Mercantilistic US Monetary Policies Has Political Implications

The conduct of ‘imperialist’ US foreign policies somewhat resembles US monetary policies: mercantilism channeled through currency wars.

Writes Professor Steve Hanke at the Financial Post, (bold emphasis mine)

The United States has a long history of waging currency wars in Asia. We all know the sad case of Japan. The U.S. claimed that unfair Japanese trading practices were behind the ballooning U.S. bilateral trade deficit.

To correct the so-called problem, the U.S. demanded that Japan adopt an ever-appreciating yen policy. The Japanese complied and the yen appreciated against the greenback, from 360 in 1971 to 80 in 1995 (and 77, today). But this didn’t close the U.S. trade deficit with Japan. Indeed, Japan’s contribution to the U.S. trade deficit reached almost 60% in 1991. And, if that wasn’t enough, the yen’s appreciation pushed Japan’s economy into a deflationary quagmire.

Today, the U.S. is playing the same blame game with China. And why not? After all, China’s contribution to the U.S. trade deficit has surged to 45%.

Above is the USDollar Japan Yen chart since 1970 (St. Louis Federal Reserve)

Yet in spite of the massive appreciation partly from US behests, Japan’s trade balance remained positive until last year (for the first time in 31 years; chart from the Economist)

Well, Professor Hanke points out that a currency war with China has had a precedent.

To appreciate just how dangerous currency wars can be, let’s lift a page from the U.S. government’s old currency war playbook. During his first term, President Franklin D. Roosevelt delivered on his Chinese currency stabilization “plan.” China’s yuan was pegged to the price of silver, and it was asserted that higher silver prices would benefit the Chinese by increasing their purchasing power. Congress granted the Roosevelt Administration the authority to buy silver in massive quantities. The administration pushed the price of silver up by 128% in the period between 1932 and 1935. As the dollar value of silver went up, so did the value of the yuan.

America’s “plan” worked like a charm, but it had consequences that Washington had not quite advertised. The rapid appreciation of the yuan threw China into the jaws of the Great Depression. Between 1932 and 1934, its gross domestic product fell by 26% and wholesale prices in the capital city, Nanjing, fell by 20%. China officially abandoned the silver standard on Nov. 3, 1935. This spelled the beginning of the end for Chiang Kai-shek’s Nationalist government.

Every political policy has designated winners and losers, which means that monetary policies too have political dimensions. And perhaps anytime the US government sees a serious contender to their economic tiara, their political-bureaucratic stewards intuitively resort to what seems as bullying or intimidation or “beggar thy neighbour” policies: currency war. [Brazil in 2010 raised the spectre of an escalation of a currency war or competitive devaluation.]

Yet such political stratagem of scapegoatism seems contrived to divert the attention of the average Americans from the policy mistakes committed by the US government (boom bust cycles, fast expanding welfare state, war on terror policies and etc…).

We can even fuse together monetary and US foreign policies—the EU’s recent sanction on Iran seems parceled into the US Federal Reserve’s bailout.

Also, the US has even been selling China as a military threat to advance US military’s exposure in Asia, simultaneously while the Obama administration has been criticizing China’s trade and currency policies. All these seem to be part of the psywar operative.

Never mind if the US seems on path towards internal policy induced decadence.

For what seems intended is the preservation of the status quo, or the entitlements of the entrenched patrons—the political class and their clients—the banking and military industrial complex—all at the expense of everyone else.

The philosophy of mercantilism or protectionism, once wrote Ludwig von Mises,is indeed a philosophy of war.

Competitive Devaluations: Japan Intervenes to Curb Yen gains for the Third Time this year

Japan intervened in the currency market today, to allegedly halt a rising yen. Today’s action is the third intervention this year.

From Bloomberg

The yen dropped by the most in three years against the dollar as Japan stepped into foreign-exchange markets to weaken the currency for the third time this year after its gains to a postwar record threatened exporters.

“I’ve repeatedly said that we’ll take bold action against speculative moves in the market,” Japanese Finance Minister Jun Azumi told reporters today in Tokyo after the government acted unilaterally. “I’ll continue to intervene until I am satisfied.”

The yen weakened against the more than 150 currencies that Bloomberg tracks as Azumi said that he ordered the intervention at 10:25 a.m. local time because “speculative moves” in the currency failed to reflect Japan’s economic fundamentals. Today’s drop reversed this month’s previous gain by the yen against the greenback, which came amid speculation the Federal Reserve may add to stimulus measures as the U.S. economic recovery stagnates.

Statements like this “I’ll continue to intervene until I am satisfied’” might mislead people to think that political authorities really have the power to control the markets.

It is true enough that their actions may have a momentary or short term impact.

That’s the yen headed lower following today’s intervention.

But from a one year perspective, the first two interventions eventually resulted to a HIGHER and NOT a lower yen (blue uptrend)! The initial intervention was in March 18 where the BoJ bought $1 billion and the second was in August 4, both interventions are marked by green ellipse.

Talk about hubris.

Nevertheless, the inflationism or competitive devaluations being undertaken by Japan has hardly been about exports—why prop up exporters when this sector account for only less than 15% of Japan’s GDP?

