Currency War – or is it?


Here at NipponMarketBlog, we have been pointing out the remarkable lack of (public) inter-governmental debate over currency devaluations taking place in a whole range of countries and economic regions.

The most interesting outcome of the latest round of G20 central bank and finance minister meetings, was the lack of any explicit criticism of unilateral devaluations on the part of any participating country, most notably Japan which has signalled an enormous expansion of the money supply, implying an even greater amount of pressure on the Yen.

Historically, countries tend to have a lot of national pride tied up in their currency, and particularly the strength of their currency. This is not necessarily the case in Japan, because of its history vis-a-vis direct currency market intervention (or manipulation), but for many countries there is clearly a somewhat irrational tendency to prefer a strong currency, despite the fact that – all else being equal – any net exporter will ideally prefer a relatively weak currency.
The monetary stimulus carried out by all the major central banks in the world, begs the question whether there exists some level of (possibly tacit) coordination. Afterall, the amounts of money pumped into the various economies are on a very significant scale and so will have (and clearly have had) an impact of exchange rates. In the context of global coordination of central bank policies as they relate to currencies, let us look at the various perspectives from various major central bank authorities:

– The Fed has a labour market objective (at least officially).

– The European Central Bank has a financial system stability objective.

– The BOJ has a growth and balance sheet objective.

– The People’s Bank of China has a soft landing objective.

For each of these four exponents, there are a whole host of other countries with their individual policy objectives that roughly fall into one or more of these categories. Clearly, any coordination is going to be very difficult.

Arguably, there is a reactive ‘domino-effect’ element to the monetary policies carried out by these central banks, despite their claims that they are engaged solely in policies designed to pursue domestic economic policy objectives. Just last week the ECB again lowered its interest rate to 0.5%, and we are seeing indications that Australia’s central bank may be considering following suit in order to stimulate an economy that is heavily dependent on slowing Chinese growth.

The following chart shows relative devaluation/appreciation of various currencies versus the USD since 2008 (Source: ZeroHedge):

Currencies 2008 - 2013

Despite the weakening of the British Pound, it will be interesting to see what the incoming governor of the Bank of England, Mark Carney will do once he takes over. Given that the fact that the austerity program imposed by Chancellor George Osborne is choking off economic activity – all in the name of reducing debt – with the no doubt unintended consequences of actually making it more difficult to reduce debt because of resultant lower tax revenues, it seems quite obvious that there will be a very large red button positioned on Mark Carney’s desk when he enters his office for the first time. This button will be connected to the printing presses somewhere in the vaults of the BoE, and NipponMarketBlog doubts very much whether Mr Carney will even take the time to sit down in his new chair before he hits that button and sends the BoE’s QE program into a whole new orbit.


Given the malaise that Europe finds itself in, it may be a question of time before the ECB and Mario Draghi are forced to follow suit.


The chart above may explain to some extent why there was little to no objection to Japan’s massive new chapter in its QE program announced in early April. Since 2008 the Yen has strengthened significantly against the dollar (or perhaps more accurately, the dollar has been debased significantly by the Federal Reserve), so in a sense the Yen has lately only been catching up. In fact, the argument could be made that if one limits one’s perspective to just currencies, the BoJ has been forced to affect a significant devaluation of the Yen, because the quantitative easing in the US has weakened the dollar to a point where Japan had to react. In fact, judging by this chart, and assuming that everyone agrees that 2008 was a ‘reset point’ that it makes sense to measure these things from (which may or may not be appropriate), the Yen could easily go to 120 versus the dollar without anyone in the Fed, the ECB or the BoE raising an eyebrow.

What happens in the Chinese central bank may be a slightly different story. China has probably been the most vocal in it criticism of Japan’s monetary expansion experiment. Afterall, the two are highly interdependent when it comes to trade, and any disruptive effects from excessive devaluation of the Yen will be met with angry reactions in Beijing. Interestingly though, China seems to also realise that it is partially dependent on Japan (especially in so far as the Japanese economy can have an effect on the regional and global economies which China depends on), and recently Mr Jin Liqun, chairman of the supervisory board at China Investment Corp, China’s sovereign wealth fund, indicated that China may accept some devaluation of the Yen in order to try to help Japan’s economy to recover. Although this was framed in terms of monetary policy, it was obvious what the gist of the message was. Here are a few quotes from Mr Jin Liqun:

“Monetary easing might be helpful but the role is very much limited. It is a necessary but not sufficient condition.”

