The danger for small currencies

A problem I've been meaning to address is the problem for smaller countries that have their own currencies, for example Sweden. Looking at what is happening in the world, we can make two rather disturbing reflections : Both the USD and EUR are pretty crappy currencies. For a while now, they have been taking turns getting beat down, while the smaller currencies have gained on them both. The problem comes if there is an all-out currency-panic.

Imagine for a while that 2008 comes in repeat, but since banks cannot fail and all debt will be bought, it is faith in currencies that disappears instead of faith in banks as counterparties. With the forex market trading trillions and trillions of currency everyday, the question is - what will traders do? And what will everyone who sits on currency hedges or swap lines or derivatives or any other form of financial position not backed by something tangible do?

If the EUR and USD jointly start falling rapidly (the risk for the EUR is still seen as the solvency of the underlying governments and not as an inflationary one), I think things could become very unstable. If the ECB continues its stealth monetization, and suddenly price inflation at the consumer level breaks out in Europe as well as the US, is it unthinkable that we get a EUR/USD rate that fluctuates within a spectrum, but rapid declines for them both against other currencies?

The natural reaction to this by smaller central banks is obvious. They will be under political pressure to inflate as well, to push their currencies down. Both Japan and Switzerland has done it recently, and China does it continously. What I fear is that those who resist will see speculative "counter-runs" on their currencies, meaning that traders figure they will appreciate rapidly, and enormous amounts of money flow into these smaller currencies, turning it into a self-reinforcing spiral. What do central banks do then? Again, I suspect that they will buckle under the pressure to inflate.

The problem is that with floating exchange-rates, smaller countries are very reliant on what the larger currencies do. And currently the worlds largest currencies are all used to monetize government debt. Thus, while I see less risk for massive inflation in smaller countries, we might not be as insulated as we think. The same thing, by the way, goes for government bonds - the difference being that it MIGHT be somewhat easier for small governments to resist printing up bonds just because the yields are approaching the zero-line (if large-country bonds turn sour, investors will scramble for any solvent government's bonds)

What panics bring is volatility, something that 2008 clearly proved. I remember logging on to the internet every morning, and seeing flashing headlines of 10% up! 10% down! Bottom is near! No bottom in sight! Panic in the henhouse, sort of. It is hard to imagine what would occur if this happened to the entire fiat currency spectrum. I am sure that politicians worldwide would announce the tying of this rate to that rate, but not until the situation got completely out of hand and started destroying commerce would anyone do anything real to solve it.

And this is why I am a constant gold bull, if I haven't mentioned that before. Gold is pretty worthless to eat, but it will keep its value while everything else fluctuates madly. Like that Glenn Beck says - don't buy it as an investment, buy it as an insurance policy. And I can tell you, I'm levering up on all the insurance I can get, until we see some real change in the world economics.