Instead, like her contemporaries, the devaluation has been meant to prop up Japan’s rapidly decaying debt laden political institutions of the welfare state-banking system-central banking.

Japan’s government has the largest share and has the biggest growth of Japan’s overall debt (McKinsey Quarterly)

And as the great Ludwig von Mises wrote

The devaluation, say its champions, reduces the burden of debts. This is certainly true. It favors debtors at the expense of creditors. In the eyes of those who still have not learned that under modern conditions the creditors must not be identified with the rich not the debtors with the poor, this is beneficial. The actual effect is that the indebted owners of real estate and farm land and the shareholders of indebted corporations reap gains at the expense of the majority of people whose savings are invested in bonds, debentures, savings-bank deposits, and insurance policies.

It is sad know how politicians misrepresent what they stand for and use class warfare or supposed underprivileged sectors to rationalize the imposition of what are truly designed as self preservation measures.

Put another way, the BoJ’s serial devaluations has actually been meant to illicitly transfer the resources of the average Japanese citizens to the political class and her banking system. Incidentally, the latter, like the Euro counterparts, has been under strain.

From Bloomberg (Topix Banks index)

Share prices of Japan's banks have slumped since 2007.

So much for blabbering about public interest. Devaluations are all about political greed.

Will the Global Central Banks Coordinate a Global Devaluation or Plaza Accord 2.0?

Policymakers easily change tunes especially when faced with fickle political exigencies

ECB’s President Jean-Claude Trichet, once a reluctant inflationist, will join the US in resorting to ‘open arms’ inflationism.

From the Bloomberg, (bold emphasis mine)

European Central Bank President Jean-Claude Trichet said threats to the euro region have worsened and inflation risks have eased, giving officials the option to take further action should the debt crisis worsen.

The economy faces “particularly high uncertainty and intensified downside risks,” Trichet said at a press conference in Frankfurt today after the ECB left its benchmark rate at 1.5 percent. While monetary policy is still “accommodative,” financing conditions have worsened in parts of the 17-member euro region and the ECB stands ready to pump more cash into markets if needed, he said.

The Bank of England recently refrained from extending credit easing (QE) programs, this could be temporary.

From another article from Bloomberg, (bold emphasis mine)

Bank of England officials resisted calls to extend economic stimulus as they attempt to navigate a path between accelerating inflation and a faltering recovery.

The nine-member Monetary Policy Committee, led by Mervyn King, maintained the target of its bond program at 200 billion pounds ($320 billion), as forecast by all but one of 41 economists in a Bloomberg News survey. It also held the benchmark interest rate at a record-low 0.5 percent today, as predicted by all 57 economists in a separate poll. The pound rose against the dollar after the announcement.

Central banks are refocusing on bolstering growth, with the Bank of Canada saying yesterday there is a “diminished” need for it to raise rates and Sweden’s Riksbank abandoning a planned tightening. While two U.K. policy makers who were calling for rate increases dropped that position last month, the Bank of England may be reluctant to do more so-called quantitative easing with inflation more than double its target.

Again my view is that central bankers appear to be looking for justifications to employ the increasingly unpopular QE programs.

However as shown above, some of the hardliner’s stance can easily give way when confronted by the prospects of a reemergent crisis.

For political authorities, an adapted political stance have mostly been symbolical. For the public hardwired to expect actions from these authorities, it would be politically difficult or unpopular not give in, as crisis can instantaneously change popular perception. Put differently, an aura of desperation can shift what seems unpopular today to become popular tomorrow, and thus political actions can be as capricious as political sentiment.

Yet given the predilection towards QE policies, analysts at Morgan Stanley speculate that a Plaza Accord 2.0 will likely be the course of action for global central bankers.

From Barrons, (bold emphasis mine)

Is a Plaza Accord 2.0 ahead? Some 26 years ago this month, the major industrialized nations hatched a plan to lower the dollar and unleash a wave of liquidity that raised global equity markets in the mid-1980s. Could it happen again?

Yes, say Joachim Fels, Manor Pradhan and Spyros Andreopolous, who head Morgan Stanley's global economics. In a report released Wednesday, they write that monetary authorities of the developed economies -- the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England -- could react to "weak growth and soggy asset markets" with coordinated easing.

In addition, they note that surprise easing moves by leading emerging-market economies, Brazil and Turkey, would complement the process. And while the Morgan Stanley team doesn't mention it explicitly, the Swiss National Bank's decision to peg the Swiss franc to the euro also would be consistent with an internationally coordinated easing move.

In my view, competitive devaluation has not only been happening, but has been intensifying. Although coordination may only be part of the story, perhaps applied to Western and developed economy central banks. Nevertheless the path towards policy harmonization could be in the works as proposed.

Yet I’m not sure about the effects of a global concerted and coordinated devaluation.

Although one thing seems certain: This policy addiction or obsession to debauch or destroy the currency serves as THE reason to own gold.

South Korea Joins the Currency Devaluation Derby

Competitive devaluation has been the central bankers’ conventional response to emergent financial and economic problems. It seems part of their operating manual. And Asian central bankers have been engaging in the same inflationism as with their crisis affected Western counterparts.

