Saturday, July 07, 2012

LIBOR and US Dollar

The ongoing Libor scandal is interesting to watch for other reasons as well.

First, Libor is benchmark against all the debt-risk is priced. Ok, Us treasury yields are the main benchmark, but Libor performs quite similar function. What the scandal tells us is than since last so many years this benchmark was flawed. Therefore, real Libor must be something different and hence the risk linked to it must be adequately readjusted.

Second, how will you readjust the risk without knowing what the benchmark should be. In geometry a similar problem occurs when there is a change of origin. When axes or origin are/is changed the coordinates make no sense unless you know the coordinates of new origin as per the old axis. It creates a hell lot of confusion in the geometry class when this concept is taught. Same confusion can be caused in debt markets as well. Bankers will need to reprice the debt.

Same is true with US Dollar
We really don't know what is the real value of dollar but we know value of all other currencies relative to the dollar. So watch the Libor scandal unravel will point us to important lessons for dollar. So watch carefully!