The Currency War for Dummies

currencywar

By Russell Lamberti

The world is in a currency war. What is that? It’s when governments devalue their currencies in order to protect domestic industries against foreign competition. They believe that if their exchange rate is weaker domestic producers will be able to export more products overseas because they can price their product cheaply to foreigners yet still receive a handsome price in local currency terms. They also believe that a weaker currency will protect domestic producers from foreign import competition since foreigners have to price their product more expensively in the local market just to receive the same amount in their own currency terms.

How do countries go about devaluing their currencies? Well, they either print more of it into existence (since it’s only paper) or they make interest rates excessively low so that banks lend more money. When banks lend money they actually create the loans out of thin air and those loans are credited to borrowers’ accounts as if it were money or currency, and spent into the system. Either way, the supply of that particular currency increases, and we know that the more of something there is the less everyone tends to value it.

Each country is trying to devalue a little faster than every other country to gain this advantage. One country moves, then another responds to neutralise it. And this gets repeated, again and again. No one actually ‘wins’ the currency war, yet all currencies are devalued in the fight. Exchange rates between currencies tend to mask this currency devaluation since if two currencies are being devalued at a similar pace the exchange rate between them is unlikely to change much. Take for example the rand/dollar exchange rate. For the past 10 years it has fluctuated roughly around R7.50/dollar. However, because both South Africa and America are fighting the currency war, this relatively unchanged exchange rate in 10 years masks a great deal of devaluation. The best way to see the devaluation is to price each currency in terms of something that isn’t being devalued. What isn’t being devalued? Well, obviously it tends to be things whose supply is not increasing, or at least increasing very little, like gold or vintage collector stamps or water. The exchange rates between the rand and gold, and the dollar and gold, for example changed from R3,000/ounce and $350/ounce respectively at the start of 2003, to R14,200/ounce and $1,650/ounce in 2013. In other words, both currencies have lost 80% of their value against something that wasn’t being devalued – in just 10 years.

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This highlights the key feature of the currency war: Over time no one wins but currencies are collectively destroyed in the process. When currencies weaken relative to things that aren’t being devalued, this is called price inflation. Price inflation benefits those in society who are able to protect themselves from it already, usually the wealthy. It tends to harm those least able to protect themselves from it, usually the poor. Hence, the currency war is deeply harmful to the poorest in society without conferring any overall economic benefit. All the while the cost of living increases. Moreover, when the value of currencies is destroyed, people are discouraged from saving. Without savings, people become more vulnerable in lean times and can never accumulate wealth.

Low interest rates, special incentives for banks to lend money, subsidised lending programmes, quantitative easing, money printing, bank bailouts, government deficits and all other kinds of economic ‘stimulus’ efforts basically have one overarching goal in mind: to weaken the currency. These are all weapons of the currency war, which, as we have seen, is primarily a war on the poor.

 

This article first appeared on www.etmstrategy.com, the home of ETM Analytics’ Macro Strategy Service, a capital and investment advisory service based in Johannesburg, South Africa.  Russell Lamberti is Head Strategist at ETM Analytics, in charge of global and South African macroeconomic, financial market, and policy strategy.