Global Currency War: How to Keep the "Race to the Bottom" From Stealing Our Future

[Editor's Note: Late last year, global investing expert Martin Hutchinson warned investors that Brazil's fortunes were eroding. In today's commentary and analysis, Hutchinson demonstrates how this once-vaunted "BRIC" economy could start us down the path toward dangerous "de-globalization."]

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When Brazil Finance Minister Guido Mantega recently warned of a "currency war that is turning into a trade war," he wasn't far off the mark – at least as far as Latin America is concerned.

In that region – in the last two weeks alone – at least three countries have taken steps to prevent their currencies from appreciating against the U.S. dollar.

If you're a U.S. investor with no Brazilian holdings, you probably wouldn't think you'd have to worry a whole lot about what Brazil is doing to keep its currency – the real – from appreciating.

But on that point, you'd be wrong.

In fact, as Mantega warns, the fallout from a currency war could actually be quite severe – and global in reach. The games that governments are currently playing in currency markets could cause countries to set up trade barriers against imports. And that could bring about the end of the truly global economy – a "de-globalization" that would steal our current standard of living and thwart a return to prosperity.

Fortunately, there is a solution.


From Gamesmanship to De-Globalization

To some extent, Mantega's threats against the United States and China are the result of Brazil's eroding fortunes – and the latest round of global-economy gamesmanship.

For the last two years, Brazil's public expenditures have been skyrocketing – mostly through state-run companies and The Brazilian Development Bank (BNDS).

Since commodity prices have been soaring at the same time, the Brazilian inflation rate has been higher – and hotter – than authorities expected, even though the central bank has kept interest rates high. With massive foreign financing needed for the public-sector deficit, Brazil can't cut rates enough to enable its domestic private sector to grow at a healthy rate.

Hence, Mantega's rhetoric – and his attempts to tax banks' short positions on the Brazilian real – is merely an attempt to shift the blame and pain from where they should be placed: On Brazil's public sector.

Nevertheless, other commodity-exporting countries – with economies that are much less well balanced than that of gigantic Brazil – do have a problem. Cheap global money has created a commodities bubble, forcing prices up to unimagined levels and causing foreign currency to flood into their economies.

Sensibly run countries – such as Chile and Peru – understand that this is a purely temporary bonanza; at some point, global interest rates will rise to fight inflation and the flood of "hot money" into their economies will cease.

The smarter countries will attempt to fight any increases in their own currencies through the use of carefully designed intervention plans; earlier this month, for instance, Chile announced plans to buy $12 billion in the foreign-currency markets, and to follow that by issuing domestic currency bonds.

Land of the (Global Economy) Giants

China and India are at the other end of the spectrum.

Those two global-economic giants are each net importers of commodities and exporters of manufactured goods and services. And both countries are attempting to hold their currencies down artificially – albeit for different reasons.

China, worried that domestic wages are rising too fast, wants to avoid a rise in its currency – the renminbi (yuan) – in order to preserve its competitiveness.

India – like Brazil – runs an excessive budget deficit (in its case, on national and state budgets directly, rather than through state-owned companies). So it needs to hold down its own currency to maintain its balance of payments and to keep its government financing needs from "crowding out" its industrial sector (thereby keeping that part of the economy from accessing the capital markets at competitive rates).

Meanwhile, the European Union (EU) is seeking to prevent the euro from appreciating. That would affect the exports of such weaker Mediterranean countries as Spain and Italy which would be helped by a declining dollar. Japan, which normally copes well with a rising yen, is worried that a further rise will push its economy back into recession.

A Race With No Winners?

This gives us a pretty good picture of why this evolving currency war has been labeled as the "race to the bottom."

In short, pretty much every major economy is trying to weaken its currency against its competitors – albeit by a variety of methods. Some are holding interest rates artificially low. Others – as Brazil and China are increasingly attempting to do – are trying to drive down their currencies by putting direct blocks in the way of currency appreciation.

Let's be clear: Each protectionist "currency war" move blocks the free flow of finance around the world, and raises the temptation on competitors to raise barriers of its own.

If this persists, there will be two results – both of them bad.

First, this will cause inflation. With every country trying to depreciate its currency, interest rates will tend to remain at artificially low levels. Furthermore, thanks to several different forms of "quantitative easing," these countries will also tend to print more money than they should. This means that inflation, already surging in emerging markets like Brazil, India and China, will pretty soon become a major worldwide problem.