From the Wall Street Journal, (bold emphasis mine)

Is anyone really surprised inflation in South Korea has hit a three-year high? They shouldn't be. Seoul is, like so many other East Asian governments, in large part a victim of economic policies hatched in Washington. Yet Korean policy makers seem to be doing everything they can to make their monetary problems worse.

The government was quick to blame last week's price-rise data—up 5.3% for August compared to the same month last year—on that old inflationary whipping boy, the weather. Summer flooding supposedly depressed agriculture supplies and pushed food prices higher. Perhaps that even explains part of it.

But alarm bells also should be ringing over energy prices. The consumer inflation data included increases of between 2% and 10% on various oil and gas products as the government scales back increasingly unaffordable subsidies. No Korean oil fields were flooded since there aren't any Korean oil fields to flood. Clearly something bigger than Mother Nature is afoot.

Such as monetary policy, both in the U.S. and in Korea. Korea has been hit by the same dollar tidal wave the Federal Reserve has unleashed on the rest of the world. These inflows have caused inflation spikes all over, with consumer price rises of nearly 4.5% in Thailand, more than 3% in Malaysia, above 5% in Singapore and so forth in recent months. A weak-dollar policy out of Washington inevitably strains everyone else in what still is the Asian dollar bloc.

Korea, however, has managed to make matters worse by attempting a form of competitive devaluation of the won on the sly. Dollar inflows have also sparked currency appreciations in most corners of Asia, with the yen (up 17.5% vis-à-vis the dollar since January 2010), Singapore dollar (14%) and Thai baht (10%) leading the pack.

But in Seoul, the central bank has refrained from raising interest rates that are still negative after accounting for inflation, despite unsustainably robust growth and mounting evidence of rising prices. Data on foreign-exchange reserve accumulation over the past two years also suggest the government may be quietly buying dollars and selling won, although the government denies this.

Political authorities, adapting the mercantilist view, have been averse to see their currencies appreciate, so their common response has been to resort to the beggar thy neighbor approach of inflating the system.

The five year chart of the South Korean won (from yahoo). The won has not recovered from the 2008 collapse relative to the US dollar.

The race to destroy currencies has been the principal reason why gold prices will continue to blossom.

Hot: Swiss National Bank to Embrace Zimbabwe’s Gideon Gono model

The Swiss National Bank has impliedly adapted Zimbabwe’s Central Bank Governor Gideon Gono’s hyperinflationary model.

From Reuters, (bold emphasis mine)

The Swiss National Bank said on Tuesday it would set a minimum exchange rate target of 1.20 francs to the euro and would enforce it by buying foreign currency in unlimited quantities.

The Fiat money standard’s race to perdition via competitive devaluation seems to be accelerating.

All these for saving the banking system. As I recently wrote,

Late last week, the US Federal Reserve has extended a $200 million loan facility via currency swap lines to the Swiss National Bank (SNB), as an unidentified European bank reportedly secured a $500 million emergency loan. This essentially validates my suspicion that the so-called currency intervention by the SNB camouflaged its true purpose, i.e. the extension of liquidity to distressed banks, whose woes have been ventilated on the equity markets.

Hot: BSP’s Amando Tetangco says Philippines Open to Currency Intervention

Given the recent fad of currency interventions initiated by the SNB and the BoJ, the Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) has threatened to join the bandwagon

From Bloomberg,

The Philippines is prepared to impose controls to cap volatility in the peso after its currency rose to a three-year high this week, central bank Governor Amando Tetangco said in an e-mail late yesterday. The bank “will not go against the fundamental currency trend but will not hesitate to use tools, including imposing prudential limits on certain transactions of banks,” he said.

Gadzooks. This guy speaks as if he has been bestowed with supernatural powers to control the marketplace, like the fabled King Canute who commanded the sea waves to halt.

The Philippines has already been engaged in subtle currency interventions, but because of the political correctness, which are meant to advance the remittance and export based interest groups, the BSP honcho has announced his willingness to do much further actions at the risks of unintended consequences

These people are hardly accountable for their actions, and would boldly take any measures at our expense.

Well, if competitive devaluation becomes widespread or the predominant measure worldwide, then expect inflation to accelerate.

Global hyperinflation could turn into a real risk.

Japan Intervenes to Curb Rising Yen

From one currency intervention to another, yesterday the Swiss Franc, today the Japanese Yen (the BoJ finally made good their earlier broadcasted plan)

From Bloomberg

Japan intervened in the foreign- exchange market to sell yen, Finance Minister Yoshihiko Noda told reporters today in Tokyo.

The nation acted alone, and was in touch with other countries, Noda said. The Bank of Japan separately said in a statement that it will end its policy meeting today, one day early. Noda said that he hopes the central bank will take appropriate action.

All these money being printed will flow somewhere.

Bottom line: Paper money, as Voltaire said, will eventually return to its intrinsic value: ZERO

Questions and Answers on Philippine Monetary and Fiscal Issues

The following is my to answer some of the questions that my colleagues have posted on facebook group which they say is required for their research.

Role of Central Bank and Currency Interventions

With reference to the record $66.2 billion Gross International Reserves (GIR) the Philippines has tallied for the first quarter of 2011, this can be broken down into Foreign Investments, Gold, Special Drawing Rights (SDRs), foreign exchange and Reserve position in the fund.

