|
Currency wars are one of the most important dynamics in the global financial system today. A currency war is a battle, but it’s primarily economic. It’s about economic policy. Countries want to cheapen their currency to promote exports. For example, a cheaper dollar makes Boeing more competitive internationally with Airbus.
But the real reason countries engage in currency wars, the one that’s less talked about, is that countries actually want to import inflation. Take the United States for example. We have a trade deficit, not a surplus. If the dollar’s cheaper it may make our exports slightly more attractive.
It’s going to increase the price of the goods we buy — whether it’s manufactured good, textiles, electronics, etc. — and that inflation then feeds into the supply chain in the U.S. So, currency wars are actually a way of creating monetary ease and importing inflation.
The problem is, once one country tries to cheapen their currency, another country cheapens its currency, and so on causing a race to the bottom.
I started writing about this years ago in my first book, Currency Wars. My point then is the same today: The world is not always in a currency war, but when we are, they can last for five or ten, fifteen and even 20 years. They can last for a very long time.
There have been three currency wars in the past one hundred years. Currency War I covered the period from 1921–1936. It really started with the Weimar hyperinflation. There was period of successive currency devaluation.
In 1921, Germany destroyed its currency. In 1925, France, Belgium and others did the same thing. What was going on at that time prior to World War I in 1914? For a long time prior to that, the world had been on what’s called the classical gold standard. Gold was the regulator of expansion or contraction of individual economies.
If a country had a balance of payment surplus, it acquired gold. It had to be productive, pursue its comparative advantage and have a good business environment to actually keep some gold in the system — or at least avoid losing the gold it had. It was a very stable system that promoted enormous growth and low inflation.
|
That system was torn up in 1914 because countries needed to print money to fight World War I. When World War I was over and the world entered the early 1920s, countries wanted to go back to the gold standard but they didn’t quite know how to do it.
|
That system was torn up in 1914 because countries needed to print money to fight World War I. When World War I was over and the world entered the early 1920s, countries wanted to go back to the gold standard but they didn’t quite know how to do it. There was a conference in Genoa, Italy, in 1922 where the problem was discussed.
The world started out before World War I with the parity. There was a certain amount of gold and a certain amount of paper money backed by gold. Then, the paper money supply was doubled. That left only two choices if countries wanted to go back to a gold standard.
They could’ve doubled the price of gold — basically cut the value of their currency in half — or they could’ve cut the money supply in half. They could’ve done either one but they had to get to the parity either at the new level or the old level. The French said, “This is easy. We’re going to cut the value of the currency in half.” And that’s what they did.
If you saw the Woody Allen movie Midnight in Paris, it shows U.S. expatriate living a very high lifestyle in France in the mid-1920s. That was true because of the hyperinflation of France. It wasn’t as bad as the Weimar hyperinflation in Germany, but it was still bad. If you had a modest amount of dollars, you could go to France and live like a king.
The U.K. had the same decision to make but they acted differently than France. Instead of doubling the price of gold, they cut their money supply in half. They went back to the pre-World War I parity.
That was a decision made by Winston Churchill, who was Chancellor of Exchequer at that time. It was extremely deflationary. The point is, when countries double the money supply, they have to recognize that they’ve trashed their currency. Churchill felt duty-bound to live up to the old value.
He cut the money supply in half and that threw the U.K. into a depression three years ahead of the rest of the world. While the rest of the world ran into the depression in 1929, the U.K. it started in 1926. I mention that story because to go back to gold at a much higher price measured in sterling would have been the right way to do it. Choosing the wrong price was a contributor to the great depression.
Economists today say, “We could never have a gold standard. Don’t you know that the gold standard caused the great depression?”
The gold standard as it existed at that time was a contributor to the great depression. But it was not because of gold itself, it was because of its artificial price. Churchill picked the wrong price and that was deflationary. The lesson of the 1920s is not that you can’t have a gold standard, but that a country needs to set the gold price correctly.
They continued down that path until it became unbearable for the U.K., and they devalued in 1931. Soon after, the U.S. devalued in 1933. Then France and the U.K. devalued again in 1936. There was a period of successive currency devaluations and so-called “beggar-thy-neighbor” policies.
The result was, of course, one of the worst depressions in world history. There was skyrocketing unemployment and crushed industrial production that created a long period of very weak to negative growth. Currency War I was not resolved until World War II and then, finally, at the Bretton Woods conference.
That’s when the world was put on a new monetary standard. Currency War II raged from 1967–1987. The seminal event in the middle of this war was Nixon’s taking the U.S., and ultimately the world, off the gold standard on Aug. 15, 1971.
He did this to create jobs and promote exports to help the U.S. economy. What actually happened instead? We had three recessions back to back, in 1974, 1979 and 1980.
Our stock market crashed in 1974. Unemployment skyrocketed, inflation flew out of control between 1977–1981 (U.S. inflation in that five-year period was 50%) and the value of the dollar was cut in half.
Again, the lesson of currency wars is that they don’t produce the results you expect, which are increased exports and jobs and growth. What they produce is extreme deflation, extreme inflation, recession, depression or economic catastrophe. This brings us to Currency War Three, which began in 2010.
Notice I omitted the period from 1985–2010, that 35-year period. Why?
That was the age of what we call “King dollar” or the “strong dollar” policy. It was a period of high growth, price stability and good economic performance around the world. It was not a gold standard system nor was it rules-based.
The Fed did look at the price of gold as a thermometer to see how they were doing. Basically, the United States told the world that it was on a dollar standard.
|
We, the United States, agree to maintain the purchasing power of the dollar and, you, our trading partners, can link to the dollar or plan your economies around some peg to the dollar. That will give us a stable system.
|
We, the United States, agree to maintain the purchasing power of the dollar and, you, our trading partners, can link to the dollar or plan your economies around some peg to the dollar. That will give us a stable system. That actually worked up until 2010 when the U.S. tore up the deal and basically declared Currency War III. President Obama did this in his State of the Union address in January 2010.
Here we are and they’re still continuing. That comes as no surprise to me.
A lot of journalists will see the weak yen for example, and conclude we’re in a currency war. Of course we are. We’ve been in one for five years. And we’ll probably be in one for five more years, even longer.
Currency wars are like a seesaw — they go back and forth and back and forth. And now in early 2016, the seesaw is about to swing again...
Soon — perhaps just weeks from now — I believe markets will be hit by the third and biggest currency shock since the currency wars started in 2010. And no one is expecting it. But its impact could be felt immediately, and it could be devastating.
Stocks could flash crash by over 10% in a matter of minutes, causing a sell-off… oil prices could crash even lower than $28 per barrel… and some financial institutions might go bankrupt, taking savers money with them.
Furthermore, the most powerful financial weapon the has will be destroyed, and America’s biggest “frenemy” will gain the world’s #1 financial advantage. To top it all off, a full scale war between two biggest powers in one of the world’s most critical regions could explode. The U.S. might even get dragged into the fighting.
The sneak currency attacks by Switzerland and China we saw last year were nothing compared to the currency shock I’m forecasting now.
When America is betrayed by its sworn “ally” in the coming weeks, there will be a violent market reaction.
Regards,
Jim Rickards
for The Daily Reckoning
|
