The violent currency movements that have become the latest phase of the financial crisis show the continuation of the process Socialist Economic Bulletin has analysed which may be described as 'from the threat of a heart attack to the danger of gangrene'. What to look for in each unfolding latest phase of the crisis may be outlined via this metaphor.
In the first stage of the crisis the decline in asset prices, unleashing a violent liquidity crisis, meant that there was a risk that the patient would die immediately from a massive collapse of its most vital organs - its economic heart and the brain. Some of the key, system making, financial institutions entered a state of collapse. This was shown in the wave of bankruptcies and collapse of interbank lending.
This, therefore, triggered the second phase of the crisis. To attempt to ward off immediate death blood and oxygen had to be pumped into the most central organs as rapidly as possible and at any cost. This was the phase of the bank bailout packages - now totaling over $2.5 trillion dollars.
This in turn ushered in the third phase of the crisis. Starved of financial blood and oxygen, in the context of a huge diversion of resources into the central core of the system, gangrene is threatening to set in within outlining parts of the system - weaker companies within the advanced economies and the less economically strong countries as a whole. This is, therefore, producing two phenomena.
The first effect is a renewed stock market crash in the economically advanced countries as it becomes evident many companies will be severely damaged, and some may go bankrupt, due to both the credit crunch itself and the oncoming recession - while the most key banks may be bailed out most individual companies will not. The second is rapid falls in the currencies of the overwhelming majority of developing countries as funds are withdrawn from them due to fear of economic turbulence, or worse.
Two exchange rate blocs are therefore being formed. The first is a high exchange rate block with three key members. The first two, Japan and China, are in this bloc due to their competitive economies as revealed in large balance of payments surpluses. Japan's currency is rising against even the dollar, and therefore against virtually every currency in the world, while China's currency is remaining stable against the dollar and therefore moving upward with the latter against most other currencies.
The third member of the high exchange rate bloc, the US, is a member due to it being a safe haven - whatever the problems of the US it is not going to collapse and therefore funds are withdrawn from other markets to be safe there. This has the effect of temporarily stabilising the core of the system, by relatively increasing the price of dollar priced assets, but at the expense in the medium term of lowering even further the competivity of the US economy.
The second currency bloc is of countries with falling exchange rates. In this are the Eurozone, the pound, Eastern Europe and virtually every economically underdeveloped country. In parts of the latter, starved of financial oxygen, gangrene will threaten develop. Such currency devaluation itself, in the short termm becomes an element of crisis due to making it harder to repay foreign debt.
Death from collapse of the central organs has been warded off for now. But serious problems are developing in the periphery that may also spread infection to the centre.