Breakdown of Gross International Reserves (Bangko Sentral ng Pilipinas)

Reserve assets can further be broken down into securities mostly in foreign bonds and notes and secondly in foreign currency cash and deposits.

Reserve asset breakdown Bangko Sentral ng Pilipinas

The role of the BSP, like all other central banks, is to manage exchange rate fluctuation and or the state of balance of payments.

They do this by either indirect foreign currency intervention (tweaking money supply) or indirect foreign currency intervention (buy or sell foreign currencies with local currency) [Steven M. Suravonic, International Finance Theory and Policy]

And in managing capital inflows they can be sterilized or non-sterilized. Non sterilized intervention can result to inflation.

Jang-Yung Lee explains [IMF 1997 Sterilizing Capital Inflows]

Capital inflows result in a buildup of foreign exchange reserves. As these reserves are used to buy domestic currency, the domestic monetary base expands without a corresponding increase in production: too much money begins to chase too few goods and services.

To ease the threat of currency appreciation or inflation, central banks often attempt what is known as the "sterilization" of capital flows. In a successful sterilization operation, the domestic component of the monetary base (bank reserves plus currency) is reduced to offset the reserve inflow, at least temporarily. In theory, this can be achieved in several ways, such as by encouraging private investment overseas, or allowing foreigners to borrow from the local market. The classical form of sterilization, however, has been through the use of open market operations, that is, selling Treasury bills and other instruments to reduce the domestic component of the monetary base. The problem is that, in practice, such sterilization can be difficult to execute and sometimes even self-defeating, as an apparently successful operation may raise domestic interest rates and stimulate even greater capital inflows. Unfortunately, many developing countries also lack the tools available to run a classical sterilization policy, or find it simply too costly to do so. This is often the case wherever the financial system is not fully liberalized.

The Philippines has undertaken both measures with questionable results.

From the ADB Institute,

As described earlier, the BSP has engaged in both sterilized and unsterilized intervention. A simple correlation analysis indicates that intervention, as measured by the percentage of international reserves, has limited impact on the exchange rate’s level, percentage change, and volatility (Table 11 [ PDF 53.5KB | 1 page ]).¹⁰ The results indicate that intervention had a modicum of success in reducing exchange rate volatility in the Philippines between 1993 and 1996. Meanwhile, intervention prevented a rise in the exchange rate (measured in US$/peso) after the crisis, particularly during the period 2003–2007. In many instances the results are counter-intuitive, i.e. the correlation coefficient is positive, similar to the result of the impulse response function that was presented in Section III (Figure 4 [ PDF 42.8KB | 1 page ]). ADB Institute, Evaluation of Policy Responses, March 5, 2008

External Debt (Fiscal and Monetary Issues)

The question of debt has also been raised.

External debt as defined by the BSP covers all short-term and medium-term obligations of the BSP, commercial banks, public and private sectors payable to non-residents.

One must be reminded that external debt which covers by the national government is a fiscal issue whose repayment is allocated by the Philippine Congress. The 2011 php 1.645 trillion budget allocates 23% to debt servicing (dateline Philippines, President Aquino’s Budget message—Office of the President’s Official Gazette)

The BSP’s role according to Manila Bulletin/Cuervo Far East is to set “internal annual debt ceiling to monitor foreign borrowings, either from commercial sources or from official development assistance funds or donor aids.”

External Objectives and the Role of Forex Currency Reserves

Now domestic monetary policy is about domestic political and economic issues, and is hardly about coordinating inflation with external sources.

External issues are assumed by currencies that play the role of foreign currency reserves, where the conflict of interest between domestic and international objectives engenders what is known as the Triffin Dilemma.

IMF During the 1997 Asian Crisis and the Philippine Debt Moratorium in 1970-80s

During the Asian crisis the left has blamed liberalization, pegged currency and high interest rates (Walden Bello) when the problem has been a global rotational issue of bubble cycles.

Paper money has never been about sound money. It has been about political objectives.

As to whether the restricting Peso ‘inflation’ would hurt the US dollar hegemony, US dollar’s hegemony depends largely on the sustainment of its inflationist policies. If the US recklessly pursues a dollar debasement as their main policy thrust, countries will either jointly devalue (race to the bottom or competitive devaluation) or abandon the US dollar as a foreign currency reserve.

Finally, with regards to the role played by the IMF during the Philippines during the Philippine debt moratorium

Country-data com provides some clue: (bold emphasis mine)

On October 17, 1983, it was announced that the Philippines was unable to meet debt-service obligations on its foreign-currency debt of US$24.4 billion and was asking for a ninety-day moratorium on its payments. Subsequent requests were made for moratorium extensions. The action was the climax of an increasingly difficult balance of payments situation. Philippine development during the decade of the 1970s had been facilitated by extensive borrowing on the international capital market. Between 1973 and 1982, the country's indebtedness increased an average of 27 percent per year. Although government-to-government loans and loans from multilateral institutions such as the World Bank and Asian Development Bank were granted at lower-than-market rates of interest, the debt-service charges on those and commercial loans continued to mount. In 1982 payments were US$3.5 billion, approximately the level of foreign borrowing that year and greater than the country's total debt in 1970. The next year, 1983, interest payments exceeded the net inflow of capital by about US$1.85 billion. In combination with the downturn in the world economy, increasing interest rates, a domestic financial scandal that occurred when a businessman fled the country with debts estimated at P700 million, escalating unrest at the excesses of the Marcos regime, and the political crisis that followed the Aquino assassination, the debt burden became unsustainable (see table 16, Appendix).