Jin Liqun

“If printing money could solve the problem, it would be so easy. Every country can print money. Some people believe quantitative easing is a panacea. It’s not a panacea. If you don’t do something else to support this policy, it’s a recipe for disaster.”

In other words, China is willing to accept some level of devaluation of the Yen, but is keen on the Japanese government undertaking other supportive activities such as fiscal stimulus and structural reform as well.

Here at NipponMarketBlog, we believe that in a sense the global currency war have been declared a non-issue, as far as global economic and financial bodies such as the IMF are concerned. As we have alluded to in the past, the perception of the current state (and even more importantly momentum) of the global economy is so dire, that for all intents and purposes, unilateral competitive devaluation of a country’s own currency in order to obtain a competitive advantage on the global goods and services markets has been deemed an acceptable (if not necessary) evil. We can illustrate this by looking at the growth rates for the G7 countries, going back to 1980:

Screen Shot 2013-04-28 at 19.55.26

Clearly,  growth momentum is slowing, despite the global equity markets marching ever higher. Equity markets are of course only moving higher because the whole global financial system is awash with cheap money (courtesy of central bank printing), and that money is desperately chasing some form of return and/or yield. Corporates have been growing earnings during the period from 2008 by significantly reducing costs (hence the high unemployment rates throughout the world), and so that partly justifies the rise in equities, but the main reason is that there are precious few alternatives in a world where central banks have all but eliminated yield on debt products.

The price of copper – the metal being such an integral part of so many industrial activities – is rightly seen as an indicator of the strength of global economic growth. Arguably it has been used as a medium of speculation, along with all other commodities, but the chart is illustrative nonetheless. It shows the S&P500 overlaid on the copper price chart.

Dr Copper

The implications here are self-evident. Either the copper price is currently falling for no reason, or the S&P500 is ‘levitating’ in spite of economic fundamentals deteriorating. We see clearly from this chart that historically the price of copper (which is dictated mainly by real economic activity, i.e. industrial supply and demand) has trumped the S&P500 (which is dictated by investors’ hopes for the future). We at NipponMarketBlog know which bet we would take.

In this context, NipponMarketBlog came across an extremely disconcerting point made by a well known commentator on global equities, bonds and commodities markets (especially Gold) during the past several decades. The assertion was made that some corporates are now blatantly borrowing money at virtually zero cost to buy up their own shares in the equity markets, in order to reduce the number of shares outstanding and thus (at least theoretically) push up their own share price. In the short term it may well increase the company’s share prices, thus releasing the management bonuses that are tied to reaching certain share price levels.

This seems to NipponMarketBlog to be a highly unusual activity that frankly reeks of ‘moral hazard’ issues, in addition of course to saddling the company with debt that it will eventually have to repay (possibly at higher interest rate levels). It also makes one wonder just how precarious the current equity market levels are, since the rise in price has less to do with the market genuinely functioning as a pricing mechanism and re-evaluating the company’s actual value, and more to do with simply supply side manipulation. In addition, this reduction in shares outstanding generates paper profits for all shareholders (most of whom are passive holders at this point), but it also pushes the share price up to potentially unsustainable levels vis-a-vis valuations – especially when earnings growth slows or turns negative (which NipponMarketBlog believes it will before too long). In that event, it could suddenly prove to be a very long way to fall very quickly for many of these shares.

Finally, we present a chart showing that operating earnings per share for the S&P500 has been growing at an ever-decreasing pace since the Fed’s QE began. Usually not that bullish a sign for equity markets. Or perhaps “this time it’s different”?

US OP 2013

At any rate, the global economy appears very much to be slowing down, and there is an understandable fear amongst policy makers and central bankers that this will have an uncontrollable and very adverse impact on the global stock markets and hence the entire financial sector, and subsequently the real economy.

