Monday 9 December 2019

Currency wars are here to stay, but that might not be all that bad for investors

James Saft

YOU might want to learn to stop worrying and love currency wars, which are here to stay and, for investors, might not be all that bad.

A host of central bankers and policy makers have been talking currencies in recent days, generally about how their own should be weaker and other peoples' should be strong.

This is a natural result of the interaction of growth being scarce and of aggressive monetary easing in many leading economies.

Everyone wants to capture what growth there is, and those who ease monetary conditions through asset purchases get the benefit of weaker currencies which make their exports more competitive.

The risk, as in the 1930s, is in a round-robin of aggressive currency weakening leading to tariffs and trade wars, which don't just reapportion the pie but which tend to shrink it.

This doesn't have to happen, and until it does the best way to think of the currency wars is as monetary easing by another name.

If Japan, as it is and will do, creates money and drives the value of the yen down it not only creates demand at home by encouraging cash off of the sidelines, it also encourages other countries to follow suit with their own easings.

This may turn out to be terrible policy, but it sure is good for risk assets, as we are seeing.

There are, naturally, winners and losers. Europe, whose euro has strengthened markedly, comes to mind, but the global net result is more money and more economic stimulation. So long as it continues as a slap fight, rather than a trade shooting war.

At this point the currency wars are simmering nicely.

Japan's Prime Minister Shinzo Abe won his "monetary regime change" last week as the Bank of Japan, acting at his behest, doubled its inflation target to 2pc, and said it would start "open-ended" asset purchases next year.

The yen, which has weakened markedly in the last four months, actually rallied on the news, in part because of the delay in asset purchases.

Meanwhile, European Central Bank policymaker Jens Weidmann cried foul, citing Japan and Hungary, and warning that such steps could lead to an "increased politicisation of exchange rates".

Meanwhile, outgoing Bank of England chief Mervyn King and colleagues pulled a neat trick, condemning currency devaluations in others while seemingly calling for it in the British pound.

King warned that, without a rebalancing of global trade, "an increasing number of countries are coming to the view that only a lower real exchange rate will provide the stimulus to demand that their economies require.

"Several have taken action to achieve that end. That is a recipe for competitive depreciations, what some have called 'currency wars'."

In literally the very next paragraph he lauded sterling's own 25pc fall from 2007-2009, while the most recently released minutes of the BOE's monetary policy meeting warned that sterling might be too high for the economy to rebalance, a clear warning of currency skirmishes yet to come.

Britain is far from alone in seemingly wanting things both ways. James Bullard of the St Louis Federal Reserve Bank warned recently of the potential for currency wars caused by BoJ policy, an assertion that is easier to sympathise with if you don't consider the Fed's own open-ended commitment to keep buying up bonds until unemployment subsides.

Net-net, everyone wants weaker currencies and most everyone is going to be expanding their central bank balance sheets or shooting off their mouths trying to get it. It's childish, but it is also economically stimulating.

Think of a currency war as being a sort of fun-house mirror image of an asset price bubble. In an asset bubble, we all engage in the illusion that we can become wealthy by buying and selling things, like houses or shares of Apple, to one another at ever increasing prices.

The net result is stimulative unless and until things go too far and a bust ensues. In a currency war, we all try to beggar our neighbours, and while some succeed and some don't, the overall net result is more money chasing the same amount of assets.

Both often end badly, but fighting the riptide of a currency war or asset bubble is a good way to drown.

For now, investors ought to relax, let the tide carry them and then consider the best place to exit.

Indo Business

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