The Philippines had turned to the IMF previously in 1962 and 1970 when it had run into balance of payments difficulties. It did so again in late 1982. An agreement was reached in February 1983 for an emergency loan, followed by other loans from the World Bank and transnational commercial banks. Negotiations began again almost immediately after the moratorium declaration between Philippine monetary officials and the IMF. The situation became complicated when it came to light that the Philippines had understated its debt by some US$7 billion to US$8 billion, overstated its foreign-exchange reserves by approximately US$1 billion, and contravened its February 1983 agreement with the IMF by allowing a rapid increase in the money supply. A new standby arrangement was finally reached with the IMF in December 1984, more than a year after the declaration of the moratorium. In the meantime, additional external funds became nearly impossible to obtain.

In each of these arrangements with the IMF, the Philippines agreed to certain conditions to obtain additional funding, generally including devaluation of the peso, liberalization of import restraints, and tightening of domestic credit (limiting the growth of the money supply and raising interest rates). The adjustment measures demanded by the IMF in the December 1984 agreement were harsh, and the economy reacted severely. Because of its financial straits, however, the government saw no option but to comply. Balance of payments targets were met for the following year, and the current account turned positive in FY (fiscal year--see Glossary) 1986, the first time in more than a decade. But there was a cost; interest rates rose to as high as 40 percent, and real GNP declined 11 percent over 1984 and 1985. The dire economic situation contributed to Aquino's victory in the February 1986 presidential election.

Hope this helps,

Benson

The Possible Implications Of The Next Phase Of US Monetary Easing

``In a free economy the principal cause of a cumulative deficit in a country's international payments is to be found in inflation. Reference to it has been already made. A sustained policy of inflation leads a gold-standard country to a cumulative loss of gold and finally to the abandonment of that system; then the national currency can freely depreciate. In a country whose currency is not convertible into gold, inflation leads to its continuous devaluation in terms of foreign currencies.” Michael A. Heilperin, International Monetary Economics

I have more proof that the next wave of inflationism will take place not because of the political exigencies to restore “export competitiveness” (a.k.a currency wars) or about the US unemployment woes, even if the latter has been used as justification for the coming actions, but to save the US banking system.

QE 2.0 And The Legal Face Of The US Mortgage Crisis

The US Federal Reserve through Mr. Bernanke in a recent speech said that “the risk of deflation is higher than desirable[1]” and that “Given the committee’s objectives, there would appear — all else being equal — to be a case for further action[2]”

So there seems to be a strong likelihood of Quantitative Easing (QE) 2.0 will take place during the next Fed meeting in November 2-3.

Yet, what’s wrong with the two illustrations? (see figure 1)

Figure 1: US Stocks Rallying Without Financials

Basically, the US stockmarket has been rallying absent the financials, the former leaders. The financials, as seen by S&P Financials (SPF: left window, bottom pane), have lagged and has been weighed by the banking index (BIX-left window, main chart)

The poor performance of the US banks can be traced to the next phase of the mortgage crisis.

Apparently the US mortgage mess has been transformed from a financial and economic issue into a major legal morass: The issue of property titles—where the complexities of the Mortgage Backed Securities (MBS), during the boom days, may have led to string of fraudulent actions which may have caused a “chain of broken titles”.

Gonzalo Lira has the details[3] but here is the kernel,

``A lot of the foreclosed properties might not have been foreclosed legally. The people evicted might still have a right to their old houses. The new buyers might not actually own the REO’s they bought off the banks. The banks could be on the hook for trillions of dollars, and in the sights of literally millions of lawsuits.”

The initial tremor has been a wave of foreclosure moratorium.

According to Chad Fisher of USA News[4],

``JPMorgan Chase has suspended foreclosures in 23 states while the company looks at 115,000 mortgage foreclosure files to find potential errors in its documentation. Ally Financial and Bank of America are looking for errors in files for all 50 states and suspending foreclosures. Goldman Sachs' Litton Loan Servicing, PNC Financial, and OneWest Bank began are checking their files, but Wells Fargo and Citigroup are holding their ground, stating that their affidavits are valid and sound...This time the states are banding together to stop foreclosures based on illegal affidavits submitted by mortgage companies in foreclosure proceedings.”

One risk is that banks may be required to buy back mortgage securities if they are the originators. This could put under further strain the banking industry’s capital position that could trigger another seizure in the banking system.

And perhaps QE 2.0 is meant to assume this role—to provide another subsidy to industry by acting as lender or buyer or guarantor of last resort.

Of course the foreclosure moratorium presents as another burden to the housing industry, which serves as another reason why QE 2.0 will, once again, be in operation.

As we have long said, this has much less been about the US economy, but about protecting the banking system, which has been the anchor to the de facto US dollar monetary system, from the risks of collapse.

