Currency Wars

I have a pet theory that a good way to understand history is to examine the currency arrangements. Historians will address the rampant debasement of the currency by the Romans in the third century, for example, but they never try to explain events through the lens of currency. I think you can argue that the history of money is the history of man in the sense that the arc of civilization is the mastery of money by the people in charge.

Two good examples are Charlemagne and Offa of Mercia. They were contemporaries and both reformed the coinage and mastered seigniorage. Forever after them, a key goal of the ambitious ruler was to control the coinage and use it as part of his arsenal against his adversaries. Closer to home, the history of the world post World War II is all about the dollar and its role as the reserve currency of the world.

Anyway, it looks like James Rickards was right a few years ago when he said the world is descending into a another currency war. That’s a great book, by the way. The Wall Street Journal reports that China is debasing its currency and sending shock waves through the emerging markets.

China’s devaluation of its currency jolted global markets Tuesday, hitting stocks and commodities and boosting government bonds.

The Dow Jones Industrial Average fell 1.2% to 17402.84, erasing most of the previous session’s gains. The S&P 500 fell 1% to 2084.07. The pan-European Stoxx Europe 600 index closed 1.6% lower.

Oil and metals prices also fell sharply, while demand for haven assets pushed down bond yields in the U.S. and Europe, as investors worried that Beijing’s move signaled concerns over growth in the world’s second-largest economy.

The moves came after the People’s Bank of China on Tuesday pushed down the yuan’s trading range against the dollar, setting its daily fixing rate 1.9% lower. Investors reacted to the move by pushing the yuan down almost 2% from that level.

Financial markets saw it as a sign that Chinese authorities believe it is necessary to act to boost flagging growth, said Ewen Cameron Watt, chief investment strategist at BlackRock’s Inc.’s Investment Institute.

They call currency devaluation “beggar thy neighbor” for a reason. China, in an effort to boost exports, will start printing money, thus lowering its value against the dollar and other currencies. That will make Chinese products more competitive in US and European markets. This may be fine for the US and Europe as it means cheap goods and people like cheap goods for a while.

The trouble is everyone else will have no choice but to follow suit and debase their currency. It can easily become a race to the bottom. International management through central banks is probably enough to keep things from getting out of hand, but there are unknown unknowns. The biggest is the off the books carry trade market that is possibly over $9 Trillion USD now.

The entirety of this market is leverage. You borrow money to invest it in another currency. Presumably, settlement of both ends of the transaction leaves a profit, but big moves in the currency rates means huge losses. Those losses are covered by liquidating other assets to cover the loss. This can set off a cascading effect blowing up whole markets in days, even with the loss prevention systems governments have in place. The most obvious example is The Asian Financial Crisis of ’97.

Life is not a math problem and so economic problems become political problems. Brazil, which is already struggling, cannot withstand a currency war. This is not a country with a stable political and cultural foundation. The current president is already under fire so a deepening economic crisis will probably lead to political turmoil or worse. Military coup is the traditional way of doing things in Brazil so you never can rule that out as a possibility.

Currency wars never end well. The currency war that started in the 1920’s ended with depression and world war. The disorganized flight from the Bretton Woods system eventually led to the current system of towering world debt that may be about to tip over. The only way for the West to maintain their massive custodial states is through unlimited credit emissions. A full on currency war probably brings that to an end.


12 thoughts on “Currency Wars

    • No doubt. I always love how the reporters say the market was up or down due to traders worried about something or other. It’s like they market has a soul and self-awareness.

      I think in this case the smart money was caught off guard and that means they are surprised by it. The conventional wisdom has been that China was solid and ready to take off again. Now, it probably mean they are in choppy waters at best.

  1. My understanding is that the Chinese have a massive stock and property bubble as a direct result of their effort to scrub the currency. The stock market bubble has already burst, and the property bubble is sure to follow. Also, before this devaluation China was actually letting its currency rise in an effort to stop capital flight, which was the result of the market sell-off. It sounds to me like they are pretty close to melt down over there, are losing control, and are panicking.

    • China is a long away from crisis. This is mostly a crisis generated by the western media for clicks and page views…financial news sensationalism as usual. If you want to see the next crisis, look to Turkey, Venezuela, and Brazil, for example, which have plunging currencies, high inflation, capital flight, and high debt loads..much worse than China. Even Russia is in worse shape than China.

  2. So the “shemitah” is right? Everybody is saying that a major economic Collapse will happen next month.

    • I don’t think “collapse” in the classic sense is possible. The Greek drama has me doubting that a bit, but I still think the world has passed the point where collapse is possible for a large modern country. Instead, I think wholesale reorganization is probably in the offing. In America, state and local government are being squeezed to death by pensions and health care. At some point, that becomes untenable. Similarly, the national government cannot keep piling on debt and must deleverage.

      The lesson from the Roman third century is that social arrangements can carry on a long time despite being untenable. The lack of a plausible alternative is probably the biggest prop in the current system.

      • I long ago said that money is little more than a measure of confidence. If you have a promissory note then you reasonably expect the promise to be honoured. Confidence in the system has thus far achieved wonders, literally and figuratively.

        What I never thought, naive that I am, was that it would be more of a confidence trick. Still, if we continue not noticing then all is well.

  3. It’s not just about printing money anymore, Z. I think that the Japanese were the first to figure out that by buying truly large amounts of U.S.debt and balancing their financial account, they could have a current account that was grossly imbalanced while avoiding the inflation that would accompany a gross trade imbalance in classical economic theory.

    The fact the the story mentions that the value of U.S. debt is increasing shows that the market expects the Chicoms to buy more U.S. debt, feeding our habit and theirs.

    • Possibly. Reading the financial stories today it sounded to me like the Chinese were trying to inflate. It’s a black box so everyone is speculating. I get the sense this has not been coordinated with the Fed or ECB, but that’s impossible to know at this point.

      The truly scary thing is no one really knows what the hell is going on in the Chinese banking systems. I recall reading in the 1990’s how the PBOC was hiding bad debt with the old good bank/bank bank skit. Imagine what they are doing now with more sophisticated tools.

      • My idea of the Chinese economy is two men in a row boat. One guy has a bucket and is bailing as fast as he can. The other guy is busy drilling holes in the bottom of the boat.
        Or maybe better, the guy riding a Tiger who wants to get off while not being dinner.

        • Culturally, the Chinese are still Chinese. That means they will never let the barbarian round eyes see inside the forbidden city. It’s why I think it is lunacy to include them in international arrangements as if they are just another western democracy. But, the people in charge of our countries believe in the transcendent power of technocracy.

    • Looks like they are doing exactly what you said. They are hoovering up treasuries right now. The 10-year took a header this week.

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