Global Investing

Amid all the furious G7 money printing of recent years, Brazil was the first to sound the air raid siren in the “international currency war”  back in 2010 and it continues to cry foul over the past week. With its finance ministry issuing fresh warnings last night over hot-money flows being dropped by western economies on its unsuspecting exporters via currency speculation,  Brazil’s central bank then set off its own defensive anti aircraft battery with a surprisingly deep interest rate cut late Wednesday. Having tried everything from taxes on hot foreign inflows to currency market intervention, they are braced for a long war and there’s little sign of the flood of cheap money from the United States, Europe and Japan ending anytime soon. So, if  you can’t beat them, do you simply join them?

The prospect of  a deepening of this currency conflict — essentially beggar-thy-neighbour devaluation policies designed to keep countries’ share of ebbing world growth intact — was a hot topic this week for Societe Generale’s long-standing global markets bear Albert Edwards. Edwards, who represent’s SG’s “Alternative View”, reckons the biggest development in the currency battle this year has been the sharp retreat of Japan’s yen and this could well drag China into the fray if global growth continues to wither later this year. He highlighted the Japan/China standoff with the following graphic of yen and yuan nominal trade-weighted exchange rates.

Edwards goes on to say that this could, in turn, create another explosive FX standoff between China and the United States if Beijing were to consider devaluation — the opposite of what the protectionist U.S. lobby has been screaming for for years.

“We have long stated that if the Chinese economy looks to be hard landing, as we believe it will, the authorities there will actively consider renminbi devaluation, despite the political consequences of such action.”

“Clearly, the US will not respond well if China chooses to devalue. But China might argue that as its reserves are now declining there is clear downward pressure on its currency and that, after all, the US has asked it to allow market forces to have more of an influence!”

With the ECB’s second cheap money flood in three months coursing through European banks and financial markets and the possibility at least of a further interest rate cut in offing, the relief in Europe’s austerity-wracked periphery is palpable. But what of the impact on the relatively buoyant “core” in Germany, the bloc’s largest economy and super-competitive export engine? Darren Williams at money managers Alliance Bernstein reckons  German inflation is being cooked up by this super-easy ECB money, coming as it does against a backdrop of  relatively brisk German credit growth and house price inflation there of some 5.5% last year which is “positively explosive by German standards”.

This is the flipside of pre-crisis euro zone problem with “one-size-fits-all” monetary policy. Before 2007,  sluggish  German growth meant ECB policy was kept far too loose for the faster-growing  peripheral economies who then generated credit and inflation-fueled booms that boosted real-estate prices, private and public sector debts and eroded competitiveness.  Now, monetary policy appropriate to a euro-wide slowdown fueled by the hobbled periphery looks far too too loose for Germany.

However, Williams posits that if Germany can tolerate an effront to its anti-inflation psyche then this move could help rebalance skewed intra-euro current accounts by boosting German domestic demand for the exports of its troubled euro neighbours while curbing the super-competiveness of German exports flooding other euro economies and undermining producers there. That’s not the way many in Germany want the rebalancing to happen clearly. But even the most ardent hawks in Berlin probably now acknowledge that endless austerity and economic contraction in its nearest neighbours or the sort of financial implosion likely from a euro collapse would not be in Germany’s best interests either. So, a little compromise perhaps.