The problem with mainstream media is that they have been focused on the aspects of currency wars, emanating from so-called imbalances, when the predicament is apparently internal: Incumbent unsustainable policies and their unintended consequences.

The Deadly Effects Of Competitive Devaluation

I’d like to add that the impact of the so-called “currency wars” will greatly depend on the degree of reaction by Emerging Market central banks relative to the inflationism applied by their contemporaries in the developed economies.

Since currency wars or “competitive devaluation” function as a subtle form of protectionism, which implies of multiple participants, the effect isn’t likely to be temporary or short term but a lasting one with disastrous results.

We are not new to this, according to Murray N. Rothbard[5], (bold highlights mine, italics original)

``Of course, the world had suffered mightily from fluctuating fiat money in the not too distant past: the 1930s, when every country had gone off gold (a phony gold standard preserved for foreign central banks by the United States). The problem is that each nation-state kept fixing its exchange rates, and the result was currency blocs, aggressive devaluations attempting to expand exports and restrict imports, and economic warfare culminating in World War II.”

The major difference is that countries then went off the gold standard and eventually returned to a modified US dollar-gold fix, known as the Bretton Woods system[6], while today we are operating plainly on a paper money US dollar standard. So essentially, the competitive devaluation being staged by today’s global central banks sails on unchartered waters.

Figure 2: Imports Then And Today

Besides unlike in the 30s, global trade was much less of a factor (see figure 2). And less global trade translated then to geopolitics that had been mainly based on nationalism.

Today, the world has been alot more trade oriented. And so far, the responses by emerging market monetary authorities have been benign, defensive and less confrontational.

For instance, Thailand reportedly will remove a 15% tax privilege accorded to foreigners on income from domestic bonds[7]. Also lately Brazil’s government will move to “to raise the country's Financial Operations Tax, known as IOF, on certain types of incoming foreign investment will be insufficient to resolve the country's problems with an appreciated local currency, Brazil's National Confederation of Industries, or CNI, said Tuesday[8].”

South Korea also joins the clamp down on foreign currency speculation by increasing probes on currency derivatives[9].

And to confirm our suspicions[10], Asian central banks have been heavily intervening on their respective markets to curb currency appreciation. According to a news report ``Authorities in the region were estimated to have bought a combined $23.2 billion via intervention from last week until Tuesday, according to traders estimated compiled by IFR Markets.[11]”

And signs are likely that reactive interventions also involves the domestic central bank (Bangko Sentral ng Pilipinas) in the slowing the appreciation of the Peso[12].

And of course the overall effect of competitive devaluation is to raise the price of commodities (see figure 3).

Figure 3: Stockcharts.com: Commodity Inflation

So whether it Gold (Gold), Agriculture commodities ($GKX-S&P GSCI Agricultural Index Spot Prices), industrial metals ($GYX S&P GSCI Industrial Metals Index - Spot Prices) or energy products ($GJX-S&P GSCI Energy Index Spot Prices) we seem to be witnessing broadening signs of commodity inflation emanating from these collective policies. This is aside from the financial asset inflation in Emerging Markets.

Author Judy Shelton quotes Euro currency founder Robert Mundell in an interview[13],

``'The price of gold is an index of inflation expectations," Mr. Mundell says without hesitation. "The rising price of gold shows that people see huge amounts of debt being accumulated and they expect more money to be pumped out."

In explaining the failure of the Bretton Woods system, Mr. Mundell again in the same interview says

"The system broke down," he hastens to explain, "not because of fixed rates. Fixed exchange rates operate between California and New York . . . the system broke down because there was no mechanism to keep the world price level in line with the price of gold." (emphasis added)

In other words, sustained interventions and inflationism deflected or distorted the exchange ratio between money relative to gold which induced huge unsustainable imbalances that caused the monetary system to disintegrate.

Applying this to competitive devaluation, this implies that protectionism via the currency valve will only risks leading the world to inimical trade wars or shifting bubble cycles or hyperinflation/breakdown of the currency system.

So for a full scale currency war to take place, the effects are certainly not negligible.

In A Currency War No Nation Wins

It’s even equally ridiculous to hear mainstream proponents advocate currency wars as solution to global imbalances such as “China wants to impose a deflationary adjustment on the US, just as Germany is doing to Greece”[14].

On the first place no one is trying to deflate other nations directly for their own benefit. Policies are most shaped to conform with perceived interests of local entities that takes external interests as secondary objectives.

For instance, QE 2.0 appears directed at the banking system rather than promoting demand via export competitiveness via the currency channel.

Next, people and not nations are the ones who conduct trade and trade balances likewise reflect on this.

Another, currency values are not the sole factor that determines trade balances, there are many issues such as scale of capital, technology, infrastructure, cost of doing business through tax and bureaucratic regime, legal institutions, property rights, state of the markets and labor and many others that influence the business environment.

Fourth, it isn’t true China or Greece has been deflating (see figure 4).

Figure 4: Tradingeconomics.com: Inflation in China and Greece

The problems of Greece, for instance, reflect more on the rigidity of a relatively closed economy[15] and the overdependence on a welfare state than from its Euro anchor. I’d suspect that even if Greece were to operate on its former currency, the drachma, and allowed to devalue; the internal rigidities won’t miraculously bring them to an export giant as misperceived by the mainstream.

