major currency 'death spiral'

[Cees Binkhorst]

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http://www.marketwatch.com/story/einhorn-bets-on-major-currency-death-spiral-2009-10-19

Oct. 19, 2009, 2:39 p.m. EDT
Einhorn bets on major currency 'death spiral'
Major institutions should be broken up if necessary, Greenlight manager says

By Alistair Barr, MarketWatch

NEW YORK (MarketWatch) -- Greenlight Capital is betting on the possibility
of a major currency collapse and a surge in interest rates, the hedge-fund
firm's manager David Einhorn said Monday, citing ballooning government
deficits in some of the world's most developed countries.

Einhorn, who warned about Lehman Brothers' frailty before it collapsed
last year, also said financial institutions that are deemed as "too big to
fail," such as Citigroup Inc. , should be broken up.


Greenlight has been buying physical gold this year because Einhorn is
concerned that efforts to save the financial system and fuel economic
recovery are undermining the value of such currencies as the U.S. dollar.

On Monday, he said Greenlight has added new trades to this investment
theme, buying long-dated options on much higher interest rates in Japan
and other developed regions -- effectively giving the firm the chance to
make big profits from a jump in rates. The options, bought from major
banks, are tied to interest rates four to five years out, Einhorn noted.

"Japan may already be past the point of no return," he said during a
presentation at the Value Investing Congress in New York.

Japan's debt is equal to 190% of the country's gross domestic product and
its government deficit will be 10% of GDP this year, according to Einhorn.

Japan has been able to borrow money at roughly 2% a year to finance these
deficits, partly because the country has many savers willing to buy
low-yielding government bonds. However, some of these savers may begin
spending instead as they enter retirement, Einhorn argued.

"When the market refuses to refinance at cheap rates, problems emerge," he
said, adding that this could trigger a "currency death spiral."

Interest rates have been very stable in Japan for years, so the options on
higher rates that Greenlight bought were relatively cheap. Einhorn said
the "asymmetry" of that trade was interesting: If rates were to jump
suddenly in Japan, Greenlight stands to make "multiples" on its positions.

"There remains a possibility that I'm wrong, and I hope I am," he
commented. But earlier in the speech he remarked: "Just because something
hasn't happened before, that doesn't mean it won't."
Remedy to shore up system

Einhorn also compared potential problems in sovereign-debt markets to the
financial crisis that engulfed markets last year.

When Lehman collapsed, investors reacted by dramatically increasing the
cost of borrowing for rival Wall Street firms to the point where their
business models were threatened, he Einhorn. The collapse of any major
currency could have same impact of rerating the cost of financing
governments in deficit.

Unlike Japan, the United States isn't past the point of no return, the
fund manager stressed. However, he criticized financial-reform proposals
pushed by Treasury Secretary Timothy Geithner, arguing they provide a
government backstop for the largest institutions, entrenching them
further.

No institution should be too big to fail, Einhorn contended. "The real
solution is to break up anything that fails that test. Lehman shouldn't
have existed in any size to threaten the financial system."

The same applies to Citigroup and Bear Stearns, which J.P. Mortgage Chase
& Co. acquired, as well as American International Group Inc. and "dozens"
of other firms, he said.

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