The first shots in the new currency war

“In times when growth is hard to come by,” says David Smith in The Sunday Times, everyone wants a weak currency. With the developed world’s heavy debt load hampering consumption and investment, growing exports is key to bolstering growth. A weaker currency makes exports cheaper for foreign buyers.

Unfortunately, this is a zero-sum game. “When one currency falls, others must rise,” says Buttonwood in The Economist. “Those countries react by trying to force their currencies back down and the world ends up back where it started.” In 2010, Brazil’s finance minister, Guido Mantega, described this process as “currency wars”.

Money printing, or quantitative easing, has emerged as the main way of weakening a currency: the more you produce of something, the more its value falls. Low interest rates also tend to undermine a currency (as they imply a low return on assets denominated in it).

Monetary policy across the developed world is extraordinarily loose. At present, “38 countries are pursuing a zero- or negative-real-interest-rate policy”, says Felix Zulauf of Zulauf Asset Management. “I have never seen anything like it.”

The latest skirmishes

The past few weeks have seen another eruption of currency tension. The latest trigger has been the rapid slide in the Japanese yen. Prime Minister Shinzo Abe has been urging the bank of Japan to adopt a much looser monetary policy in order to boost growth, and the prospect of further money printing has brought out the yen bears.

This in turn has irritated pretty much everybody. The euro has gained 14% against the yen in the past few months, which helps explain why Jean-Claude Juncker, head of the Eurogroup of finance ministers, has called the euro’s exchange rate “dangerously high”. Europe is dependent on exports to lift overall output.

Currencies vs gold

Meanwhile, Norway’s central bank has signalled that the krone’s recent strength means it will hesitate to raise interest rates, even though Norway is in the middle of a housing boom.

South Korea has seen its currency, the won, appreciate by a fifth or so against the yen since last summer. This is particularly painful because Korea competes with Japan in many sectors, including cars and electronics. A Hyundai manager describes the yen’s fall and the won’s rise as “double torture”.

The Korean central bank has been intervening in the forex market to stem the won’s rise. The battle between two of Asia’s most formidable exporters does not yet amount to a full-blown currency war, but the danger is that “it is heading that way”, says Smith.

A repeat of the 1930s?

In the 1930s, countries desperate to export their way out of depression pushed their currencies down, aggravating their trading partners’ problems and prompting further devaluations. This race to the bottom created political tension and led to widespread protectionism, exacerbating the global downturn and preparing the ground for war.

Currency wars are “a very dangerous game”, says Zulauf, and could well end in “national confrontations”. “This is a replay of the 1930s,” warns Pimco’s Bill Gross.

Who will be the winner?

There is, however, an upside to competitive devaluations for investors. If currencies are continually being debased by money printing or historically low interest rates, that’s good news for the one medium of exchange that has retained its value throughout history: gold.

Investors have stayed confident in the value of gold for centuries because it can’t be debased by being easily reproduced, like paper currencies. As the bar chart shows, it has surged against major paper currencies over the past decade. And with the currency wars just hotting up, the rush into the hardest asset of all looks far from over.

  • Colin

    You confuse two different concepts when you say, “Low interest rates also tend to undermine a currency (as they imply a low return on assets denominated in it).” Falling interest rates are good for assets denominated in that currency, because if brings value forward from future cash flows. But once rates reach their bottom and start rising – that’s when low rates are bad for assets but good for currencies relative to other currencies that aren’t raising rates.