The theme of Taipan’s Las Vegas conference was “Opportunities in a Global Cash War.” On Monday – just after the conference ended – a highly placed Brazilian official echoed the exact same idea.
Said Guido Mantegna, the finance minister of Brazil:
“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.”
As the Financial Times notes – and as we have explained many times in these pages – a weak currency lowers the cost of exports, which helps the exporting country sell more. The trouble is, not everyone can have weak paper at the same time. Currencies trade in relative terms. They are valued against one another. Dollars are always priced in yen, euros, and reals or vice versa. So if one is weak, one or more of the others must be stronger.
When countries go head-to-head in an effort to weaken the exchange rate, it’s called “competitive devaluation.” In the 1930s, the term for this was “beggar thy neighbor.”
As the WSJ reported last week,
Beggar-thy-neighbor currency devaluations proved ruinous for the global economy in the 1930s. Is the world setting off down the same slippery slope again?
Japan‘s decision to intervene in the currency market to drive down the value of the yen blew a hole in the developed world’s united effort to persuade China and other Asian countries to stop artificially holding down their currencies. Meanwhile, speculation that the U.S. and U.K. could soon resume quantitative easing has hit the value of the dollar and sterling.
As rhetoric heats up and economies struggle, governments start to lose patience with each other. This is where aggressive trade policy comes in. Part of the trouble in the 1930s was a surge of protectionism (as embodied in the Smoot-Hawley Tariff Act), which led to a collapse in global trade.
As you likely know, policies of “quantative easing” (QE) are also dilutive to a currency’s value, for the same reasons as to why taking Monopoly money from the bank makes the price of Boardwalk and Park Place go up. As countries “stimulate” at home, prices get pushed higher.
The relationship is not always simple, of course. Sometimes extra stimulation fails to push prices up, because the extra money pumped into the system gets soaked up by debt. Or sometimes the stimulation only pushes up the price of certain things – like gasoline or groceries or junk bonds – while having zero effect on, say, wages or the price of real estate.
This is why your editor favors looking at the financial system as a sort of plumbing system, with central bankers as the master plumbers. Unfortunately, these plumbers are nowhere near as skilled as the Super Mario Brothers of Nintendo fame. They often send liquidity down the wrong pipe, causing some other pipe to burst. They rarely get the liquidity just where they want it. And sometimes the pipes jam up completely, in which case the liquidity arrives in the wrong place or fails to arrive at all.
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Exporting Inflation
The other tricky thing about this whole business is, countries can actually export inflation or deflation.
For a while, the topic du jour on matters of trade was “the China price.” The China price was usually the lowest price you could find for a manufactured good, because Chinese workers were willing to produce at the lowest cost. As these low-priced goods made their way into economies around the world, non-Chinese workers found they could not compete. Thus, the influence of the “China price” was deflationary.
At the same time, and as we know all too well, China has had strong inflationary impacts on the system too. For example, it was Asia and the Middle East exporters who played a large hand in keeping the bubble going, by selling oil and “stuff” to Americans on credit and then recycling the dollars back into U.S. Treasury bonds.
When America bought, say, $100 billion worth of oil or “stuff,” China and the big oil exporters would take that $100 billion and sock it right back into U.S. Treasury bonds for safekeeping, thus keeping American interest rates low. This in turn helped the cheap credit boom continue.
America, too, has managed to export inflation quite effectively by sending its paper dollars everywhere. For example: As Brazilian farmers sell their goods in the global marketplace, they get dollars in their bank accounts. Those dollars are then exchanged, at the home bank, for Brazilian reals (the local currency). A flood of dollars coming in thus threatens to push up the value of the real, for simple reasons of supply and demand. So the central bank of Brazil has to print up fresh reals to keep the currency value “competitive.” Voila – more inflation pressure.
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The Trade Collapse Threat
And yet, lest you think all this printing is a one-way ticket to hyperville, keep in mind that a collapse in global trade – like a worldwide housing double dip – would be a very deflationary event.
If the “currency wars” get hot enough, the rhetoric among nations will turn nasty. (It already has between China and Japan, which we will explore later this week.) As retaliatory trade measures are taken, trade flows slow down or stop completely. This is bad for business and bad for the global economy. When exporters go out of business, wages are cut back and jobs are lost. Banks get hit as their exporter business loans go sour. The weight of debt hangs heavy as tax revenue and profits dry up. All this is deflationary.
Then, too, there are geopolitical factors at work that could lead to a mighty surge in the $USD just when the dollar bears least expect it – but we’ll save that topic for another day.
At this point, the only thing that can be said with firm certainty is that the ongoing currency wars will be of strong benefit to gold. The yellow metal has the unique property of being an attractive asset in times of inflation OR deflation, in part because of gold’s long-standing value as a safe haven (you could say its “brand” is thousands of years old) and because gold prices are hard to manipulate.
This, in turn, is because gold itself functions as a sort of neutral currency – a stateless one that cannot be printed. As yours truly observed at the conference,
What would it look like for the euro, the U.S. dollar and the Japanese yen to all be subject to mass printing press forces at once? The currency relationships between various currencies might stay stable, sort of like the relationship between two cars traveling at 80 miles an hour. If two or more cars are traveling fast at exactly the same speed, it’s theoretically possible for a chain linking the cars together to hold.
But certain other assets – like gold – will see prices skyrocket when the above scenario occurs. That’s because gold is the one form of “currency” that central bankers can’t conjure up from thin air at will. And in a world of macroeconomic danger and fear and persistently high unemployment, that means gold is an
