With frigid temperatures expected to hover between 15-degree and 23-degree
Fahrenheit this weekend in Moscow, it's a wonder why the world's most powerful
finance chiefs and central bankers would schedule their Feb 15-16th meeting
in Vladimir Putin's backyard. Instead, a better venue for the Group-of-20 would've
been the Cayman Islands. The Islands are warm year-round, with average highs
holding steady in the 80's. January and February are the coolest months with
lows averaging in the lower 70's. However, Russia holds the presidency of the
G-20 this year , - so finance chiefs will have to endure the frozen tundra.
A January 16th warning issued by Russia's central banker Alexei Ulyukayev
has also set the narrative for the G-20 meeting. "The world is on the brink
of a fresh "currency war." Japan is weakening the yen and other countries may
follow. If Japan continues to pursue a softer currency, reciprocal devaluations
would hurt the global economy," Ulyukayev warned. "We're on a threshold of
very serious and confrontational actions. The new government of Japan is a
course towards a very protectionist monetary policy through a sharp depreciation
of the yen. Other colleagues from respected central banks and governments already
pursue this policy. This is not a path towards global coordination but rather
a separation," Ulyukayev declared.
Guido Mantega, Brazil's finance minister, quickly chimed in, warning that
the Federal Reserve's "protectionist" gambit to roll out more quantitative
easing (QE) would reignite "currency wars" with drastic consequences for the
rest of the world. "It has to be understood that there are consequences. The
Fed's QE-program ($85-billion per month of money printing) will "only have
a marginal benefit in the US as there is already no lack of liquidity . And
that liquidity is not going into production. Furthermore, Japan's decision
to expand its own QE, coming on the heels of the Fed's decision (to expand
QE to $85-billion per month), is evidence of growing global tensions. That's
a currency war," he declared.
Yi Gang, a deputy governor of the People's Bank of China (PBoC), and chief
of the State Administration of Foreign Exchange, said he's worried about the
fallout from QE and the Zero Interest Rate Policy (ZIRP), in the G-7 economies. "QE
for developed economies is generating volatility in financial markets in terms
of capital flows. Competitive currency devaluation is one aspect of it. If
everyone is doing super QE, which currency will depreciate?" he asked.
As the European, Japanese, and US-governments sink deeper into a morass of
debt, the ruling politicians are pressuring their central bankers to print
more money, in order to finance their budget deficits. So far, five central
banks, - the Federal Reserve, the European Central Bank, Bank of England, the
Bank of Japan and the Swiss National Bank have effectively created more than
$6-trillion of new currency over the past four years, and have flooded the
world money markets with excess liquidity. The size of their balance sheets
has now reached a combined $9.5-trillion, compared with $3.5-trillion six years
ago.
In turn, the tsunami of ultra-cheap cash is inflating bubbles in the world's
bond and stock markets. On Feb 13th, hedge fund trader Jim Rogers commented, "The
US-stock market is near its all-time highs because the Federal Reserve is printing
staggering amounts of money. This is very artificial,'' Rogers warns. And the
willingness of the political puppets at the Fed and other central banks to
keep buying hundreds of billions of dollars' worth of government bonds makes
it easier for the ruling political elite to sustain the massive deficit spending
that's running up a record-breaking national debt. Rogers adds, "It's a vicious
cycle and it's all insanity. No sound person in his sound mind would say, this
is the way to run things. Of course, it's going to lead to more inflation.
But the government says we don't have inflation. If you shop, you know that
there's inflation.''
Global investors appear to be convinced that several more trillions worth
of printed currencies will be flowing through the global pipeline in the years
ahead. "It's outrageous what they're doing," Jim Rogers, chairman of Rogers
Holdings told CNBC television on Feb 8th. "The Federal Reserve is printing
money as fast as they can, and the Bank of Japan says they're going to print
unlimited money. You know what the Federal Reserve said? 'We'll match you and
we'll print more money, too! "This is insane!" Regarding Fed chief Ben Bernanke,
Rogers said, "He doesn't understand economics, he doesn't understand finance,
he doesn't understand currencies. All he understands is printing money,'" Rogers
said.
