MoneyWeek Roundup: The coming currency war

Last week was painful for George Osborne. First it emerged that the UK was borrowing more than expected and on course to overshoot its target. Then on Friday, the latest GDP figures showed that Britain’s economy shrunk 0.3% in the last quarter of 2012. Both pieces of news had the vultures circling with expectations high that at least one of the ratings agencies will strip Britain of its AAA rating.

There’s no doubt things are looking bleak for Britain. That’s why a team of MoneyWeek analysts have compiled a special report, investigating just what’s wrong with the UK economy and working out how small private investors can protect their wealth. This report has already caused quite a stir and is rapidly becoming essential reading for all investors.

And having mentioned GDP, I’d like to point you in the direction of MoneyWeek’s latest video tutorial. GDP is constantly referred to by journalists, politicians and economists. There’s now even talk of moving to a version of it for central-bank interest rate decisions – NGDP. Deputy Editor Tim Bennett explains how GDP works and highlights its many pitfalls. Next week, he’ll be tackling NGDP, a much talked about new measure that could impact us all.

A race to the bottom

In Thursday’s Money Morning, John Stepek took a look at the currency wars being waged by the world’s great financial powers.

In a nutshell, says John, it comes down to this: “No one wants a strong currency these days. Everyone wants more export growth. If they have to stuff their neighbouring countries to get it, then so be it.” The notion that central banks are independent has been well and truly discredited, as they slavishly follow politicians’ demands for a weak currency.

One of the highest profile cases is Japan, says John. A strong yen has made life difficult for Japanese exporters so now we have the new prime minister, Shinzo Abe, “virtually dictating policy to the Bank of Japan”.

Thanks to the work of Abe and his predecessor, “the yen has plunged against the dollar over the last three months or so. For most of last year it was near its all-time high of around ¥77 to the dollar. Now it’s dropped as low as ¥90.” But John wouldn’t be rushing to short the yen right now. Indeed, he thinks it might “stop for a breather”, especially as the Japanese form of quantitative easing (QE) isn’t quite as radical as the British equivalent. But the Bank of Japan won’t be able to drag it’s feet forever, says John. Eventually the politicians will get the upper hand.

“The BoJ governor will be replaced in a few months. And this time, Shinzo Abe will replace him with someone rather more like Ben Bernanke – someone determined to ‘do what it takes’. Once that happen, there’s no saying how far the yen could fall.”

John is also bearish on the Australian dollar. Last year, John predicted the Aussie would fall on fears of China’s slowdown – and it did. However, it has since risen on nascent signs of a Chinese recovery. Nevertheless, John remains bearish.

“The rest of Australia’s economy is nowhere near as strong as the mining industry. Manufacturers are being hammered by the strong Aussie dollar. Consumers are saving, not spending. All else being equal, the central bank would probably quite like to cut interest rates to try to help everyone else out. And if every other country starts to ‘fix’ its exchange rate, I don’t think Australia will stand by and watch.” As such, John reckons the Aussie definitely won’t get back to its high point when it bought just over US$1.10 and will probably struggle to get back above US$1.065. 

John’s outlook on the euro is more mixed. “The euro’s biggest weakness – that it’s a Frankenstein currency – is also its biggest strength.” John’s point is that individual member countries could abandon the euro and return to their former currencies – not an option for most Americans – means that the European Central Bank (ECB) has “a modicum of interest” in guarding its value. But the flipside of this argument is that if there is a “fresh eurozone panic” the currency will plummet.

The truth is there are a vast number of interrelated factors that can move an exchange rate. And we cover the outlook for the world’s major currencies in more detail in next week’s issue of MoneyWeek magazine, out next Friday.

Don’t be conned by hedge funds

In Thursday’s Penny Sleuth, Tom Bulford railed against the so-called “masters of the universe” – hedge funds. “The average hedge fund recorded a gain of 3% last year”, says Tom. That’s “miles below the 13% rise in the global equity market. Not very impressive!”

Of course, we can all have an off-year, but the long-term statistics are even worse. “They show that the total return delivered by hedge funds over the past decade is a feeble 17%, equivalent to barely 1.5% per year. This compares to the 90% return that a ‘simple-investment portfolio’ of 60% shares and 40% sovereign bonds would have produced. For that matter, it is also less than would have been produced by simply plonking the money in the bank and forgetting about it.”

What makes all this even more galling is the fees that these hedge funds charge. Most used the ‘two and 20’ structure, which sees them charge a 2% annual management fee, plus 20% of any profits. Of course many readers will probably not share Tom’s outrage. After all, aren’t most hedge fund customers rich, sophisticated investors who should know better?

No, says Tom. “Two-thirds of the assets under hedge fund management come from pension, charitable and other such institutional funds. In other words, this is our money, and thanks to decisions made by the people who oversee these funds, we have all lost billions while hedge fund managers have made a fortune.”