Second, each barrier erected against the free global flow of currencies will also serve as a barrier that impedes the free global flow of finance that is an essential ingredient of our tightly integrated, "globalized" world economy. And what's more – as the comments by Brazil's Mantega underscore – currency protectionism will inevitably be followed by trade protectionism, as countries find currency protectionism inadequate and impose tariff barriers, anti-dumping legislation and quotas to protect powerful domestic lobbies.

While globalization is no panacea, its impedance by this means will really torpedo our standard of living – just as it did in the 1930s. A system of tariff and non-tariff barriers and impedances to free exchange is inevitably far less economically efficient that one in which goods and investment can flow freely.

There is a solution: There has to be a total reversal of the fiscal and monetary policies that we're seeing worldwide right now. More specifically, we urgently need to see:

  • An end to the excessive supply of cheap money flowing around the world right now.
  • Higher interest rates and smaller budget deficits.
  • And a willingness by governments to absorb a smaller share of the world's financial resources, which will lessen – or (even better) bring an end to – the dangerous "crowding-out" effect.
  • And an additional willingness by governments to encourage an economically healthy "capital formation" via a positive return on savings.

In other words, we need an end to "Bernanke-ism" both here in the United States and worldwide.

The sooner this change is forced, the better. I'm not overreaching when I say that our future prosperity is at stake.

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  1. Half Athenian Half Spartan | January 18, 2011

    All of this talk is just a repeat on the last century. I just hope the war doesn't follow it. On the bright side we have 30 years of inventions pent up in corporations so a temporary de-globalization and collapse of big corporations sounds painful and it is but I am willing to sacrifice my good life for a few years (say 10) to rebuild our industry for my grandchildren who will live in an era mot much different then the last Kondratiave wave upswing including the tech explosion. The SCI FI world is not really SCI FI. Its real, its just bubbled up in corporate offices. The new patent laws are about to change things. New companies and spin offs will dominate the stock market. Old names will dissapear into reletaive historical obsurity. Even one of my inventions still not produced but works in theory is a zero point discovery. Its just a .5 zero point but with some help it can be .99 This will eviscerate oil gas nuclear and even wind and solar. The only competitor left will be hydro nickel fusion and they are years away from production.

  2. mark noeth | January 18, 2011

    We need, we need, we need. You know 'they' will let it all burn down so they can consolidate the currencies (save us from ourselves) in the name of globalization, don't you? Of course, you're right about what's needed, but what's the chances? The race (to the bottom or otherwise) is so that the relative winner(s) can be in a slightly more advantageous position when consolidation (in stages) comes. The lesson from the Euro is that it was better to be Germany than Italy when consolidation came. It might be sold or told differently to the public but…

  3. Moran | January 18, 2011

    Martin you are dead right – and wrong. While we desperately need to sober up and force governments globally to stop deficit financing – nobody can afford for the booze to stop.

    At least the EU countries on the ropes know how deep their hole is. Not here in the US Twilight Zone where the central bank, politicians on the take, and banksters all preach denial and diversion. A Fed that refuses to be audited and a Treasury Dept run by a tax dodger.

    The US has ensured that our problems are now the worlds problems. The only question is how long the race to the bottom lasts. We better hope for decades.

  4. Marie | January 18, 2011

    So is the solution a one-world currency that gets bantered around?

  5. Carlos Paulino | January 18, 2011

    This analysis is worthy of the Chinese lobby. I am all for a trade war now. Let's call their bluff. In this war is "to each its own". If we divide the world America wins. Only the strong survive. Let Treasury bonds go down. Then buy them back at flea markets prices. Stop foreign aid now. Who cares about anarchy 2000 miles away. If a war breaks out we also win. No need for political correctness anymore. Our enemies do not follow correctness or international law. China would starve without our trade and holding the bag with worthless US debt. If they sell our debt who is going to buy? We must impose import tariffs on China. We bomb North Korea's nuclear facilities and let Israel bomb Iran. Call their bluff. Put a naval blockade on Venezuela and watch everybody get in line again. Its time to flex our muscle. This is no time for apeacement. Globalization has not benefited America. Otherwise why are we talking about this? Hu Jintao said it…"the US dollar is no longer the world currency". So let's show them. No state dinner for the Chinese. Feed them a White House barbecue.