As the chart above shows, - the Bank of Japan (BoJ) and the Fed have been
flying under the radar, - engaged in a "competitive currency devaluation," since
the middle of 2009. Both central banks have increased their local money supply,
and used the freshly printed monies to purchase vast quantities of mortgage
or government debt. For its part, the BoJ has increased the size of the monetary
base in circulation to a record ¥132-trillion, - that's up nearly +44%
from ¥92-trillion three years earlier. Likewise, the Fed's money printing
spree has increased the size of the high octane MZM money supply by $2.15-trillion,
or +23% since May of 2010, in a race to the Foggy Bottom with a "beggar thy
neighbor" - "currency war."
Until recently, Japan was losing the tug-of-war over the yen's exchange rate
versus the US-dollar. The sheer size of the Fed's massive QE onslaught overpowered
the BoJ's counterattack. The US-greenback tumbled to a 15-year low of ¥76
in the second half of 2011. The BoJ was forced to step-up its intervention
efforts on two occasions, when it injected ¥13.5-trillion of liquidity
($175-billion) in July and October of 2011 into the Tokyo currency market,
its biggest intervention effort since 2004. Still, the BoJ's herculean efforts
couldn't lift US-dollar above ¥82 for most of 2012. Largely as a result
of the chronically weak US$ /yen exchange rate, Japan's exports fell -5.8%
last year, and the country logged a record annual trade deficit of ¥7-trillion
($78-billion) in 2012. It was second consecutive annual trade deficit recorded
by Japan that for decades racked up hefty surpluses, helping to finance its
ballooning debt .
Little more than 20-years ago, Japan's economy was being held out as an exemplary
model destined to become the wave of the future for global capitalism. Yet
on Feb 14th, Tokyo announced that its economy, the third largest in the world
after China and the US, had contracted for a third straight quarter. Japan
has endured its fifth recession over the past 15-years , hobbled by the unrelenting
strength of the Japanese yen, which undercuts its export opportunities and
corporate earnings that are repatriated from overseas. Companies listed on
the Nikkei-225 index said their net income had plunged -31% on average, in
the July-to-September quarter compared with a year earlier.
Former Prime Minister Noda acknowledged that the situation was "severe" and
said the government would meet it with a "sense of crisis." But his words only
served to underscore the failure of successive governments to revive the Japanese
economy since the collapse of the real estate and financial bubble at the beginning
of the 1990's. Noda announced he would dissolve the lower house of parliament
on Nov 16th, triggering an election on December 16th that in turn, swept his
Democratic Party of Japan from power.
Japan's Liberal Democratic Party, (LDP) under the leadership of Shinzo Abe,
reclaimed control of the government, and immediately began to exert maximum
pressure on the BoJ to buy an "unlimited amount" of long-term government bonds
(JGB's), in order to weaken the yen, and thereby raise the cost of imported
goods. The unlimited printing of yen would continue until Japan's inflation
rate rose to +2%. "We need to overcome the crisis that Japan is undergoing.
We have promised to pull Japan out of deflation and correct a strong yen. The
situation is severe. We need to do this. Quantitative easing by the BoJ will
help to correct a too strong yen and it will push-up stock prices. That will
help boost investment and lead to rises in wages, jobs and household revenues.
We'd like to shorten the time needed for this to happen," Abe said on Dec 16th.
The Kyodo news agency said the LDP would draft an extra budget for 2012/13
worth up to 10-trillion yen and issue debt to pay for it.
A few days later, on Dec 20th, the BoJ agreed to expand its JGB-buying and
lending program, by ¥10-trillion to ¥101-trillion ($1.1-trillion) by
a unanimous vote, increasing its QE pipeline for the third time in the past
four months. And even before the BoJ officially begins its Big-Bang QE counterattack
sometime in April, Japan's LDP chief has already managed to engineer a significant
strengthening of the US$ to as high as 94-yen this week, simply through a bit
of "Jawboning." Koichi Hamada, a chief advisor to PM Shinzo Abe, helped to
give the US$ a lift above the psychological barrier of ¥90 by saying on
Jan 20th, "If the dollar goes above ¥110 there may be reason for worry,
but at ¥100 yen or ¥95 yen, it's OK," he said.
