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The 1997
Asian Financial Crisis serves as a reminder of what happens when
competing economies engage in a round of competitive currency devaluations.
The crisis began after impressive growth in the so-called tiger economies
abruptly stopped, leading to stock market crashes and currencies losing about
70% of their value. The recession that followed lasted two years, during
which time the IMF loaned South Korea, Indonesia and Thailand $110 billion.
In exchange those countries had to adhere to strict austerity measures
including higher taxes, reduced public spending, privatizations and higher
interest rates, to cool their overheated economies resulting from the
stimulus package. By 1999 growth returned, albeit with stock markets and
currencies far below pre-1997 levels.
The currency meltdown was triggered by the default of a large property
developer and a financial company in Thailand. When the Thai baht wasn’t
able to maintain its peg to the US dollar, it was devalued and floated.
Other Asian currencies soon followed, including the Malaysian ringgit,
Indonesian rupiah and Singapore dollar.
The resulting inflation/ currency crashes in the countries involved -
Thailand, Singapore, Malaysia, Indonesia, the Philippines and South Korea -
led to ghastly inflation, massive job losses and a dramatic fall in the
standard of living. The only people unscathed were Western tourists who,
carrying a fistful of dollars, were able to enjoy cheap vacations.
But that was over 20 years ago, and politicians have poor memories. In
America today, we have what is shaping up to be a currency war between the
world’s major powers, the effects of which could be far more severe than the
‘97 crisis that was, thankfully, confined to a regional contagion.
What is a currency war?
A currency
war is what happens when those on the losing end of trading
relationships decide to engage in a policy of currency devaluation. By
keeping their own currency low against their trade competitors their exports
will be cheaper. The race to worth less soon becomes a competition with
successive rounds of currency devaluation spreading amongst former trade
partners.
Trade war to currency war?
Arguably, the US government now, under President Trump, is preparing for
what could be a full-blown currency war, between the United States, the
European Union and China – plus whoever else the US President happens to be
targeting.
As seen in the chart below, in 2018, the Chinese yuan was strengthening
hitting 6.25 (6 yuan to a dollar is stronger than 7 to the dollar) to the
dollar. But due to China opening its economy to more foreign investment the Chinese
currency weakened.
The People’s Bank of China (PBOC) has to allow market forces to play
a greater role in setting its value and China’s currency might weaken
further - overseas funds will increasingly play a role in China’s bond market
which might lead to increased flow of funds out of the country further
depreciating the currency.
US$ to CNY, www.xe.com
Then in May of this year the yuan suffered a crisis of confidence due to
the escalation of the trade war.
US President Trump cried foul over what he deems as unfair currency
devaluation saying China can nullify the effects of the billions of tariffs
the US has levied against it, by cutting the yuan’s value, something it has
done for years.
“We should be entitled to have a fair playing field ... because our Fed is
very, very disruptive to us,” Trump told
SquawkBox, via CNBC, referring to the central bank’s policy of raising
interest rates, thereby keeping the dollar high.
South
China Morning Post notes that China’s exchange rate is at
the heart of trade negotiations because the US administration has demanded
that Beijing agree to limit the yuan’s decline to the extent that it did not
fully offset the US tariff increase – a condition that analysts said was
acceptable to Beijing to end the trade war.
Meanwhile the euro has appreciated about 20% against the US dollar. That,
combined with comments from European Central Bank President Mario Draghi, has
put Trump in a foul mood regarding the European Union, even as he agreed to
defer for six months a planned US tariff on cars and car parts from the
trading block.
Draghi said last week that “in the absence of any improvement”, referring
to low growth and low inflation, more stimulus will be needed to goose the
European Union’s economy. That could include interest rate cuts or a return
to quantitative easing, where the ECB, like the US Federal Reserve, prints
dollars to purchase government bonds.
After he signaled two rate cuts this year as the solution, the euro sunk
0.3% against the dollar, prompting Trump to complain on Twitter that a weaker
euro made it easier for Europe to compete against the US.
“Mario Draghi just announced more stimulus could come, which immediately
dropped the Euro against the Dollar, making it unfairly easier for them to
compete against the USA. They have been getting away with this for years,
along with China and others,” the president wrote in a tweet.
