Currency Wars Set To Break Out As Volatility Grows!
- As I write this the Japanese government has asked the BOJ to intervene in the forex market and the USDJPY has rocketed from 83.0 level to 84.11 in a matter of minutes. The Japanese economy is in trouble because of the strong Yen. At 83-84 to the USD, their economy is slowing because they are not competitive.
- As the United States weaken the USD many countries have to decide what forex rate their currencies have to be at. If the currency is too strong, like the Japanese Yen, the economy will go into recession. Asian export economies like Korea, Taiwan, Japan… are most vulnerable. Although, a weakening of the USD is inevitable, most countries do not want a forex rate that will set them on the road to recession. Thus, there will be a certain forex level where the countries will start to follow the USD down in its devaluation. ie competitive devaluations.
- All fiat currencies are on the competitive devaluations route to toilet paper status. This is to make their economies competitive vis-a-vis their neighbours/competition. For America, since the USD is the world reserve currency, they cannot devalue against a specific currency. It will be a political tinder box. At some point in time when QE fails, my belief is that America will devalue the USD against gold.
- Here is how it will work. The treasury department in conjunction with the FedRes will announce that they are revaluing gold price from say $1250/oz to $10,000/oz. Effectively, they are saying, they will buy gold at a floor price of US$10,000/oz. This will be highly inflationary. The rest of the world will then decide what they want to do next. Most countries will follow suit because if they don’t their economies will collapse (due to unfavourable exchange rate). This will stimulate inflation worldwide. Fiat currencies will be bashed by gold and there will be a flight to hard assets: commodities, precious metals…
Currency wars set to break out as volatility grows
GET set for an outbreak of currency wars with the potential to shake global confidence as markets move towards the volatile October period. The long-standing debate between China and the US is again at a flashpoint, while Japan is aggrieved that China’s central bank is pushing up the value of the yen.
The investors’ flight from the euro may also gather speed under renewed concerns over the sovereign risk. The Australian dollar, which is being pushed higher as investors assess the strength of Australia’s economy and the prospect of further rate rises, is set to be buffeted by changing market assessments of risk.
A confluence of international meetings over the next six weeks will elevate market concerns into the political domain. The International Monetary Fund is meeting in Washington early next month, followed by the G20 finance ministers and central bank governors later in the month, and the G20 leaders’ summit in Korea in early November.
An attendee at a G20 meeting of finance ministry and central bank officials in Korea last week says the US and China appeared to be headed for a clash, with little sign at the meeting of compromise on either side. On the eve of the last G20 summit, held in Toronto in June, China defused a crisis by announcing it would abandon its rigid peg to the US dollar in favour of a return to a managed peg against a basket of currencies. However, after an initial rise of about 0.4 per cent, the renminbi then retraced half the move.
Westpac chief currency strategist Robert Rennie says the US may be underestimating Chinese irritation with the US Federal Reserve, which announced a fresh bout of quantitative easing shortly after the G20 summit. “China doesn’t like quantitative easing and what it does to the dollar, and there is a sense of frustration from China that this was outside the background gentlemen’s agreement.”
However, Democrat congressmen are in search of scapegoats for the continuing malaise in the US economy and China is an inviting target. Although the US monthly trade deficit reported last week was slightly smaller than previously, there was no change in its monthly deficit with China, which, at $US26 billion, was the second biggest since the financial crisis. The cry that the “Chinese are taking our jobs” is going up in US industries ranging from solar panels to aluminium.
The US is under pressure to retaliate, with its Department of Commerce maintaining the option of declaring China a currency manipulator. However, there are concerns within the US administration about China’s reaction to any such move.
The US is annoyed that Australia will not back its campaign to get China to raise the value of the renminbi, believing its case would be strengthened if it could rally more allies. However, Treasury does not believe a revaluation of the Chinese currency would achieve much. It holds that China’s surpluses are the result of it saving more than it invests. Australian officials say it is more productive to encourage the Chinese to improve social safety nets so that individuals have less need to self-insure, and note that Beijing is taking some steps in this direction.
China is also under pressure from Japan. As part of its campaign of diversifying its holdings of foreign reserves away from the US dollar, the Chinese central bank has been buying Japanese government bonds, adding to the upward pressure on the yen.
As with the US, Japan is also under political pressure to do something and a weakened government makes its response unpredictable. “While China can buy Japanese bonds, Japan can’t buy Chinese government bonds using its foreign reserves. I feel that’s unnatural,” Finance Minister Hoshihiko Noda said last week.
The yen rose to a 15-year high against the US dollar last week, and a nine-year high against the euro. In the perverse world of foreign exchange, the prospect of deflation in Japan, and the evident reluctance of the Bank of Japan to embark on forceful quantitative easing to avert it, makes the yen an attractive safe haven. In a deflationary world, a given amount of currency buys ever more goods.
The Swiss franc is also suffering safe-haven inflows on fears of deflation, hitting a record high against the euro last week. The Swiss National Bank suffered paper losses equivalent to about $15bn trying to stop the rise of the currency earlier this year.
The Australian dollar also touched a record high against the euro last week. However, it is fast money coming here rather than refugee investors in search of a safe haven. The Australian dollar, like equities, remains the risk-seeker’s play. If you think the world economic recovery is going to stabilise and that the Asian region will retain healthy growth through 2011, then the Australian dollar will do well. Another assault at parity with the US dollar would be in the offing.
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