In this environment, and with unemployment levels far in excess of what is acceptable, public finances on a knife’s edge and the money printing presses in the central banks desperately (yet ineffectually) trying to kick-start growth, the consensus seems to be that “anything goes”, including the normally frowned-upon unilateral devaluation and beggar-thy-neighbour policy. Of course, the key here is to understand that ultimately there is no such thing a unilateral devaluation. If a country devalues its currency, it will have a direct impact on all its trading partners, and they may well follow suit themselves, thus negating the effects of the initial devaluation. One has to wonder if the central bankers never studied game theory. If the BOJ engages in so-called unilateral QE, with the implicit goals of debasing the currency and possibly attempting to inflate away debt levels, the only rational course of action for the ECB, the BOE, and even the Fed and everyone else is to follow suite in order to at least maintain ‘parity’ relative to the initial state of affairs. It is ultimately a Zero-Sum game that will have no winner.


In this context, it seems to NipponMarketBlog that governments and central banks appear slightly schizophrenic about what their roles in global economics are these days, and precisely which goals they should be pursuing. Labour market policies? Financial market policies? Inflation boosting policies? Inflation suppression policies? Growth policies? It doesn’t take a genius to work out that several of these are mutually exclusive.

Nonetheless, central banks seem to think that there is always an easy fix for any problem, and so far, printing money has been considered the universal solution to all ills. What is striking is that here appears to be very little in the way of structural reform in the pipeline. Ultimately, the issue is not one of debt per se, but one of overly lose credit for decades and resultant irresponsible lending and spending, which ultimately caused massive debt levels in the private sector – both for the consumer and in the financial sector – that are now migrating in various forms onto the public sector balance sheets.

Unless the actual illness is addressed, it appears to NipponMarketBlog that there is precious little point in addressing the symptoms. Japan has, at least officially, committed to structural reform of the domestic economy alongside its fiscal and monetary stimulus. We remain concerned that these efforts on structural reform will be of a similar ilk to those attempted instituted by former Prime Minister Koizumi (who was seen as a savior for Japan at the time), and that they will ultimately suffer the same ineffectual fate.

Junichiro Koizumi

What is true for the moment however, is that devaluation has always been and still is the most straightforward, and perhaps more importantly, the most politically expedient way to stimulate domestic growth (at least theoretically), and Japan and every other major country and economic region is now unapologetically pursuing this rather short sighted course of action.

One could even argue that the term ‘currency war’ is now a misnomer. It may appear to be a race to the bottom, but since virtually every central bank is engaged in the activity of debasing its own currency, the net result across the board will of course be zero. You simply can not devalue meaningfully relative to another currency, if that currency is itself also being devalued.

So what is really going on? The cynical view is that the world’s central bank are engaged in tacit collusion to inflate away their respective governments’ debt.

At first glance it would seem to be a somewhat elegant solution. Inflation is forced up, so in nominal terms the ability to service the debt improves because the debt stock is becoming relatively smaller as overall prices (and thus tax revenues) keep rising. But as we here at NipponMarketBlog have pointed out before, this only works for as long as the market maintains confidence in this course of action. If at any point the holders of the issued debt lose faith in the government’s ability to repay the debt, then the game is up and the subsequent spike in interest rates will render that government insolvent in the short term, and unable to raise further debt in the medium term. This leaves only default (complete or partial) in the long term.

As has been said before, QE is a dead-end, and it has no exit strategy. It is an all-or-nothing bet that has never been attempted before on this scale.

It seems to NipponMarketBlog that the world’s central banks have simply ignored these very obvious truths, and stuck their heads deep into the sand, hoping that somehow the problem will solve itself if they just drag things out for long enough and apply ever more of the same medicin to the unresponsive patient.


Of course, the reality is that the only thing that will change between now and the ultimate end point (whatever that looks like), is that government debt levels will continue to rise and interest rates will be stuck at near zero indefinitely, because any rise in rates will render government debts unserviceable vis-a-vis the exploding interest costs. But at some point the music will finally stop when governments can no longer credibly persuade bondholders to keep buying new debt, or when investors lose confidence in central banks and central banks in turn lose control of interest rates and hyper-inflation kicks in.

When this happens the whole scheme will come crashing down, resulting in massive social and economic dislocations, the ramifications of which will be felt for decades – possibly even generations. Presented like this, it is difficult not to find oneself thinking ‘Ponzi Scheme’ – except when this one fails, the fallout will be on a scale that will make Bernie Madoff look like a small time pick-pocket.


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