Currency Wars

[Magox]

It's sort of a long read....

 

CURRENCY WARS

 

We addressed this topic in the last newsletter RACE TO THE BOTTOM; where developed nations economies such as the U.S, England, Japan and the Euro zone were all seeking to competitively debase the value of their currencies in order to artificially stimulate their own economies through exports. As we have noted, there is little hope in domestic demand for goods and services in each of these countries, so their best hope for growth is to cater to the needs of the economies that are growing such as China, Brazil, India and Russia; and devaluing their currency is one way to remain competitive.

 

However, over the past few weeks a new dangerous dynamic has begun to occur, and that is the rhetoric coming out of the G-20 Nations (which are all of the big countries in the world) is heating up. None of these countries want to see the value of their currency get hammered, but this is precisely what we foresee in the future. The problem is that if Japan devalues its currency then the pressure is on for the U.S to do the same, and if the U.S goes through with this policy of currency debasement, then the pressure for the Euro zone to do the same increases and of course the Brits have to follow through with their currency devaluation strategy and naturally everyone ends up pretty much where they began. What makes this potentially worse, and in our view likely to occur, is that each of these economies will continue these strategies with a whole new round of currency debasement policies and we go through the same vicious circle with the very same result.

 

So what are the side-effects of these policies? We know the benefits, you get increased exports through competitive currency valuations (at the expense of immediate inflation in the emerging markets), you get a boost in domestic demand through lower interest rates and increased liquidity (although I believe it to be a negligible boost), increased short-term confidence for the capital markets (stocks), and banks get to repair their balance sheets through basically free money from the fed.

 

But for every benefit there is a cost. The obvious cost is that when you devalue your currency the cost of commodities goes higher, which of course leads to inflation. The price of oil today is at $85 a barrel, the cost of grain commodities such as wheat, corn, and soybeans are all soaring, the cost of OJ, cocoa and coffee are rising, cotton is near all time highs, and Gold and Silver are going through the roof, currently standing at $1360 oz. for gold and $23.40 an oz. for silver.

 

While the Federal Reserve and other CNBC stock cheerleaders will tell you that there is no inflation and that we have to fight deflation, the reality is that there is inflation for everyday people such as you and me. Think about it, what do you spend money on? Gasoline to go to work, food for your family, clothes, heating and air conditioning, plastic products, anything that you buy at the store (every store that sells a product has to have it shipped to them which means that they use diesel fuel to get there), health care, college tuitions, etc, etc. Yeah ok, no inflation my ass! The worst part about this currency devaluation policy is that this hurts the low to middle-income earners more than anyone, especially people from the developing nations such as China and India. Why? Because food, clothes and energy make up a much larger portion of their disposable income than upper-income earners, so when these prices go higher it leaves these folks with less to save and spend on other items.

 

Another side-effect is that as these nations look to devalue their currencies they take on policies that lower interest rates across the board which means that many folks who are averse to taking risks and usually park their money in savings and money market accounts are now getting hammered because they are earning next to nothing with these accounts. They earn MAYBE ½%, meanwhile their daily living costs are rising significantly more than these measly savings rates. The other safe-haven investment is US treasury bonds. Well, there are two potential and likely problems with this; one is that just as with the savings and money market accounts, the interest earned is tiny, while the other problem is that these Bonds are priced extremely high and at some point there will be a more sustainable recovery that will take hold and inflation WILL TAKE HOLD, even in the eyes of FED. It may take years but it will come, and when that happens the value of these bonds will get crushed and people will rush out of bonds and move in a significant way to riskier assets that perform well under inflationary pressures. Meanwhile, these folks who wanted to preserve their capital through investing in bonds will end up with an outcome that they never envisioned.

