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Home > Blogs > Ian Fraser and Anthony Harrington > 2012: The Year Ahead- The currency wars roll on

2012: The Year Ahead- The currency wars roll on

Looking Ahead to 2012: The currency wars roll on, by Anthony Harrington and Ian Fraser Ian Fraser and Anthony Harrington

One of the more influential books to appear late in 2011 was Jim Rickards’ Currency Wars, which likens the struggle by various nations to secure competitive advantage for themselves by weakening their currency, to the military conflicts of WW1 and WW2. According to Rickards, while we all hope there will never be a military WW3, we are already in currency WW3, or C-WW3.

Before we can see what this means in terms of 2012 and C-WW3 – and more specifically, what it means for the impact on the euro, which Rickards sees as being the big loser in the present conflict - we need a bit of background. As Rickards explained in a recent TV interview, one of the characteristics of currency wars, much like the massive global conflicts they are analogous to, is that they are very protracted, long drawn out affairs that can take a decade or two to run their course.

Currency WW1 parallels the period of the great depression and comes to an end around 1939, but also includes the whole of the 1920s, or the boom run up to the Great Depression. On this view the hyperinflation of the Weimar Republic was simply a continuation of conflict by other means. As Rickards puts it, “Germany was over-indebted with war reparations from WW1 and both France and the UK owed the US huge war debts. Massive unpayable sovereign debt is one of the linkages between C-WW1 and our present C-WW3.”

In his view, C-WW2 began in the late 1960s and continued to the early 1980s. The first shot in the present “conflict” was fired by the Federal Reserve Chairman Ben Bernanke’s QE1 precipitated the present conflict by trying to “steal” growth for the US through currency deflation, or even debasement. “When there is not enough global growth to go around, you steal growth from the other guy by deflating your currency. Then everyone jumps in,” Rickards says.

This is not just a trendy way of rehashing what we all already know. For Rickards, viewing the present as a rolling moment in an ongoing global currency war has predictive power. With all its major currency pairs weakening around it, the euro has to strengthen, despite all the sovereign debt woes plaguing the Eurozone. A strengthened euro can buy more for less, which is the definition of deflation. Deflation in turn will give the European Central Bank the green light to start monetising some debt by printing euros, despite its horror of hyperinflation.

Once the ECB starts down this path and has printed enough euros, the euro will start trading down versus the dollar. Rickards predicts that if the euro slides down from $1.30 towards $1.20, the Fed will retaliate by launching QE3 on a massive scale.

“Forget the idea that the Fed’s mandate is job security or full employment. The Fed is there to protect the banks and the people who run the banks. If you go by 80 years of history, this is what their mandate really is. And if the ECB prints euros, the US will print dollars,” Rickards says.

The end game, according to Rickards, which comes when paper currencies have been totally debased, is either a recalibration of the currency, with one new unit equalling squillions of the old unit, or a return to the gold standard. The Weimar Republic’s hyper-inflation ended with the launch of the Reichmark backed by gold. For Rickards, an orderly or a disorderly return to gold is the ultimate end point. If this is so you would expect gold to continue to increase in value as paper or fiat currencies are seen to debase themselves.

The fact that gold trended downwards fairly dramatically in price through late November and December 2011, hardly fits this. However, Rickards suggests, the fall in the gold price is explained by the fact that there are both “fundamentals” (the weakening of fiat currencies) and “technicals” (banks and hedge funds selling gold big time to pay down debt) in play, with gold responding to both.

“In the long run the fundamentals will prevail, and the price of gold will rise and rise, but in the short-run the technicals can definitely dominate,” he says.

The currency wars, however, are about more than just Europe versus the US, or Sterling versus the euro, versus the dollar. One of the other major zones of conflict, Rickards reminds us, is the US dollar versus the Chinese Yuan.

However an unexpected truce between old adversaries signed in the dying days of 2011 has the potential to dramatically reduce the dollar’s might in the ongoing monetary hostilities.  On December 28 China and Japan signed a pact intended to promote yuan-yen trade. The deal which symbolizes a dramatic thawing in relations between Tokyo and Beijing will, for the first time, enable Chinese and Japanese trading companies to switch between yuan and yen without having to convert to dollars first.

According to Bloomberg View the deal will trigger the appreciation of the Yuan and a fall in US creditworthiness, as well as hastening the rebalancing of the Chinese economy, and nudging the Yuan towards its “inevitable” status as a global reserve currency alongside the dollar, Yen and Euro.  The Bloomberg editors wrote:

“For all parties, this process has both benefits and costs, but in the end all stand to gain. A fully internationalized yuan would be free to appreciate. China’s trade surplus, a destabilizing force in the world economy, would then be self-correcting, and the friction in U.S.-China economic diplomacy would subside ….

“When the dollar loses its pre-eminence as a global currency, the U.S. will need to adjust. Dollar bills in circulation are, in effect, a gift to the U.S. -- they cost cents to print yet they buy a dollar’s worth of goods and services, a hidden form of payment that economists call seigniorage. A stronger yuan will transfer some of this seigniorage to China.

“More important, creditors may look more cautiously at U.S. bonds if the dollar becomes just another currency. If by then America hasn’t beaten its addiction to public borrowing, this change would force the U.S. to do so, and the experience could be unpleasant."

Currency movements are going to be highly revealing indicators of the big tectonic plate movements in geo-politics through 2012. Stay tuned...

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Tags: Ben Bernanke , central banks , China , currency wars , dollar , economic recovery , EU , euro , European Central Bank , Federal Reserve , financial crisis , FX , FX traders , Japan , regulation , sterling , Yuan , yuan appreciation
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