As a result of a weaker yen across the board, - against the US-dollar, China's
yuan, the Korean won, and the Euro, Japan's Nikkei-225 index turned in its
strongest performance in seven years, surging more than +30% higher since Mr
Noda's government fell on Nov 16th. Likewise, Wisdom-Tree's Japan Hedged Equity
Fund (NYSEArca: DXJ) with its tilt towards Japanese exporters soared by $10
per share to as high as $41 this week. "The proof is in the pudding. Evidence
is stronger than any talk," LDP advisor Hamada remarked, citing the significant
rally in the Nikkei-225 index as a result of a weaker yen.
Wisdom Tree's fund, - DXJ is useful for US-investors, - it hedges its currency
exposure to the Japanese yen by shorting yen futures and forward-contracts.
It doesn't necessarily carry a net short-yen exposure; rather, "the Index and
the Fund seek to track the performance of equity securities in Japan that is
attributable solely to stock prices without the effect of currency fluctuations." On
Nov 30th, DXJ started a new "revenue filter," and removed companies that derive
more than 80% of their revenues from Japan from the portfolio. For the top
10-holdings, 41% of their revenue is generated in Japan, down from 73% under
the previous mix. Currently, the top-8 holdings in DXJ are (1) Mitsubishi UFJ
Financial Group 5.8%, (2) Takeda Pharmaceutical 5%, (3) Canon 4.45%, (4) Honda
Motor 4%, (5) Mitsui 3.4%, (6) Japan Tobacco 3.1%, (7) Nissan Motor 3%, and
(8) Toyota Motor 3%.
In New York, Toyota Motor (NYSE ticker: TM) has seen its stock price soar
from roughly $77 in mid-November to around $105 in mid- February, its highest
close in more than four years. The yen's slide helps Japanese makers of cars
and ships compete against their Korean rivals in markets such as Europe and
the US. Also, Toyota 's annual operating profit increases by ¥35-billion
for every 1-yen drop in the value against the US-dollar, according to the carmaker.
At Toyota, the world's biggest carmaker, net income for the quarter ended Dec
31st was ¥31.55 per share, up +22% from a year earlier. Even without the
help of a weaker yen, Toyota recaptured its #1 sales crown from General Motors
by selling 9.75-million vehicles globally in 2012, with impressive product
lineups and marketing initiatives.
However, on January 30th, the French government began to complain loudly about
Tokyo's underhanded techniques to weaken the value of the yen. Not only did
the Euro surge +26% higher to 127-yen, a 33-month high, but through the effects
of cross currency trading, the Euro's exchange rate versus the US$ also rose
above $1.3500. That's far above what some economists estimate to be the threshold
of pain for French exporters at $1.2200 . "The Euro is too high compared with
what the European economy deserves," said France's Industry Minister Arnaud
Montebourg. In response, the Group-of-7 clique of finance officials hastily
crafted a communiqué, pledging to refrain from engaging in a currency
war, responding to France's allegations of the deliberate manipulation of the
yen exchange rate.
G-7's Phony Communiqué, "We, the G-7 finance ministers and central
bank governors, reaffirm our longstanding commitment to market determined exchange
rates and to consult close in regard to actions in foreign exchange markets.
We reaffirm that our fiscal and monetary policies have been and will remain
oriented towards meeting our respective domestic objectives using domestic
instruments, and that we will not target exchange rates. We are agreed that
excessive volatility and disorderly movements in exchange rates can have adverse
implications for economic and financial stability," the G-7 communiqué said.
If ten people read the same communiqué , each one may understand it
differently. Perhaps, only one of them will interpret it correctly. As such,
in the opinion of the Global Money Trends newsletter, the G-7 is skirting a
fine line, - saying that outright buys and sells of currencies in the open
market, and the use of "Jawboning" to influence foreign exchange rates is off
limits. However, it's permissible for central banks to print unlimited amounts
of their respective currencies, if it's used to monetize debt. Buying bonds
is allowed, even though the scheme has the indirect effect of influencing foreign
exchange rates.
