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 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 8-Oct-2010
8-Oct-10 News -- Fears of international 'currency wars' grow, as dollar weakens

Web Log - October, 2010

8-Oct-10 News -- Fears of international 'currency wars' grow, as dollar weakens

This weekend's IMF meeting is expected to be contentious.

Fears of international 'currency wars' grow, as dollar weakens

On Friday, global financial officials will be attending the twice yearly meeting of the International Monetary Fund (IMF) in Washington, and the major item on the agenda will be discussions of possible "currency war" in the next few months, according to CS Monitor

On Thursday, European Central Bank (ECB) President Jean Claude Trichet "excess volatility and disorderly movements" in international currency exchange rates could harm the world economy.

IMF director Dominique Strauss-Kahn said that using exchange rates "as a policy weapon" to undercut other economies and boost a country's own exporters "would represent a very serious risk to the global recovery."

The words of alarm are triggered by what appears to be an international chain reaction going on right now:

For many officials in the international community, the country to blame is China. As is often the case, economic issues are the motivating factor for xenophobia between the Chinese on one hand and the Americans and Europeans on the other. If only China would allow the yuan to strengthen, then Chinese goods would be more expensive in Europe and America, and the world would be saved.

The mood of the Europeans is summarized in this opinion column from the Australian:

"Get ready for the currency wars. We've got months of them to come, as this week's bad-tempered summit meeting in Brussels between China and the European Union showed.

European ministers, led by the commission President, Jose Manuel Barroso, found themselves almost tongue-tied; partly grateful to China for lifting their economies out of recession and partly furious at it for undercutting their exports.

What emerged was an incoherent yelp of rage directed at Beijing and one hopeless demand: that China should let its currency rise in value because . . . well, because it would be unfair to Europe not to."

America's Treasury Secretary Timothy F. Geithner says that China's policy of keeping the yuan cheap on world markets "sets off a dangerous dynamic" that encourages other countries to follow suit and risks touching off a destructive, tit-for-tat competition for jobs and trade. The Washington Post quotes him as saying, "It's unfair to countries that were already running more flexible regimes and let their currencies appreciate." This statement is a sign that things could get ugly.

And as we mentioned briefly yesterday, the House of Representatives has passed a bill by a vote of 348 to 79 to impose punitive tariffs on the Chinese. If the bill becomes law, it would start a major trade war with China, according to Spiegel.

This would be reminiscent of the international trade war that followed the passage of the Smoot-Hawley tariff act in 1931. Almost every economist in 1931 said that the Smoot-Hawley act was a bad idea, but the idea was so popular that the bill was passed and signed anyway. This is a good example of how great events are driven by huge generational trends, rather than the intentions of politicians. The Smoot-Hawley act was an economic disaster for Japan, as their major export, silk, was almost completely shut down. A year later, Japan invaded Manchuria. It would not be too much of an exaggeration to say that the Smoot-Hawley law was the first hostile act of World War II.

Perhaps Chinese Premier Wen Jiabao had the Smoot-Hawley experience in mind when he spoke at a business summit in Brussels on Wednesday. Here are some excerpts, from the Xinhua transcript:

"On the exchange rate of the Chinese yuan, I said yesterday when meeting with the Euro Group troika that European political and business leaders should not join the "chorus" to pressure China to appreciate the yuan. ...

The euro exchange rate experienced large fluctuations recently, but it was caused by the U.S. dollar, instead of the yuan. How can you place the blame on China? The imbalance of trade is caused by structural problems against the backdrop of globalization. It should not be politicized. We pursue balanced and sustainable trade, and in no way seek surplus. ...

You should not pressure China on the yuan's appreciation if you consider the issue from another perspective. Many Chinese export enterprises have profit margins of only 2 to 3 percent, 5 percent at most.

Should the yuan appreciate by 20 to 40 percent, as demanded by some people, a large number of Chinese export enterprises will go bankrupt, the workers will lose their jobs and the migrant workers will have to go back to the rural land, making it hard for society to remain stable. The world will by no means benefit from a crisis in the Chinese economy.

China contributed about 50 percent of the global economic growth in 2009. It is a huge market with great potentials for many enterprises. Once again, I would like to tell our friends in the industrial and business community candidly: Don't pressure China on appreciation of the Chinese yuan."

His predictions that appreciating the yuan would cause massive social unrest in China is undoubtedly correct, as we've been saying for years that China is headed for civil war anyway. Wen is quite aware of the danger, as he famously said in 2007 that "China is 'unsteady, unbalanced, uncoordinated and unsustainable.'"

From the point of view of Generational Dynamics, the real financial crisis is yet to come, with the collapse of banks and stock market crashes around the world.

It's worth saying a few more words about the inflation/deflation debate that seems to be continuing.

There are two measures of inflation, and they have to be understood separately. One measure is a country's "internal" inflation measure, the Consumer Price Index (CPI), which measures the cost of goods within the country.

The other measure is "international," and it's a relative measure. Even if one country's currency weakens, it may actually end up stronger if other countries' currencies weaken more.

Internally, most countries are experiencing a deflationary spiral, meaning that as the cost of ordinary goods -- groceries, rent, transportation -- is going down along with the CPI in each country's currency.

Internationally, we seem to be approaching these "currency wars," where countries are going to be racing one another to devalue their currencies the most, in order to benefit the most from the international export business.

As the international reserve currency, I expect the US dollar to remain strong relative to other currencies, even if the Fed initiates a new round of quantitative easing. This is contrary to the expectations of many pundits. These pundits are focused on possible quantitative easing by the Fed, but they aren't focusing on the devaluations being practiced by other countries, which are expected to weaken those currencies more than the dollar.

I would caution all but the most sophisticated readers to stay away from buying gold or silver, as metal prices appear to be in a bubble. If you absolutely must buy gold, for emotional reasons, then take possession of the actual metal. Many gold stocks and certificates are not backed by actual gold, and you could lose your entire investment.

I'm frequently asked the best way to protect your money, and for several years my answer has always been the same: For the vast majority of people, the best bet is to keep all your assets in liquid cash, either in a government insured bank account or in short-term (6-12 month) Treasuries, but not in money market funds or in long-term Treasuries.

(Comments: For reader comments, questions and discussion, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (8-Oct-2010) Permanent Link
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