Currency wars enter new phase

That we are in a currency war is now obvious.  That our leaders cannot stop it becoming deeper and more acrimonious, is, after the total failure of the IMF meeting to find any policy agreement at all, now also obvious. They cannot solve it for the simple reason that is it their policies that are causing it.

At the IMF meeting not only was there no new policy to avert spreading competitive currency devaluations but what became apparent was that there is a tightening logic which will force more countries to join in. We are about to enter a new phase of the war.

The looming domestic crisis inside every nation is exactly what is locking them in to the very actions which are fuelling the currency war.  Every nation is beyond being desperate for export growth.  The stark reality is that whichever nations do not achieve some export led growth will implode under a debt load they cannot hope to pay back. EVERY nation has predicated its ‘recovery’ on levels of growth they cannot and will not achieve through domestic sales and consumption.

The problem is that the actions taken to stimulate growth and protect the interests of each nation’s ruling financial class, are precisely those which caused and are fuelling the currency war.  None of the ruling elite have a single new idea. And are thus determined upon a course of repeating what has already failed – but doing it bigger. In the U.S. more debt will be created and however much of it they cannot sell, they will buy themselves.

Their hope and intent is for the new money to stave off the cash flow strangulation their banks still face from non-performing loans, further bloat the buying power of the banks so as to allow them in turn to drag an empty Dow Jones ever higher and to try to devalue the dollar by flirting with inflation.

In Europe we too will print up more debt and we too will end up buying a lot of its ourselves.  And the hope will be that this helps to devalue the euro.  We, of course, will be immensely aided by keeping sovereign default concerns helpfully simmering away. As long as they don’t actually boil over, they are Europe’s most potent currency weapon. And the envy of the US.  Europe is now on course to let Ireland and maybe one other, restructure. That too will help devalue the Euro.

That will hurt the US, strengthen the Swiss frank and further impoverish all those Eastern nations whose borrowings are in swiss franks.

China will continue to export cheap goods made possible by their low valued currency which they will NOT re-value, and will use the profits to buy up metals and food. That buying will send prices of both up and up causing the inflation in all the things we need, even while all the worthless paper the banks are hoarding continues to deflate.  Watching all this happen the US and Europe will continue to complain bitterly about the value of the Yuan and China will continue to ignore them.

Japan will continue to hyperventilate as the utter hopelessness of their situation becomes clearer and clearer.  They too will try and fail to devalue.  The day they try to sell debt on the open market they will begin their final collapse.

Of course the obvious question all this printing and attempting to devalue raises, is why hasn’t it worked?  The simple and true answer is that when everyone tries to devalue at the same time, then all their efforts cancel each other out.  In a race to the bottom there can still only be one winner. And this is indeed what is happening. BUT there is another dangerous dimension that has so far been ignored.

All the money printed has to go somewhere?  If it stays in the domestic economy, you have too much money chasing too few goods and therefore you get inflation and eventually hyper-inflation (which to be clear are quite different animals).  But in this case the printing has not stayed in the country to chase too few goods. It has gone abroad to chase goods and high-return and/or to fuel currency speculation.  And that is a major part of why there has, so far, been no massive inflation or hyper-inflation. (Not the whole answer. The other major reason is that so much of the money has been sucked into the shadow system where it has replaced the lost value of the banker’s rotten and worthless paper and provided the cash flow to keep them alive)

The newly printed up money has gone out into the world looking for higher returns than are available in the economies which printed it.  Western cash has flooded into the ‘hot’ emerging economies of Brazil and India and would go to China if China would let it.

It might sound great to have a flood of new investment. And to a point it can be.  Indian, Brazilian and even Australian companies have found a lot of cheap money about.  BUT there is SO much money around it is forcing itself into and overstuffing, every buying opportunity and causing speculative bubbles everywhere including in bonds and currencies.

Thus Brazil and India are finding that their economies are in danger of being destabilized.  Like putting higher and higher voltage through a transformer, first it copes, then it gets hot and then it just melts.   So India has just said it is considering capital controls to stop the flow of new money. If they don’t they will find speculative bubbles forming in all sorts of commodities which will hurt both their own people and us.

But here is the further interesting part.  IF they do take action and IF they do stop or restrict the in-flow of the newly printed money we are flooding them with, THEN, where does all the money go?

Part of the reason all our printing has not caused any serious problems, so far, at home, is because it has gone abroad causing trouble over there rather than here. We have exported inflation. What happens if it starts to come home, or in the sace of QEII finds nowhere lucrative or accomodating to go in the first place?

If capital controls are brought in, in the expanding economies, our new money will have nowhere to go and no hope of a return.  It will mean there will be virtually no good effect from QEII in terms of stimulating growth which will push our banks closer to the insolvency which awaits them.  It will also, conversely, greatly increase the potency of devaluing those currencies which have printed it. Which will cause larger swings in their values. Which will make the currency war more volatile and dangerous.

Domestically we might find ourselves suddenly much closer to inflation or even hyper-inflation. Simply because so much more of the new money will stay at home. But we could also find the devaluation effects might be more sudden and potent than we thought, and our borrowing costs may jump accordingly.  If the US finds its rates edge up, that could have devastsing effects which I do not think the Fed is ready for.

The currency war is about to enter a new and much more dangerous phase.