Not surprisingly , Japanese Finance chief Taro Aso welcomed the communiqué,
saying on Feb 12th that it recognized Tokyo's threat to unleash Big-Bang QE,
which could flood the world with as much as ¥100-trillion, - is not aimed
at the foreign exchange markets. "It was meaningful for us that the G-7 properly
recognizes that steps we are taking to beat deflation are not aimed at influencing
currency markets," Aso told reporters. The problem with this logic of course,
is that the traders in the FX-markets view QE as the most lethal weapon in
the central banks' arsenal for influencing bond yields and currency exchange
rates.
Russia Weighs in on Global Currency War, As tension over the Japanese yen's
exchange rates grows and G-7 central bankers try to head-off the outbreak of
a full scale "currency war," that could spread beyond the Tokyo and US-currency
markets, - Alexei Moiseev, Russia's Deputy Finance chief told the CNBC television
network on Feb 14th, that the G-7, of which Russia is not a member, should
not be making unilateral policy decisions or announcements on foreign exchange
policies. "This kind of decision should have been discussed on the G-20 platform.
This is G-20 week and the very reason that the focus in developing economic
policy has shifted to the G-20 is that the G-7 no longer represents a sufficient
proportion of the world's financial markets and economies," he said.
In regards to Moscow's handling of the Russian rouble, Moiseev replied, "We
are actively moving away from any manipulation of the currency. Last fall,
the central bank officially declared that Russia is moving towards a flexible
exchange rate so we have a target of 2015 to commit to make no interventions
in the exchange market," said Moiseev . On Feb 13th, Russia's central bank
(Bank Rossi) decided to hold its refinancing rate unchanged at 8.25% for the
fifth month in a row, rebuffing a call by President Vladimir Putin to join
the currency war bandwagon, by easing its monetary policy. The Russian economy
is grappling with a +7.1% inflation rate, and Bank Rossi says its not in an
enviable position to lower interest rates, until inflation cools off first.
A stronger ruble has help contain the cost of imports.
However, the Kremlin shouldn't be too upset if the BoJ and the Fed continue
to print an extra $2-trillion of paper currency in the year ahead. Other central
banks could join the currency war, including the People's Bank of China, (PBoC),
which on Feb 5th, injected 450-billion yuan ($72-billion) into the Shanghai
money markets, its largest single-day injection ever conducted in the interbank
market, in order to prevent the value of the Chinese yuan from rising against
the US-dollar, and to artificially inflate Shanghai red-chips. As more central
banks join the race to devalue their currencies, it could act to lift the price
of Russia's most important commodity.
Moscow has high oil prices to thank for bolstering its stash of foreign currency
reserves, reaching $533-billion this week, and in turn, high oil prices is
supporting capital inflows into the Ruble and the local stock market. Two-thirds
of the Russian Trading System (RTS) Index is made up of stocks in the energy
sector, which are benefitting from high crude oil and natural gas prices around
the globe (outside of the US). Exports of fuels and metals typically account
for three-quarters of total Russian exports, and the natural gas and oil sector
is responsible for as much as 60% of federal budget receipts. In order to fulfill
its budget obligations in 2013, Moscow's break-even point for Urals blend is
around $117 per barrel.
Perhaps, Mr Putin's most striking achievement is having fixed Russia's fiscal
mess . In contrast to persistent budget deficits in the 1990's, and a default
on its debts in 1998, Putin has taken advantage of bigger streams of revenues
from crude oil and natural gas, to repay Russia's external debt and built-up
assets in a stabilization fund, which was recently used to inject fiscal stimulus
into the local economy. As a result of budget surpluses and debt repayments,
Russia's public-debt-to-GDP ratio has declined to 6% of GDP, down sharply from
61% in the year 2000 . But Russia's budget balance is still heavily dependent
on the oil price. Strip oil out and its public finances have been deteriorating
since 2005.
