung it all on the Swiss.

Here is how the Fed describes the resolution in its report:  To overcome this market friction, the SNB jointly announced with the ECB and subsequently with the Narodowy Bank Polski (the National Bank of Poland) and the Magyar Nemzeti Bank (the central bank of the Republic of Hungary) that all these central banks would directly distribute CHF-denominated funds to their counterparties.

That is what the chart above and this chart (also take unaltered from the Fed report) explain.

Fed charts

In essence the world let the Swiss National Bank become a second central bank for the European Central Bank (ECB),  National Bank of Poland (NBP),  as well as the Central Bank of the Republic of Hungary (MNB).

This worked for that moment but created a huge financial rift for the times ahead.

So let’s speed ahead into the future… now and onto May 2012.  May I first add the fact that if we get past May… we might breathe a little sigh of relief but the problem will not end there.  The next large window of risk will come in October 2012.

Anything can happen at any time but now until May is when the risks are the highest until October 2012 when risk will rise again.

This future problem is described also in the Fed’s report which says: While the exchange rate interventions were part of the SNB’s unconventional measures to avert deflation risks in Switzerland, an unintended side effect of the interventions was the resolution of the international CHF liquidity shortage:

The supply of the additional CHF 150 billion is available to the banking system on a permanent basis and, consequently, the majority of banks are awash with CHF liquidity.

Our excerpts here of this Fed report ends with: The size of the exposure has raised many concerns about the financial stability of the banking sector, given the possibility of continued CHF strength or even appreciation.

There you have it.  The problem in 2009 was the banks did not have any Swiss francs. When they lent the Swiss Francs which they did not have, this created a potential liability if the Swiss Franc rose…which it did.  The problem now is that non Swiss banks are awash with 150 billion Swiss francs and no place to invest them.

This creates an overhang that could crush traditional investors like a rock trap who follow the investing norm and pull the stick.


This is why I have just created a report “The Swiss Trap” for my Multi Currency subscribers and would like to offer this report to you.

The Swiss Trap describes the problem above… includes the total Federal Reserve Report and describes what could happen in the next euro crunch…. most likely to start around March 20, (54 days from now) when Greece defaults on the 18.5 billion dollars it owes bondholders that day.

Bloomberg Businessweek described the problem in a recent report “A Greek Default: You Can Mark It on Your Calendar” that says:  Negotiations over how to shrink the Greece’s unaffordable government debt make the brinkmanship over the U.S. debt last summer look simple.

A Bloomberg report also says: ‘Disorderly Default’.   Talks between Greece’s Prime Minister Lucas Papademos, Finance Minister Evangelos Venizelos and Charles Dallara, the managing director of the Institute of International Finance, which represents private creditors, will resume Jan. 18, according to a Greek Finance Ministry official who declined to be identified.

Greece’s creditor banks last week broke off talks after failing to agree with the government about how much money investors will lose by swapping their bonds.

“We remain concerned that Greece may suffer a disorderly default in March,” Mansoor Mohi-uddin, chief foreign-exchange strategist at UBS AG in Singapore, wrote in a Jan. 14 note. “A Greek default would have a major impact on the euro as it would spread contagion to other bond markets in the euro zone.”

Contagion is the euro zone is the problem.  Greece’s default is a forgone conclusion but the worry is how far has the rot spread?  Will Portugal and then Spain also falter… perhaps even Italy and now France’s debt has been downgraded!   All these concerns could cause the euro to fall.

The Trap is Set

The falling euro will set the trap which is described in our report,  “The Swiss Trap”. This report descibes why the problem exists… the trap and  how it can destroy the savings, investment and speculations of millions of investors.

Avoid the Trap and Profit Instead

The report also describes how to avoid the Swiss Trap and earn profits with a little known investing vehicle called an ETP…not to be mistaken with the ETF.

ETPs are shares traded on the London Stock Exchange (LSE) available to all investors large and small.  Investors can invest millions or as little as $1,000.

ETPs are similar to ETFs.  The “Swiss Trap” describes the differences… and how these alternate features allow investors to profit from the 150 billion dollar Swiss Franc Overhang.  Plus this report names brokers in London and the US who can purchase these ETPs for you.

If you are a Multi Currency Portfolio subscriber, read the Swiss Trap at your password protected site here.

Not a Multi Currency Portfolio subscriber?

Subscribe to our multi currency portfolio service and get the password, Swiss Trap, free.


Here is one more way to read the Swiss Trap free now.

Enroll in our February 10-11-12, Super Thinking + Investing and Business seminars and I’ll enroll you as a Multi Currency Portfolio subscriber for a year FREE.