  6. fallingman | January 18, 2011

    Yeah, a world currency is the solution to debased national and regional currencies like putting a bullet through your skull is the cure for the headache you get from banging your head against the wall.

    The solution is replacing phony money with real. As with the rest of Mr. Hutchinson's sensible suggestions above. don't hold your breath.

    Do our corporatist masters want to see a world fiat currency? Oh, you bet they do. Why? At that point, they'd have total control of the money supply. Very handy when you want to rule the earth. That's the plan.

  7. BB | January 18, 2011

    Enjoy getting the latest news and topics of interest

  8. Johannes Scheibel | January 18, 2011

    Global Currency War:

    You forgot to talk about the printing of US dolars.

  9. arthur lee davis | January 18, 2011

    To : Marie,
    It is doubtful a one world currency, would do anything other than to make those waters a little muddier . The complex solutions, are a few in the makings, some of which, B.B., already knows . Probably hampered by the helm, and those major importers,of huge ship loads of foreign durable goods, and a zillion other daily use items, excluding those super oil tankers, some of which hold anchor at sea, as their home ports . Review commodities, in past history, you will be enlighten to find there were gradual to modest increases . Watch as the surge across the board, as crude oil starts it`s rapid increase to today s outlandish prices, then note the timeline of correlation . May give you a better reason and logic, as to why, the world currency is fundamentally a very bad idea to even toy with .

  10. Richard Stooker | January 18, 2011

    Hi, Martin,

    In offering hope, you must realize you're making us feel more depressed.

    The United States is now controlled by a president who hates capitalism. At its best, his party is dedicated to staying in power by buying votes. Many in the party of opposition accept the status quo. There are enormous voting blocks who oppose all spending cuts. We just passed healthcare reform so we can spend trillions of dollars more that we don't have.

    Nobody wants to hear talk of higher interest rates, reduced government spending, ending cheap money, and encouraging capital formation.

    You must be one of those racist hate mongering Tea Partyers!

    However, so far we've kept our disagreements confined to the political arena. Look at the riots in Greece over cutbacks and the student riots in Great Britain protesting higher school fees.

    Our government is stealing from foreign creditors by reducing the purchasing power of the dollar and from its residents by not including the cost of food and fuel in the official inflation figures, so people whose income is indexed to the CPI are not going to have a raise for several years in a row – despite price rises in food and energy.

    I pray we avoid the violence and unrest we're seeing in Europe, but I fear the worst.

    I'm not a gold or silver bug, but this race to the bottom seems bad news for the current system of all 100% fiat currencies. No major economy has been unable to refrain from trying to undercut its competition to encourage more exports.

    I believe in stocks in companies that provide essentials. Gold is pretty, but you can't eat it.

    American Campus Communities

  11. DD | January 19, 2011

    Carlos Paulino – You say "stop foreign aid now" – then this should include the billions upon billions upon billions of dollars that the US gives Israel each an every year. Israel is nothing without US support.

    Also what makes you so sure the US would win at anything? Who is the US to tell other countries what to do, when to do it and how? The lies, deceit and fraud that is coming out of the woodwork from within this country is appalling, so from where I'm standing few countries would side with the US if it came to it. This country cannot be trusted.

    The US is also the most indebted country in history and from what I understand China are in a position to cut her losses and run and if she (and others) had any sense, then perhaps that's what she should do. To add to this, many analysts are saying it is the US that is at the helm of manipulating the currencies, not Brazil, China or any other country.

    Also the US military cannot be sustained at this level and with this kind of debt. You will see a major decline is the US military in the coming years.

    As for NK, the world knows if the US were to have gone into any country anywhere in the world for WMD's, the NK should have been confronted way before Iraq and any others, but I have three good reasons why the US didn't go into NK:
    1) There is no oil in NK
    2) NK does not care for or about Israel
    3) They'd put the US's ass right back where it belongs and the US knows it.
    I am sure there are people out there who can add to my list as well.

  12. Carlton Fischt | January 23, 2011

    We have been fed this "globalization is good" story for at least 10 years now. I haven't seen anything "good" about it yet. I say lets go back to national sovereignty, protect "our" standard of living and jobs, stop the lopsided trade agreements, disallow doing business with countries that use "slave" labor, disallow doing business with countries that do not live up to comparable environmental standards, stop doing business with countries that "steal" intellectual and artistic property, and do not do business with countries that hate us and want to destroy us…and yes, China is the biggest offender.

