How to stop worrying and love currency wars: James Saft

January 23, 2013

Jan 23 (Reuters) – You might want to learn to stop worrying
and love currency wars, which are here to stay and, for
investors, might not be all that bad.

A host of central bankers and policy makers have been
talking currencies in recent days, generally about how their own
should be weaker and other peoples’ should be strong.

This is a natural result of the interaction of growth being
scarce and of aggressive monetary easing in many leading
economies. Everyone wants to capture what growth there is, and
those who ease monetary conditions through asset purchases get
the benefit of weaker currencies which make their exports more
competitive.

The risk, as in the 1930s, is in a round-robin of aggressive
currency weakening leading to tariffs and trade wars, which
don’t just reapportion the pie but which tend to shrink it.

This doesn’t have to happen, and until it does the best way
to think of the currency wars is as monetary easing by another
name. If Japan, as it is and will do, creates money and drives
the value of the yen down it not only creates demand at home by
encouraging cash off of the sidelines, it also encourages other
countries to follow suit with their own easings.

This may turn out to be terrible policy, but it sure is good
for risk assets, as we are seeing.

There are, naturally, winners and losers. Europe, whose euro
has strengthened markedly, comes to mind, but the global net
result is more money and more economic stimulation. So long as
it continues as a slap fight, rather than a trade shooting war.

At this point the currency wars are simmering nicely.

Japan’s Prime Minister Shinzo Abe won his “monetary regime
change” Tuesday as the Bank of Japan, acting at his behest,
doubled its inflation target to 2 percent, and said it would
start “open-ended” asset purchases next year. The yen, which has
weakened markedly in the last four months, actually rallied on
the news, in part because of the delay in asset purchases.

Meanwhile, European Central Bank policymaker Jens Weidmann
cried foul, citing Japan and Hungary, and warning that such
steps could lead to an “increased politicization of exchange
rates.”

WANTING IT BOTH WAYS

Meanwhile, outgoing Bank of England chief Mervyn King and
colleagues pulled a neat trick, condemning currency devaluations
in others while seemingly calling for it in the British pound.

King warned that, without a rebalancing of global trade, “an
increasing number of countries are coming to the view that only
a lower real exchange rate will provide the stimulus to demand
that their economies require. Several have taken action to
achieve that end. That is a recipe for competitive
depreciations, what some have called ‘currency wars’.”

In literally the very next paragraph he lauded sterling’s
own 25 percent fall from 2007-2009, while the most recently
released minutes of the BOE’s monetary policy meeting warned
that sterling might be too high for the economy to rebalance, a
clear warning of currency skirmishes yet to come.

Britain is far from alone in seemingly wanting things both
ways. James Bullard of the St Louis Federal Reserve Bank warned
recently of the potential for currency wars caused by BoJ
policy, an assertion that is easier to sympathize with if you
don’t consider the Fed’s own open-ended commitment to keep
buying up bonds until unemployment subsides.

Net-net, everyone wants weaker currencies and most everyone
is going to be expanding their central bank balance sheets or
shooting off their mouths trying to get it. It’s childish, but
it is also economically stimulating.

Think of a currency war as being a sort of fun-house mirror
image of an asset price bubble. In an asset bubble, we all
engage in the illusion that we can become wealthy by buying and
selling things, like houses or shares of Apple, to one another
at ever increasing prices. The net result is stimulative unless
and until things go too far and a bust ensues. In a currency
war, we all try to beggar our neighbors, and while some succeed
and some don’t, the overall net result is more money chasing the
same amount of assets.

Both often end badly, but fighting the riptide of a currency
war or asset bubble is a good way to drown.

For now, investors ought to relax, let the tide carry them
and then consider the best place to exit.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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