Currency War

Make no mistake that WAR is upon us; while it might not involve soldiers, bombs, or bullets, the weapons are economic monetary policy. This war has been a long time coming and an article at CNBC this morning made references to the

similarity of the previous big currency war in the 1930s. In the 1930s nations were facing an equally depressing economic environment and governments tried as they might to invigorate their economies. As economic depression reaches a crescendo, nations look inward and begin to adopt isolation and self-interest policies; that can bring forth tensions with other nations. In the 1930s nations came off the gold standard (temporarily) and they started inflating their currencies through printing more and more. The hope was to reduce debt (paying it off with an inflated currency) and also increase exports to increase demand for the nation's products. Those nations that first came off the gold standard had the jump on other nations and for a little while it certainly seemed to help, but in reality it only delayed the inevitable. World War II, which came only a few short years later, was not drummed up because Hitler or Hirohito (Japanese Emperor) were crazy. It was driven by economics and the laws of supply and demand. In Germany, the nation had suffered a depression that made the U.S. Great Depression seem benign. Germans had no food, their currency bought nothing, and on top of that the nation was being drained of any and all resources and capital from the Treaty of Versailles. Hitler's war machine created jobs, patriotism, and economic stability. Eventually they needed more steel, iron, oil, and food as the nation grew and rather than trade he ventured forward to take it by force. Meanwhile in Japan, the isolated island had its oil supply in Indonesia cut off by a U.S. naval blockade and President Roosevelt eventually forced an embargo against Japan and sent troops and planes to China. Japan's attack on Pearl Harbor was not to instigate war, but to eliminate the U.S. fleet so that Japan could regain control of their oil supply in Indonesia and also continue their push into South East Asia for more resources.

Watching movies and educating ourselves through propaganda means that we usually lose sight as to WHY. There is no doubt that Hitler was an evil person as movies, history books, and propaganda portrays him; however, WHY did Germany (and furthermore more Japan) enter into war? Again, if you follow economics, commodities, supply & demand, it is simple. Just like today, why is the U.S. committed to a lengthy war in the Middle East? The answer is simple - oil. Do you honestly think that if there was NO OIL in the Middle East that we would send troops to fight and die in a desert? Of course not. Pol Pot and the Khmer Rouge of Cambodia was an evil empire and killed MILLIONS of people; why did we not send troops there? Because there were no resources, no demand, no supply, and no economic reason to risk action.

What started in the 1930s as a currency war, is starting again today and, ironically, it is the same players, U.S., Europe (with Germany the dominant player), Japan, and England. All these nations and zones are loaded with massive sovereign debt and deficit spending at levels that are unsustainable. Europe, Japan, and the U.S. are on the brink of a massive currency war, the generals are the Presidents of the central banks and their weapons are interest rates and the printing press. Japan has fired the first salvo recently as they have raised their inflation target and have gone on a massive printing spree to drive down the value of the Yen. Japan had been the world's lender for decades, with zero interest rates. It was their core economic strength. Sure the U.S. currency was the world reserve, but if any nation, business, bank, or corporation needed to borrow money they would go to Japan and borrow for next to nothing. After the recession hit, the U.S. lowered interest rates very close to zero and started their own printing presses, then Europe followed suit. Initially all three of these currencies; Euro, Yen, and Dollar inflated in a realm of equilibrium; neither one dominating the others to any level of major concern. However, Japan had been quickly losing its status as the world's lender as banks were now turning to Europe and the U.S. to borrow cheap money. Additionally, exports - which Japan heavily relies on started declining. It was and is a double blow to the Japanese economy. Japan's latest government has set forth the most aggressive policy of putting their printing presses into hyper-drive and are willing to do anything and everything to weaken their currency. It has worked and the Yen is falling radically against the dollar, creating upward inflation pressure on the euro and U.S. dollar. It makes Japan more competitive, while it created negative pressure on U.S. and European exports.

Japan's very aggressive position could spur rather massive trade and monetary policy changes in both Europe and the U.S. Some economists believe we could see certain tariffs and trade wars break-out to curtail Japan's export boom and help boost domestic lead exports. It could also force the central banks in the U.S. and Europe to take more extreme measures in their current monetary policies, which could further increase the pending inflation bubble.

The emerging markets, primarily the BRICs, will certainly take action and have far more room to do so. The bigger problem is that Europe and the U.S. are already running at close to zero interest rates and have massive monetary inflation policies (such as QE). The next salvo could be a trade tariff, trade limits, or other capital/trade controls.

When currency wars break out the knee-jerk reaction for nations is to take on self-interest protectionist strategies and policies that only heighten the tension between nations.

The inflation bubble is increasing and this forth coming probability of a currency war will only drive inflation higher.

This morning the ECB held rates unchanged at 0.75% and the ECB President will certainly come under fierce pressure from the recent rise in the euro, which is creating additional pressure on exports. He is taking a let's wait-and-see approach and certainly has his eye on Japan and U.S. monetary policies.

Meanwhile in England, the Bank of England is also keeping their rates at 0.5% and will maintain their money printing scheme as well.

After the ECB announcement, U.S. Fed President Charles Evans immediately responded that the Federal Reserve monetary policy will remain accommodative until the economy improves. What he is really saying and confirming is that we will keep printing money and trying to fight Japan's successful attack, which drove their Yen lower.

What does this mean for us? Simply, MORE inflation! The government will continue to report that there is no inflation, using the CPI model, which is really a cost of living model. But it will increase and eventually will not be contained.

Several experts, like Kyle Bass and others, believe that an extreme currency/trade war could easily morph into an actual war. Why would they say this? Because time and time again, if history is any measure, what starts out as a currency/trade war usually ends up as an actual physical war. One reason is that the war machine brings forth jobs. One only has to look at World War II as an example of this. What brought Germany, England, and the U.S. out of a recession? War, unfortunately. I am not so sure if it will come to that; however, we could see - like we have in Iraq and Afghanistan, limited engagements for resources that serve two purposes; first, to secure resources ("U.S. interests") and second, because it will create jobs if the government ramps up military production.

Continue to pay attention to the dollar, pound, euro, and yen. Watch central banks and their policies. Listen to the WTO and trade negotiations. This is where the currency war will be fought.

Michael Williams publishes a FREE daily Market Preview.
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