So I wouldn’t know what kind of world these analysts live in, but their narratives has been far from appropriate accounting for the facts. They would seem to be like snake-oil salesman.

Lastly, since inflationism is a subtle form of redistribution, i.e. from savers to spenders and from creditors to debtors, this will be beneficial only to a few but at the expense of society. Therefore, claims that the US will benefit from a currency war is unalloyed canard.

Doug Noland of the Credit Bubble Bulletin rightly observes[16],

``The U.S. cannot win the “currency war.” In reality, central bankers in China, Japan, Brazil, South Korea and elsewhere aren’t even battling against us. They have, instead, been waging war on the market. If foreign central bankers had not intervened and accumulated massive dollar holdings (international reserves up an incredible $1.5 TN in 12 months!) – in the process providing a “backstop bid” for both our currency and the Treasury market – it would be an altogether different market environment today.

``There will be no answer for global imbalances found by the U.S. “inflating the rest of the world.” The problem with inflationism is that one year of inflationary measures leads only to the next year of greater inflation.”

And I certainly agree that inflationism is an addictive agent. But like abuse of use of illegal substances, such actions will have long term deleterious implications.

QE 2.0 Should Boost Emerging Market and Asian Equity Assets

As we have long repeatedly argued, global policy divergences has been prompting for cross border capital flows that has been buoying emerging market assets including that of Asia (see figure 5).

Figure 5: US Global Funds: QE 2.0 Should Lift Asian Equities

And the transmission mechanism that would boost liquidity flows isn’t only from external sources but likewise reflected from domestic channels.

Some confirmation of our view from Morgan Stanley’s Joachim Fels and Manoj Pradhan[17]

``Economies with greater slack in their economies and less inflationary pressures will try to keep their currencies from appreciating, either through FX intervention or, to a lesser extent, via the use of capital controls. Intervention in FX markets will likely mean higher domestic liquidity (in the absence of tight credit controls like in China). In turn, the domestic economy is likely to expand and goods and risky asset prices are likely to be pushed higher. These EM economies should see a boom, and higher incomes, leading to an increase in the demand for US exports. Other EM economies, whose output gaps are too small for comfort or whose inflation is already a concern, could decide to let their currencies accelerate to a greater extent. Domestic expansion here would be more limited, so there would be not so much of an income effect; but US exports would still benefit again, this time from an improved price advantage thanks to EM currency appreciation.”

Figure 6: Tradingeconomics.com: Philippines Total Forex Reserves (ex-gold)

In the Philippines, as cross border capital flow surges, domestic liquidity has likewise been expanding, as the local central bank, the BSP, intervenes in the currency markets, aside from the ramifications of the artificially suppressed interest rates.

So in the environment of the alluring sweet spot of inflationism and concerted currency debasement, cash is likely the worst form of investment.

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[1] Businessweek.com Bernanke Ponders ‘Crapshoot’ Amid Deflation Risk, October 15, 2010

[2] New York Times, Bernanke Weighs Risks of New Action, October 15, 2010

[3] Lira, Gonzalo The Second Leg Down of America’s Death Spiral, October 12, 2010

[4] Fisher Chad, 5 Things You Should Know About the Foreclosure Moratorium, US News, October 15, 2010

[5] Rothbard, Murray N. The World Currency Crisis, Making Economic Sense

[6] Wikipedia.org Bretton Woods system

[7] Businessweek, Bloomberg Thailand to Levy 15% Tax on Foreigners’ Bond Income, October 12, 2010

[8] Wall Street Journal Brazil Industry: IOF Tax Not Enough To Resolve Forex Problems October 5, 2010

[9] Wall Street Journal, Korea to Inspect Forex Positions at Banks, October 5, 2010

[10] See Currency Wars And The Philippine Peso, October 10, 2010

[11] Business Recorder, Taiwan dollar at two-year high, October 6, 2010

[12] Inquirer.net, Jan.-Aug. BOP surplus rises by 25% to $3.48B, September 20, 2010

[13] Shelton, Judy, Currency Chaos: Where Do We Go From Here?, October 16, 2010

[14] Wolf, Martin Why America is going to win the global currency battle, Oct 12, 2010

[15] See Greece And Economic Freedom, October 16, 2010

[16] Noland, Doug Inflationary Biases And The U.S. Policy Dilemma, Credit Bubble Bulletin PrudentBear.com

[17] Fels Joachim and Pradhan Manoj, QE-20, Morgan Stanley October 15, 2010

Currency Wars And The Philippine Peso

``One cause for hope of an early agreement is that many of the illusions concerning the advantage of drifting currencies and competitive depreciation have been dissolving under the test of experience. Great increases in export trade have not followed depreciation; the usual result of anchorless currencies has been a shrinkage of both export and import trade. Again, the fallacy is beginning to be apparent of the idea that a currency allowed to drift would finally "seek its own natural level." It is becoming clear that the "natural" level of a currency is precisely what governmental policies in the long run tend to make it. There is no more a "natural value" for an irredeemable currency than there is for a promissory note of a person of uncertain intentions to pay an undisclosed sum at an unspecified date. Finally, it has been learned that competitive depreciation, unlike competitive armaments, is a game that no Government is too poor or too weak to play, and that it can lead to nothing but general demoralization.” Henry Hazlitt, From Bretton Woods To World Inflation

The Federal Reserve’s prospective Quantitative Easing 2.0 has now triggered an impassioned debate among international policymakers over the risks of currency wars.

