Many Investors Missed This Story… Did You?

It’s true that this week’s big news is the situation in Iran, and you’re likely familiar with that news by now. Frankly, there’s not much that I can add to that story at this point in time. It could affect the stock market — and I’ll be watching for that.

But I’m also watching a story many investors missed.

The story I’m watching comes out of Africa, and it reminds me of the Asian contagion market crash — the late-90s financial crisis that started in Thailand.

Currency Crisis — Then And Now

Like other Asian countries, Thailand had enjoyed rapid growth and low inflation over the previous 10 years. One reason for this was the stability of the country’s currency, which was pegged to the U.S. dollar.

In early 1997, speculators began betting that the country would devalue its currency. This is the kind of trade that allowed George Soros to make $1 billion in a single day in 1992 betting against the Bank of England.

Like England earlier in the decade, Thailand lacked the foreign reserves to support the currency peg. And the Thai government was eventually forced to float the Baht in July 1997.

The value of the currency fell rapidly, losing half its value in a month. Thailand’s stock market dropped 75%, and the country’s economy suffered.

Because Thailand had extensive foreign debt it could no longer service, the country was, in effect, bankrupt. The International Monetary Fund (IMF) arranged a bailout, but the crisis spread. The debt and currency crash hurt other Asian countries including Japan, Indonesia, South Korea, Hong Kong, Laos, Malaysia, and the Philippines. Russia was also affected the next year.

The events in Asia hurt U.S. stocks as well, culminating in the October 1997 crash.

Declines in the Asian economy led to a sharp decline in the price of oil, which fell almost 60% to a low of $10.75 a barrel in 1998. The drop in oil prices led Russia to default on its debt in 1998 and led to the infamous collapse of the hedge fund Long-Term Capital Management. The hedge fund lost almost $5 billion in four months, and a collapse of the financial markets was avoided only after the Federal Reserve organized a bailout.

The big lesson from this history lecture? Currency changes in one part of the world can — and do — affect the global economy.

So, all that said, I’m wondering why no one is mentioning the news from Africa regarding the CFA franc.

As the Wall Street Journal explained:

Fourteen nations including Ivory Coast, Senegal and Cameroon use the CFA franc, a vestige of the colonial era that was once pegged to the French franc and is now tied to the euro.

Since 1945, two central banks—one in West Africa and one in Central Africa—have printed the CFA franc. France’s Treasury guarantees that they can exchange it for euros, in exchange for the central banks placing at least half of their foreign-currency reserves in its accounts. The Treasury then invests the funds in the French stock market.

This arrangement has provided stability, but evoked concerns about colonialism last year.

In response to those concerns…

[France] decided to remove the West African CFA franc from the marquee and replace it on Jan. 1 with the eco. In addition to the currency’s name change, France will close the CFA franc’s “operating account” at the French Treasury.

The requirement that the Central Bank of West African States deposit 50% of its foreign reserves at the Banque de France will also be eliminated and French representation on the West African central bank’s board will be terminated. But Paris will continue to guarantee convertibility of the new eco with the euro at a fixed rate.

Assuming the region remains stable, these changes are not important. But if the African countries increase spending, and the currency devalues, France will have to subsidize that spending. The big question is just how much France will subsidize.

What I’m Watching For Next

This is likely to be a slow-moving story — a story that may end up carrying the same weight and significance as the Asian crisis, but unfolding over months.

It’s a long-term problem, so investors can ignore it for now. But it makes me think that the next crisis is likely to start somewhere investors are ignoring, like Asia in 1997… or Africa in 2020. The fact that we’re already facing other long-term problems — including Iran and the potential for an oil shock — tells me the crisis is likely to be deep when it comes.

My indicators tell me the crisis is not upon us yet, and we should remain bullish. After all, last week’s reaction to the news consisted of a day where prices closed down 0.4%. That’s not enough to create a concern. And while we can prepare all we want, we can’t force the market to react to these events on our timeline.

For now, the trend remains up, and we remain bullish… but aware.

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