  13. Luiz Domingos | January 23, 2011

    Money Morning

    I'm retired receiving my benefits from social security benefits, I'm live in Brazil currency exchange rate (Brazilian Real) U.S. Dollar falling now it and I am U.S. Citizen.

    Thank you, Luiz

  14. James | January 24, 2011

    Mr. Huchinson, this is a thought provoking mindboggling article. Thanks!

    You mentioned in previous articles that you are a strong advocate of the Austrian School of economics of which the late Dr. Joseph Schumpeter (1883 to 1950) was one of the leading economists who popularized the term "creative destruction" in his book Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig. pub. 1942].

    I quote in Wikipedia, "He borrowed the phrase "creative destruction" and made it famous by using it to describe a process in which the old ways of doing things are endogenously destroyed and replaced by new ways. "

    It looks like the world is currently undergoing major economic changes that will lead to major economic disruptions and result in a new economic order as he envisioned. Serious study of Dr. Schumpeter examining his economic and world views seems appropriate for current times. The world has finally caught up to how he views the economic world and social order.

  15. Geoff | February 19, 2011

    Talk,talk,talk – It's quite simple really. The old rich, including the US, Europe and we down here in tiny New Zealand are getting relatively poorer because we expect a better standard of living than we earn. And the new rich south & east Asia are getting richer because they earn more than they spend. The colossal deficits in the rich led by America are a futile attempt to turn the clock back So we borrow and print and if you are in the US and feel powerful enough we bluster & threaten. There are 2 simple ways forward. First we return to earning more than we spend & second we allow the forces of "creative destruction" to do their job and hope it works.

  16. James Eccles | February 23, 2011

    my grand father "marriner Eccles" was 17 years in the federal reserve and served under truman and rosevelt and helped get us out of the great depression in the 1930 s, he warned many many years ago that if things keep going as they were and polices did nt change for the people than the goverment would take over and we would lose your rights as free people with the right to choose as we believe not as we are told, now
    THEY ACT LIKE THERE IS NO LONGER A SUPPLY AND DEMAND. THERE ARE MORE PEOPLE ON THIS EARTH THAN EVER BEFORE, THERE Is DEMAND MORE THAN EVER BEFORE.. ITS THE EBB N FLOW THAT MAKES UP OUR ECONOMY. HOW LONG ARE WE GOIN TO PUT UP WITH THIS. ITS BLACK AND WHITE AN RIGHT IN FRONT OF US. WAT ARE WE GOING TO DO ABOUT THE WAY THINGS ARE BEIN RUN? IT IS OUR DUTY AS AMERICANS TO STAND UP AGAINAST THIS crap. ITS IN THE CONSTITUTION TO NOT LET THEM TAKE OVER. "POWER TO THE PEOPLE, THE PEOPLE GOT THE POWER"! THEY ARE TRYIN TO MAKE US MIS TRUST EACH OTHER SO WE WONT COME TOGETHER AND RAISE AGAINAST THEM. STAND UP PEOPLE AND FIGHT FOR WHAT IS YOUR GOD GIVEN RIGHTS, TOGETHER WE CAN BEAT THIS OPPRESSION STAND UP AND BE HEARD!down with large goverment and the kruption each city should goveren there own, break down large goverment and all that it brings. one world goverment would be the wrost it would breed more of what is already ocurring. i want an accounting of where my tax dollars are being spent and in my own city.
    the coruption is out of control it s going to have to be taken back. thier not going to just and it over thats for sure. we need to begin to trust and
    count on each other again and dont believe a word they say, they lie and cheat and ours kids and there kids will suffer if we dont get back what is rightfully ours. Our freedom
    NOW OR IT May be to late ! ? Move it , mount up

    J.Eccles

  17. Ed | March 2, 2011

    By now, all of us should understand that money ( paper-electronic-credit ) is some massive monopoly joke. It is clear that we are at an important manipulation point. But, are the banksters on schedule or is the plan coming apart. I feel hope for the peasants when the internet is the most feared tool. Imagine also, if the new Pay Pal phone 'bump' was counterfeited. Every day I see signs that when the plague passes and we open up the castle doors, there will only be big fat crows left inside.

  18. Beata | March 5, 2011

    is there somethingabout the us treasury contract expire 2012?

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