Today, policy divergences among developed and emerging markets, which have been spurring capital flows that has boosted asset markets of emerging markets, has prompted for such worries.

Brazil’s minister Guido Mantega fired the first salvo[1] to accuse advanced economies of adapting “beggar-thy-neighbour” policies that could harm international trade.

Currency wars or competitive devaluation simply implies inflationism applied by governments in order to “boost jobs by bolstering exports”. This has been a long held mercantilist-protectionist approach, which had been debunked[2] by classical economist as Adam Smith, but seemingly being adapted by today’s leading authorities, perhaps out of desperation.

As the Wall Street Journal editorial writes[3],

``The growing danger today is currency protectionism—what students of the 1930s will remember as competitive devaluation or "beggar-thy-neighbor" policies. As economic historian Charles Kindleberger describes in his classic "The World in Depression," nations under domestic political pressure sought economic advantage by devaluing their national currency to improve their terms of trade.

``But that advantage came at the expense of everyone else. "As with exchange depreciation to raise domestic prices, the gain for one country was a loss for all," Kindleberger writes. "With tariff retaliation and competitive depreciation, mutual losses were certain."

Here is my take on the currency episode:

First, I don’t see the Federal Reserve as attempting to attain “export competitiveness” by taking on the currency devaluation path.

The Federal Reserve’s action, as well as the Bank of England, seems to be more directed at surviving the balance sheets of their respective banking systems which has been buoyed by earlier dosages of QE.

Therefore, as said above, dodgy assets that are still held by the banks would need further infusion of credit to maintain their subsidized price levels.

Second, it is political season in the US with mid-term elections coming this November. Hence, political talking points have been directed against free trade to signify attempts to shore up votes by appealing to nationalism and to economic illiterates, following the growing unpopularity with Obama administration and the Democratic Party.

This has been underscored by the recent passage of the China currency sanction bill[4] at the US House. Yet this bill isn’t certain to be passed by the Senate, which will most likely be after elections.

Third, while the currency bill has been seen as directed towards “forcing” China to revalue what most don’t know is that technicalities matters. As lawyer Scott Lincicome writes[5],

``But none of that changes the fact that, if it became law, this particular legislation probably won't have a big effect on things, at least in the near term.”

Why?

Because, according to Mr. Lincicome, ``The change in language... gives the administration 'a way to say no' to U.S. industries and could signal to China that Washington isn't looking to declare a trade war over currency practices."

In politics, it is usually a smoke and mirrors game.

Lastly, global policymakers appear to be cognizant of the dangers of applying protectionism and the nonsensical approach by mercantilist policies.

The IMF has cautioned against currency friction and has volunteered to act as a “referee”[6] to settle trade disputes emerging from such strains.

Importantly, emerging market authorities have been quite sensitive into maintaining open trade channels.

Poland’s central bank governor Marek Belka in an interview with Wall Street Journal[7] delivers a jarring statement against mercantilism.

From Mr. Belka, (bold emphasis mine)

``All those wars produce a lack of stability, and the warring parties forget the basic point. The bottom line is devaluations and appreciations change your competitive position temporarily but they don’t change your competitive position for good. If you want to strengthen your competitiveness by devaluing your currency, this is a sign of despair, this isn’t a policy. I am worried because this destabilizes the global economy and it does not lead to rebalancing, something we all long for.”

We just hope that global policymakers remain steadfast in support of freer trade than engage in inflationism which is no less than veiled protectionism.

Nonetheless, as far as the subtle competitive devaluation has been an ongoing concern, we should expect the local currency, the Philippine Peso to benefit from a far larger scale of interventionism from advanced economies as United Kingdom and Japan, whom like the US, has been engaged in “quantitative easing”.

Figure 5: Yahoo Finance: Philippine Peso Versus Quantitative Easing Economies (ex-US)

This means that the Peso is likely to appreciate against the British Pound and could likely reverse its long term decline against the Japanese Yen as Japan expands her battle against alleged deflation, which for me is no more than promoting the nation’s export sector at the expense of the rest.

Relatively speaking, the Peso is in a far better position than both of the above and most especially against the US dollar given the current conditions.

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[1] BBC.co.uk Currency 'war' warning from Brazil's finance minister, September 28, 2010

[2] See Does Importation Drain The Wealth Of A Nation?, September 13, 2010

[3] Wall Street Journal, Beggar the World Monetary instability is a threat to the global recovery October 1, 2010.

[4] BBC.co.uk US House passes China currency sanctions bill, September 30, 2010

[5] Linicome Scott, House Passes Currency Legislation; Whoop-Dee-Freakin-Doo, September 29, 2010

[6] Marketwatch.com, IMF moves to referee currency debate, October 9, 2010

[7] Wall Street Journal, Poland’s Central Bank Governor Belka on Currency Wars, October 9, 2010