All Intensive Purposes

It was an odd week in the currency markets:

[I]n possibly the ultimate example of the butterfly effect, this weeks ructions in Reykjavik snowballed across the globe, setting off an avalanche of sell orders in emerging markets from Brazil to Indonesia.

The catalyst for chaos initially seemed to be country-specific. Fitch Ratings down-graded Iceland's debt, citing an "unsustainable" current account deficit, drawing parallels with the imbalances that helped trigger the 1997 Asian crisis.

The Icelandic krona promptly tumbled, losing 9.3 per cent of its value against the US dollar in a day-and-a-half as it slid to a 15-month low. Icelandic stocks and bonds also headed south.

But the icy blast spread as far as the tropics, and indeed every corner of the emerging market jungle, prompting the Brazilian real to fall 3 per cent, the South African rand more than 2 per cent, the Indonesian rupiah and Polish zloty 1.5 per cent and the Mexican peso and Turkish lire 1 per cent.

The contagion was primarily due to traders' need to liquidate profitable positions in order to fund their Icelandic losses.

Steve Johnson, "Iceland in focus for wrong reasons," Financial Times 12 (Feb. 25-26, 2006).

Iceland's population is a shade under 297,000 -- more than 100,000 fewer people than live in East Baton Rouge Parish -- and yet because they have their own currency, the Icelandic government's management of its debt affects people from Poland to Indonesia.

Currency markets make for great metaphors: "snowballed . . . avalanche . . . icy blast . . . emerging market jungle . . . contagion."