But the thing that annoys Tom most about hedge funds is that they are traders not investors. “Trading and investment are two totally different things. Trading is just gambling. Investment means putting your money to work in enterprises that will earn a high return on capital over a number of years.”

Traders, says Tom, “simply try to make money at the expense of others”. Investors on the other hand, support “wealth-creating enterprises”.

It’s an explosive piece that won’t win Tom many friends in the fund industry and it’s well worth reading in full. If you’d be interested in hearing more from Tom, you can sign up to the free, twice-weekly, Penny Sleuth email here.

Meanwhile, another topic that’s got Tom exited is oil. Or to be more specific, a British oil discovery that could completely re-draw the global energy map. Believe it or not, this little-reported oil find could hold as much as the entire world’s proven oil reserves. Tom’s written an indepth report on the new oil province, which you can read for free here.

We have to up the minimum wage

On Tuesday, Merryn whipped up a storm of controversy in a blog post about the minimum wage. Merryn believes that the government should increase it.

The problem, says Merryn, “is that our economy is not able to produce jobs that pay wages that support families without the taxpayer stepping into help.” She is referring to the benefits paid to working members of society.

“It seems to me that whatever is causing the problem, the net effect is that the taxpayer (or the non-subsidised tax payer at least) is being forced to pay a good part of what should be the payroll costs of the world’s big corporations.”

So what’s the solution? Well, one option could be to cut benefits to workers, straight away. “That would make it pretty hard for them [companies] to get any workers (unemployment benefits would be better), but even if they could get them, I think it would force up wages pretty quickly: would you shop in Tesco if it was clear that every shelf-stacker was slowly starving to death or spending every night sleeping in a tent in the carpark? Me neither.”

Another mooted plan is to encourage companies to pay more – a “pipedream”, says Merryn. Or we could persuade the government to stop propping up house prices, thereby cutting living costs. But that, says Merryn, is also unlikely to happen.

“We’ve pointed out and eliminated all the impossible (politically or otherwise) solutions to this problem. And we are left with the possible. As far as I can see, that’s a rise in the minimum wage. I don’t much like it either. But there it is.”

The comments section below the blog quickly filled up with comments.

‘Neil Cleere’ said “If everyone has to raise the minimum wage it will be a level playing field for all UK employers. My company has to compete with European suppliers as well as UK-based ones but I believe that an increase in the minimum wage would not affect our competitiveness that much.”

However ‘Barkingmad’ disagreed. “One of the problems with raising the minimum wage would be it would increase prices and the cost of living (ie part of what it is looking to solve) and for everyone… Also if we increased it about 30% as people have suggested – how many jobs is that going to cost 10%, 20%, more? What of those people who are now unemployed and fully, rather than partially, dependent on benefits?”

How to spot an inflation spike

Before I go, I’d like to give a quick nod to this week’s most popular article on the site. For the second time running, it’s Bengt Saelensminde’s The Right Side email, and this week he investigates the likely impact of UK inflation.

First, Bengt looks at what exactly defines inflation. “Some say inflation is the increase in official money supply… Others say inflation is the increase in retail prices… But there’s a whole other concept to inflation. A school of thought that says inflation isn’t some sort of scientific concept, or even anything that lends itself to measurement. Inflation is in the eye of the beholder and comes down to faith. Specifically the public’s faith in paper currency.”

The latter concept doesn’t hold much truck with central banks, admits Bengt. “But I believe there’ll come a point when the public simply loses faith in the currency. Some say that will be when we head into hyperinflation – and it’s right to draw a distinction between the normal type of inflation (which can be corrected) and the ‘lost-faith’ type.”

The trouble is public faith is a lot harder to measure than rising prices or money supply. But Bengt has uncovered four warning signs, that he reckons will let us know when the public is about to lose faith with money.

“First, we need to keep an eye on what I call the ‘inflation indicators’. Watch out as energy and precious metals prices start to move to new highs. The rich and powerful will lose faith first and they’ll be tucking away real assets (if they haven’t already started!)”

The next sign, says Bengt, is volatility. “This will be met head on by the central planners. And the way they deal with markets going the wrong way is to print more money and prop them up. So we’re looking out for volatility followed by an escalation in quantitative easing (QE) to pay for it all.”

The third warning will come when a major Western currency ruptures. We’ve seen Iceland and Hungary come close in recent years but perhaps it will take “a biggie” like Japan to spook the public.

The final sign is a bit more arcane, says Bengt – the velocity of money. It measures “how quickly money races round the economy. The idea is that as inflation hots up, people spend money as soon as they get it. Why sit on cash if you believe it’ll buy you fewer goods in the future?”

The post certainly proved popular with readers, so if you haven’t read it yet make sure you do.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

To hear about other bits and pieces on the internet that have amused us or made us think, sign up for our Twitter feeds – we’ve listed them below.

Have a great weekend!

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Merryn Somerset Webb
• John Stepek
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