 

Which now leads us to the CURRENCY WARS; and we mentioned that the rhetoric has been stepping up lately from the G-20 Nations. Everyone is fearful of currency devaluation across the board and PROTECTIONISM. Yes, protectionism, I dont know if any of you studied the effects of theSMOOT-HAWLEY Tariff Act of 1930 which basically was a protectionist measure that took place after the initial 1929 Stock Market crash that increased tariffs on over 20,000 imported goods in which many economists believe heavily contributed to the Great Depression. Well folks, there is a possible repeat in the future. I dont believe we will see anything this dramatic, but rest assured there are tensions in the air and there are special interest powers such as the Unions and populist anger of jobs that are being shipped overseas that do play a part, because at the end of the day politics becomes a huge factor in determining trade policy. There was a poll that was released several months ago that found:

 

 

 

Seventy-four percent of self-described Tea Party Supporters would support a "national manufacturing strategy to make sure that economic, tax, labor, and trade policies in this country work together to help support manufacturing in the United States", according to the poll, put out by the Mellman Group and the Alliance for American Manufacturing. Likewise, 56% of self-described Tea Party Supporters "favor a tariff on products imported from other countries that are cheaper because they came from a country that does not have to comply with any climate change regulations in the country where the products were made." The poll also shows that President Obama's approval rating is 11 points lower among households where a family member is employed in manufacturing than a household where no one is employed in manufacturing. That underscores a trend already noted: those most affected by the Democrats' failure to deliver on their promises of trade reform are turning against the Democratic Party.

 

So as you can see there is a lot of anxiety out there for job creation. The president realizes this and so do the Republicans; the question is how are they going to move forward together (talk about a lofty goal) in creating jobs? Both parties recognize that one way to do this is by boosting our exports, and currency devaluation is one way to help achieve this goal. The other is to punish those evil currency manipulators (The Chinese, who truly arent evil). Well, the House of Representatives (or as I call them, the populist loony asylum) have already passed a bill to punish the Chinese because of their currency policies which would open the door to extra duties on Chinese goods entering the United States. The telling part about this bill was that it wasnt that all of the democrats voted for this bill, but that 100 republicans signed on as well. Why did they do this? Well, look at the poll up above.

 

I truly believe that these loons dont understand the disastrous ramifications of these policies. Havent they learned from the past? Dont they understand that when you push the Chinese they push back harder? These sorts of these things can have a snowball-effect in which one country slaps tariffs on one, the other retaliates, and then we are off to protectionist war. Oh, and btw folks, currency devaluation IS A PROTECTIONIST MEASURE.

 

Check out some of the recent comments:

 

Brazils Finance Minister Guido Mantega, a delegate to the International Monetary Fund annual meetings in Washington this week, said on Sept. 27 that theres already a worldwide currency war.

 

Canadian Finance Minister Jim Flaherty, who chairs the G-7 meeting tomorrow, said yesterday that there are concerns about interventions in currency markets.

 

China has to redirect its policy to a more domestic- driven growth and having less dependence toward exports, Luxembourg Prime Minister Jean-Claude Juncker, who chairs a panel of euro-area finance ministers, said in an Oct. 5 interview.

 

These recent events are illustrative of the fact that the pressures for adjustment are building, Bank of Canada Senior Deputy Governor Tiff Macklem, 49, said in an Oct. 6 interview. The stakes are getting higher.

 

Trichet who is the Central Bank Chief for the entire Euro zone recently stated that Beijings move to make the renminbi more flexible was not exactly what we would have hoped ourselves.

 

Theres a real danger of a more unilateral approach taking hold, said Mansoor Mohi-uddin, the Singapore-based head of global currency strategy at UBS, the worlds second-biggest currency trader. There will be more countries outright intervening and others inadvertently weakening their currencies.

 

All this serves to highlight the tensions building, said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp. in London. The camps are composed of those who believe in the need for greater discipline in the currency markets and those who believe that official interference leads to ever increasing distortions, he said.

 

Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York, said he thinks countries at this time are mostly trying to slow the ascent of their exchange rates, rather than actively undermine their neighbours. Still, theres a risk the rhetoric could become a self-fulfilling prophecy, he said. If you think its a currency war, youll act like its a currency war it leads to a downward spiral, Mr. Chandler said.

