When James Rickards’ great book Currency Wars was released a couple of years ago, I questioned if the world was in tune with his thesis. At the time, a handful of Central Banks were raising interest rates as a part of their economic cycle and not participating in the rate cuts happening around the world.
A rate cut debases the currency; it’s that simple. The Central Banks that were then raising rates and thus supporting a strong currency included: Australia, Norway, Sweden and Canada. So, seeing that these Central Banks had no interest in debasing their currencies, I really didn’t buy into the “currency wars” idea. But that was then, and this is now. Today, three of those countries have begun to cut rates, and Canada has kept its rate unchanged after the initial hike.
Central Bank Governors from Norway and New Zealand have both recently commented that they will use interest rate cuts to keep their respective currencies from strengthening, and thus keeping their exporters happy. Neither one mentioned that they would be cutting rates because inflation was in check and the economy needed a boost. Both made certain that the markets knew their intentions.
And Japan, an old soldier in this currency war, is back to its efforts to weaken the yen. New Prime Minister Shinzo Abe has said outright that he wants a weaker yen to promote inflation. So, now we have two of the largest economies in the world debasing their currency (Japan and the U.S.).
When you talk to people about currency wars, they quickly point to China as the biggest offender. But, I beg to differ. China’s currency, while managed by the Chinese Gov’t, has appreciated vs. the dollar about 30% since breaking the peg to the dollar in July of 2005. So, while the Chinese do keep their currency from floating and from gaining in value at a faster pace, they have allowed their currency to gain—small gains, sure, but gains nonetheless!
One currency that will not be joining the currency wars, according to their leaders, is the euro. They agree that debasing the euro will not be used as an active exchange rate policy. But, for how long can they remain outside the currency debasement arena?
Lower rates, lower currency
Take a look at this 10-year graph of the dollar index (DXY), which really isn’t the best way to track the dollar’s worth, but it’s used by the markets and the media. The DXY measures the dollar’s loss of value against a weighted basket of currencies – the euro (57.6%), yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish Krona (4.2%), and Swiss franc (3.6%).
Not a pretty sight, is it?
Remember the song The Leader of the Pack by the Shangri-las? That describes the U.S. and the rate cutting/debasement race in which it remains the leader. Brazil’s Finance Minister, Guido Mantega, is credited as the first to use the term “currency wars,” and he blamed the U.S. for starting this battle. At first, I laughed at him, but now I see what’s really happening around the world.
Basically, a country manages its economy with the monetary tools it thinks are needed to keep the people happy. When countries that depend on exports see those exports begin to lag, the Central Bank reacts with rate cuts. This, in turn, weakens the currency and makes exports less expensive and more competitive. Do you blame the country for doing this? Well, all actions have unintended consequences, and a debased currency means a loss of purchasing power for a country’s citizens. So, exports may strengthen, but the citizens’ ability to spend their discretionary income is reduced.
So, to me, debasing a currency is not the answer. The solution rests in a country’s ability to manage its economy so that, 1. dependence on exports is reduced, 2. it generates domestic demand, and 3. it encourages cooperation between workers and employers to prevent excessive wage growth that raises the price of exports.
How countries will win this war
Yet, debasement is the weapon of choice for countries around the world in this war. I know what you’re thinking, “But, Chuck, you’ve told us for months now, that diversifying one’s portfolio outside of the base currency is a wise thing to do.” Yes, I did, and I’m not backing off that advice. Like I said above, the U.S. dollar is leading the devaluation movement in currencies, and has been for over 10 years in the current trend. So, if the dollar is winning this race to the bottom, then non-U.S. dollar currencies could be a better value.
In the end, though, if all countries continue down this debasement road, their currencies will eventually reach their intrinsic values, which is worthless. That’s why I always include a discussion of gold and silver (even platinum) in my talks on how to diversify one’s portfolio. And I don’t get all caught up in the prices of these metals. Gold can’t be printed and debased; it’s a store of value. But, looking out on the horizon of all these currencies, I can’t think of a better environment for precious metals.
No matter where in the world I speak, I always say the same thing I say to the people in the U.S.: don’t have 100% of your portfolio denominated in your base currency. Diversify. You don’t own just one stock; so don’t own just one currency!
EverBank World Markets, a division of EverBank
P.S. There’s still time to register for the Global Currency Expo in San Diego, April 5-7, 2013. To get the EverBank preferred rate of $445 per registrant, register here before March 15, 2013.