Trashing Currencies

Liam Halligan and Ambrose Evans-Pritchard have two provocative columns this weekend that actually tie together quite nicely. The overall theme is governments debasement of their various currencies as they desperately try to reflate their economies. The lesson might well be buy gold and any other hard asset you can lay your hands on.

Halligan takes the position that having exhausted other options QE is the only option left to policymakers:

To escape the slump of the early 1980s, Western governments cut taxes, slashed interest rates and created an environment where entrepreneurs could do their thing. The eventual result was an investment explosion, a growth surge and massive job creation.

This time it’s different. We entered this recession with rates that were already far too low and government debts that were far too high. We have men like Alan Greenspan and Gordon Brown to thank for that – the “Maestro” and the “Iron Chancellor”. How future historians will wince.

Since the “credit crunch” began in earnest, there’s been little room to cut base rates – they’re now negative in real terms – and an unreformed banking sector has anyway conspired only to lend, if at all, at rates which are much, much higher. State debts, meanwhile, have spiralled to such an extent that the entire world now questions the very solvency of many “advanced” economies. So the West is still in a hole – and yet, in stark contrast to the same point in the aftermath of other deep recessions, our previous policy blunders mean that taxes are now rising and rates are going up.

Enter QE which Halligan figures is not a sustainable policy and when you strip away all of the elaborately constructed arguments supporting its use amounts to nothing more than “…printing money and hoping for the best.”

Evans-Pritchard focuses on the coordinated efforts of all of the major economic players to simultaneously devalue their currencies:

The US and Britain are debasing coinage to alleviate the pain of debt-busts, and to revive their export industries: China is debasing to off-load its manufacturing overcapacity on to the rest of the world, though it has a trade surplus with the US of $20bn (£12.6bn) a month.

Premier Wen Jiabao confesses that China’s ability to maintain social order depends on a suppressed currency. A 20pc revaluation would be unbearable. “I can’t imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs,” he said.

Plead he might, but tempers in Washington are rising. Congress will vote next week on the Currency Reform for Fair Trade Act, intended to make it much harder for the Commerce Department to avoid imposing “remedial tariffs” on Chinese goods deemed to be receiving “benefit” from an unduly weak currency.

Japan has intervened to stop the strong yen tipping the country into a deflation death spiral, though it too has a trade surplus. There is suspicion in Tokyo that Beijing’s record purchase of Japanese debt in June, July, and August was not entirely friendly, intended to secure yuan-yen advantage and perhaps to damage Japan’s industry at a time of escalating strategic tensions in the Pacific region.

Brazil dived into the markets on Friday to weaken the real. The Swiss have been doing it for months, accumulating reserves equal to 40pc of GDP in a forlorn attempt to stem capital flight from Euroland. Like the Chinese and Japanese, they too are battling to stop the rest of the world taking away their structural surplus.

It’s hard to see how any of this can come to any good end, isn’t it? Either the competitive devaluations end up being a zero sum game or the economy best able to stand the negative consequences emerges a winner while the rest suffer devastating setbacks. Of course, it might also be one of those wars in which the living envy the dead. Bernanke and his cohorts are playing a dangerous game with money creation. It could easily get out of hand, and that little bit of inflation he and others crave might well grow beyond their carefully orchestrated targets.

What started out as a mostly American and European financial crisis may well be setting in place a chain of events which pull in the rest of the World’s developed and developing economies. The Western economies have reached some practical limits both financially and politically to their ability to engage in further fiscal stimulus. Thus hamstrung, the game now morphs into one which seeks to achieve economic revival at the expense of competitor countries via currency devaluation masquerading as sophisticated central bank stimulus schemes. It’s just the next chapter not a new crisis.

Lots of people profess incredulity over the rise in the price of gold. What they should probably be confounded about is the willingness of investors to continue to invest in equities and bonds.