Free Fallin'

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The Nikkei peaked at 38,915.87 on December 29, 1989.  For years, it's been a watchword warning to people who say "in the long run, stocks always go up"; in the past two decades, it has struggled back towards 20,000 several times, but never anywhere near its former peak.  Today, it went even further, falling to a 26-year low.  The yen has been strengthening fast against the dollar and other currencies, which is very bad news for Japanese exporters. 

It's also wrecking the carry trade.  That's when you borrow at low interest rates in one place just to lend at higher rates somewhere else.  For a long time, Japan has been a popular place to do this, for two reasons:  the longtime recession has kept its interest rates low, and the government's committment to keep the currency cheap in order to subsidize exports has seemed like a shelter against a sharp currency move that would force borrowers to repay the loan in suddenly-more-expensive yen.  Now that the yen is rising seemingly uncontrollably, investors are racing to unwind their positions.

The sharp movements in the currency market are somewhat surprising, particularly the euro's decline.  Not very long ago, we were asking whether the euro would replace the dollar as the world's reserve currency; not it's the "sick man of Europe", as confidence in banks and businesses has been badly shaken.  Europe took on less mortgage risk than the US, but much more emerging markets exposure, which is looking like a very bad bet with commodity prices plunging and credit contracting.

All of this seems like a pretty stinging rejoinder to the notion that the problem is simply a failure of regulatory stringence.  The problems have spread across regulatory regimes, currencies, and banking systems; besides Canada, not a single large economy has escaped.  Perhaps the problem is Basel II--having a unified standard may have left us more vulnerable.  But there's something here deeper and more frightening than a lack of adequate rules. 

Update:  Tyler Cowen has more on the problems European banks have with emerging market exposure, and adds:

By the way, this is further evidence that the driving force behind the earlier boom was the global savings glut, and sheer giddiness, not the excessively loose monetary policy of Greenspan's Fed.  The ECB has pursued a relatively tight monetary policy since its origin.  It also will be interesting to see what trouble arises in Spain, since Spanish banking regulation has been considered a model of how to keep these problems under control.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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