 

Treasury Secretary Tim Geithner yesterday said a damaging dynamic of large economies keeping their currencies undervalued can cause quicker inflation and asset bubbles, and restrict growth. Oh really Tim? Well no kidding, how about leading through example, Timmy? Maybe he should have a conversation with Mr. Bernanke and other central bankers and tell them to stop devaluing their currencies. It isnt a coincidence that these asset bubbles occurring in oil, food and other commodities began to rise significantly when all this talk of currency devaluation began to occur. The proof is in the pudding, since the latest round of QE or the serious mention of it here in the U.S began, oil has risen 15%, the grains market 20%, soft commodities 15% and Gold 10%.

 

Though they may say theyre just trying to revive the economy and believe in a strong dollar, there are plenty of people outside the U.S. who would point the finger fairly directly and say this is evidence the U.S. is following a policy of benign neglect of its currency, said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp.

 

In response to Timmys and other Currency debasers comments, Chinese Prime Minister Wen Jiabao fired back with his view that a rapid increase of the Yuan would hobble Chinas economy, dealing a fresh rebuke to U.S. and European calls for a higher exchange rate.

 

And warned,

Do not work to pressurize us on the renminbi rate…Yes, we are going to proceed with the reforms, If the Yuan isnt stable, it will bring disaster to China and the world, Wen said. If we increase the Yuan by 20 percent to 40 percent as some people are calling for, many of our factories will shut down and society will be in turmoil.

 

So basically the message Wen Jia Bao had was:

 

Europe shouldnt join the choir (namely the U.S). And Do not work to pressurize us on the renminbi rate

 

When the Chinese say back off, they mean it, and it would be foolish to believe that they wouldnt retaliate…

 

To make things worse, the emerging market nations of Brazil, Russia, India and Russia recently came out with a statement of unity:

 

Brazil, Russia, India and China will put up strong resistance to attempts to make a harsh appraisal of currency controls at the annual meeting of the International Monetary Fund and World Bank this week in Washington, Deputy Finance Minister Dmitry Pankin told reporters late yesterday.

 

The BRIC countries have agreed on a position that exchange rates arent themselves a problem, Pankin said. Rather they are a consequence of deeper processes, such as tendencies to save, to invest, of the investment climate.

Just in case anyone was wondering, who do you think has the leverage? The countries that are struggling to grow or the ones who are thriving? I dont know about you but my money is on the ones that are growing.

 

It appears to me that we may have an old fashioned Show Down at the OK Corral. Everyone better pray that this doesnt accelerate into an all out protectionist war, because one things is for certain, if one did occur, WE ALL LOSE and say hello to the GREAT DEPRESSION II.

 

Will there be a currency war? I dont know, but I would definitely say there will be currency skirmishes and one thing is certain, the value of currencies will continue to plummet relative to commodities and the one's who will ultimately pay are the very one's who are struggling today....

Edited October 12, 2010 by Magox

[Pine Barrens Mafia]

Without our markets, there is no growth in China.

 

So, how exactly SHOULD we respond when the Chinese refuse to let the Yuan float on its own?

 

I'm generally NOT for protectionist measures. They tend to harm more than help, but how is it that American firms can compete when the Chinese do NOT compete on the same field (i.e. environmental/labor/safety regulations)?

 

 

 

[Magox]

Without our markets, there is no growth in China.

 

So, how exactly SHOULD we respond when the Chinese refuse to let the Yuan float on its own?

 

I'm generally NOT for protectionist measures. They tend to harm more than help, but how is it that American firms can compete when the Chinese do NOT compete on the same field (i.e. environmental/labor/safety regulations)?

The Yuan argument is a bogeyman. We have a trade deficit with over 90 different countries, that is a fact. Does that mean there are 90 other countries out there that are unfairly keeping their currency depressed?

 

The issue is twofold between China and the U.S.

 

The real problem is that export-reliant China has been under-consuming for 30 years while the United States has been overspending for too long, that is what has to change. Look at our savings rate, specially compared and relative to others, right before the 2008 crash we had a savings rate of 0%. We are a nation of spenders and if we want to avoid having huge trade deficits then we need to structurally change that pattern, meanwhile China has to fuel it's domestic demand, which that is what they are attempting to do through many different measures.

 

You should google Stephen Roach, he is Morgan Stanley's Asia economic chief. He is brilliant and he understands this as well as anyone.

Edited October 13, 2010 by Magox