Russia 's dependence on energy is greater today than in the mid-1990's, when
it represented less than half of exports. Russia 's output of crude oil climbed
to 10.5-million barrels per day in November, a post-Soviet high. However, at
current rates of production, Russia 's known oil reserves, including fields
in the Arctic, could be depleted in just 20-years . Kazakhstan, by comparison,
can sustain its current output for 60-years, Saudi Arabia for more than 70-years
and the United Arab Emirates for more than 90-years.
For now, the fate of the Russian ruble is closely linked to the price of the
Urals blend crude oil. Last year, the price of Urals blend suddenly plunged
from $124 per barrel to as low as $90 per barrel. Likewise, Russia's ruble
tumbled -15% to 2.9-US-cents, its lowest level since April 2009 as it tracked
the falling price of crude oil. Russia's stock markets also suffer when traders
pull their money out of riskier, Emerging markets like Russia's. Over a 3-month
period, the RTS Index plunged by -30%, briefly wiping out $260-billion of market
value. However, with the subsequent recovery of Ural crude oil to $117 per
barrel, much of the ruble's and the RTS index have been restored. The Fed's
QE-scheme and the effects of Tokyo's "yen carry" trade are helping to fuel
the recovery in the Russian financial markets.
The Hong Kong Monetary Authority (HKMA) has intervened repeatedly in the currency
market since October 20th, injecting a total of HK$107-billion, in order to
defend an archaic and fixed currency peg with the US-dollar . Under the currency
peg, the HKMA is obliged to intervene when the US- dollar hits HK$7.75 or HK$7.85
to keep the band intact. In reality, the HKMA can supply an unlimited amount
of local notes for foreign currencies, albeit at the cost of higher consumer
price inflation. Over the course of the past four years, the HKMA has more
than doubled the size of the local M1 money supply, in a determined effort
to counter the Fed's QE onslaught. In turn, the increase in the M! money supply
has helped to lift the price of Gold +125% higher to around HK$12,700 today.
Thanks to the peg, Hong Kong is forced to adopt the monetary policy of the
US. The Fed's policy of targeting the fed funds rate between zero-percent and
0.25% is matched by the HKMA targeting its overnight repo rate at an absurdly
low 0.50%. As a result, the HKMA's repo rate is pegged about -3% below the
city's inflation rate. Negative interest rates have encouraged traders to buy
riskier assets, such as Gold or stocks listed in the Hang Seng Index. If the
US$ peg were to disappear tomorrow, the HKMA could hike interest rates to combat
inflation. Many analysts forecast that the Hong Kong dollar would appreciate
by a minimum of +15%. In turn, the price of Gold and the Hang Seng could tumble
sharply. This scenario is still several years away, but once the Chinese yuan
becomes fully convertible, the ultimate endgame would be a Hong Kong dollar/yuan
peg.
Looking forward, - the G-7's call for a cease fire in the global currency
war won't take hold, if the BoJ and the Fed won't agree to turn-off their printing
presses. That's not likely to happen anytime soon. The betting is that Tokyo's
Big-bang QE would contain sufficient firepower to push the US-dollar towards
100-yen and lift the Euro to 135-yen. Central banks in China and Hong Kong
could respond by printing money, and other central banks, in Brazil and Korea
might resort to various methods of capital controls, such as placing a stiff
tax on foreign investment in their local bond and stock markets. There is simply
no end in sight to the "Currency Wars," as long as the BoJ and the Fed won't
stop monetizing debt.
When will the G-20 central banks finally agree to tighten the money spigots?
Most likely, the End Game for the global "Currency War" will only arrive when
the G-7 Bond Vigilantes are resurrected from the dead. It would take a significant
decline in Treasury bond prices, and sharply higher bond yields, caused by
the outbreak of hyper-inflation or record high crude oil prices, before central
bankers are forced to recognize the folly of their dangerous game. In turn,
sharply higher bond yields could be a catalyst for a synchronized global economic
downturn, and the onset of a Bear market for equities. The Day of Reckoning
is unknown, but it's helpful to be on the lookout for the early warning signs.
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