You Heard It Here First: A Global Currency War is Being Fought – And There Will Be No Victors

[Editor's Note: For additional viewpoints on this growing global currency conflict - including the latest profit strategies - please click here to check out a related report elsewhere in today's issue of Money Morning.]

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Brazil's finance minister, Guido Mantega, recently acknowledged to the global investment community what most trade officials already believed: An "international currency war" has broken out.

And, in this war, there won't be a real victor.

"We're in the midst of an international currency war, a general weakening of currency," Mantega told The Financial Times. "This threatens us because it takes away our competitiveness."

Mantega's comments came just weeks after Japan joined Switzerland in intervening in the foreign-exchange market. But the reality is that the currency war has been under way since 2008.

At least, that's when Money Morning Chief Investment Strategist Keith Fitz-Gerald first warned that countries – most notably the United States – would debase their currencies in a race to boost their exports and keep economic growth afloat.

"The government has adopted a weak-dollar policy," Fitz-Gerald said in an interview in March 2008. "They're sending out a message loud and clear: 'We want you to sell the dollar.'"

By holding the central bank's benchmark lending rate down in a record low range of 0.00% to 0.25% for close to two years now and buying up Treasuries in a policy known as "quantitative easing," the U.S. Federal Reserve is effectively debasing the dollar.

But the U.S. central bank isn't alone.

The Swiss central bank has been intervening to prevent the appreciation of the Swiss franc against the euro for close to six months now. The last time it intervened was in 2002.

Japan just last month sold an estimated $20 billion yen, as the currency surged to a little short of 90 to the dollar, the strongest in 15 years. The last time it intervened to sell yen in the foreign-exchange market was in 2004, when the yen was around 109 per dollar.

Some analysts and Japanese policymakers had theorized that China was attempting to hamper Japan 's recovery by purchasing Japanese bonds to keep the yen excessively strong.

"I don't know the true intention" behind China's purchase of $6.9 billion (583.1 billion yen) of Japanese government bonds in July, Finance Minister Yoshihiko Noda said earlier this month.

China, of course, intervenes in the currency market simply and directly by pegging the yuan to the dollar, despite pressure from the United States to let the currency appreciate.

Additionally, central banks and governments in Colombia, Thailand, Poland, Taiwan, Russia, Peru, Mexico, and South Africa are now either intervening directly in foreign exchange markets to try to force their currencies down, or talking about it.

South Korea has shown as much alacrity in intervening to keep the won weak, but it intends to skirt the issue when it hosts the next Group of 20 meeting in Seoul next month. China is South Korea's neighbor and largest trading partner.

"By the nature of the G-20, which is an open forum, we may discuss for example the general approach toward foreign exchange rates… or the impact foreign exchange could have on the global economy," Yoon Jeung-hyun told Reuters. "But aside from that, I do not believe that it is appropriate to have a discussion regarding the foreign exchange rate or level of a specific country."

That's because competitive devaluation has replaced the traditional economic growth models.

"Since about 2001, whenever any currency rises too much, the local manufacturers or farmers – or anyone who lives by exporting – start to scream about it. Their local governments respond by doing all they can to lower the value of that currency, having it fall in value and thus making exports cheaper – all this in the hope that the domestic economy will become better," Money Morning Contributing Editor Chris Weber said in a post last year. "Pick any period so far in this young century and you'll see that this is true."

Another problem is that the global recovery is occurring at two speeds, with emerging markets powering ahead, while developed nations stagnate. This has created a yawning interest rate gap as the central banks in developed countries leave their benchmark rates at emergency settings to stimulate demand, and policymakers in emerging markets raise rates to combat inflation. The temptation to exploit this gap is often too much for traders to ignore.

Unfortunately, this "race to the bottom," as it's been called by Money Morning Contributing Writer Peter Schiff, will have no winners. It will only have losers, the biggest of which will be the United States.

"Given the U.S. dollar's status as the world's reserve currency, America's oversized status as the world's biggest consumer, and the influence of overseas export-oriented businesses on their home governments, the falling dollar is a difficult issue for many countries to ignore," said Schiff. "And with the imminent arrival of a second round of 'quantitative easing' from the Fed, the big guns of dollar destruction are being locked and loaded. The move looks poised to set off a frantic race to the bottom among global currencies, which will have important ramifications for every investor. Unfortunately, this is one race the United States is poised to win."

That's a big reason why the price of gold last week sky-rocked to a new record high above $1,300 an ounce.

"Against this backdrop, one of the smartest things for investors to do is buy those things that not only appreciate amidst failing fundamentals, but which preserve their wealth at the same time – case in point gold and other precious metals," says Money Morning's Fitz-Gerald. "I continue to believe that we're in a long-term commodities bull market no question about it. Commodities may drop in the short term, but any such moves will likely be reviewed in history's rearview mirrors as buying opportunities, for at least the next ten years."

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  1. Ron Baldwin | October 5, 2010

    In an age of continous and dramatic productivity improvement based on available Asian labour and the technology of computers, the world should have been entering a golden age of growth and prosperity. Instead, the G20 and the USA in particular, have allowed trade and currency imbalances to destabilize world trade and to cause millions of people to live in much worse circumstances than could have been available.

    The world needs an "Exports Credit Plan"

  2. Mario | October 7, 2010

    About " you hear it here first" I wouldn't be so sure! Bill Bonner and Addison Wiggin from The Daily Reckoning newsletter, published by Agora Financial, warned about this outcome about three years ago – maybe even earlier, but I recall their predictions from three years ago.
    They also predicted preety accurate the housing bubble bust about three years before happened, the going bust of pension funds, the going broke of local Governments, and about everything wich we are whitnessing right now…The only thing they got it wrong was 200$ oil and 8$ gasoline at the pump. But I guess they were wrong only about when will happen , not if…

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