The irony in Trump’s comments is that the United States is the ultimate
currency manipulator, by lowering interest rates and buying trillions worth
of government bonds during quantitative easing, between 2008 and 2015, thus
pushing down the value of the US dollar.
 
The question is, are we moving from a trade war to a currency war? Trump’s
comments about Draghi appear to suggest a hardening of his stance against
competitive devaluations. Presumably the same spiral of currency devaluations
and tariffs could apply to the China-US trade war, if China decides to
purposely devalue the yuan to gain an advantage over the US - say as leverage
for getting a trade deal.
But it’s not just China. We are seeing signs of competitive devaluation in
other countries, with many loosening their monetary policies as the global
growth machine grinds to a halt and economies cool off.
Struggling to deal with too-low inflation, the European Central Bank is
promising to hold already rock-bottom interest rates until mid-2020; for the
same reason the US Federal Reserve signaled a rate cut is on its way. Reuters
points out that reducing interest rates or at least sounding off on
the possibilities, is “in vogue at the moment.”
US$ to EUR, www.xe.com
The news service notes that, along with the Fed, the ECB and the Bank of
Japan pursuing a dovish monetary policy, so are emerging markets, such as
India and Russia which have already started easing. Indonesia, the
Philippines and Brazil have flagged interest rate cuts in the near
future. Switzerland, Japan, Sweden and Denmark have all gone to negative or
near-negative interest rates, to try and spur growth and to stimulate
exports.
The fact that the Bank of Indonesia, which has been extremely cautious about
easing, has cut banks’ reserve ratio by half a percentage point, and is
hinting at cheaper money, shows how
dovish the world has gone.
But being dovish doesn’t necessarily mean a currency war, does it? No, but
it certainly appears the Trump administration is preparing to go
on the offensive.
Recently the Treasury Department came out with a report that
recommended nine trading partners should face scrutiny over their
currencies - China, Germany, Japan, South Korea, Ireland, Italy, Malaysia,
Vietnam and Singapore.
Also notable, the
latest report expanded the list of nations under review, from 12 to 21.
Echoing what was said about the 1997 Asian Financial Crisis, at the top,
Andrew Moran, writing for Liberty
Nation, argues nothing good can come of a race-to-the-bottom round of
currency devaluations. Even though cheaper imports would help middle class
Americans’ purchasing power, it’s not worth it considering the damage it
would due to the international monetary system, Moran writes:
Like a military conflict and a trade war, there aren’t any victors. It
can be difficult to determine when central banks fire the first shots, but
these bullets are usually pointed at their own heads because a currency war
is more like currency suicide. The act of destroying any semblance of value
will inevitably harm a nation and its economy in myriad ways, from slashing
rates to creating price inflation.
Trump’s low-dollar obsession
The Trump administration wants to keep interest rates and the dollar low.
This is a shift from Trump’s predecessors in the White House who have lobbied
for a strong dollar.
For Trump, a low dollar is the way to bring jobs back to the US after so
many were exported abroad to take advantage of lower labor costs, and
therefore rebuild the US manufacturing sector, primarily, through cheaper
exports. He’s particularly targeted China for competitively devaluing its
currency to dump cheap exports into the US, such as steel and aluminum.
The problem for the United States is that throughout the past several
years, the dollar has remained high in relation to other currencies, and that
has created a large trade deficit – $825 billion for 2018. As the country
with the world’s reserve currency, the United States has to run
trade deficits, because the US dollar is far and beyond the most demanded
currency in the world. Just about all commodities are priced in US dollars
and the USD is the currency in which most international transactions are
conducted. A relentlessly high dollar means the US will always run a trade
deficit.
It’s a problem though, because a trade deficit means the US imports more
than it exports – consumers are buying more goods and services from abroad
than locally. Think Walmart. However, US exporters face resistance from
foreign buyers because products priced in dollars are more expensive. They
want a low dollar.
It is primarily the result of the trade deficit – and especially the trade
deficit with China, – that prompted the Trump administration to engage in a
series of tit for tat tariffs, now totaling hundreds of billions worth of
goods, with its most powerful economic competitor.
Here’s where the problem comes in. If the US deliberately lowers its
currency, through interest rate reductions, and injecting billions of dollars
into the economy, through bond-buying, even under the guise of fixing its
trade deficit, America’s trading partners get miffed. Because the US under
Trump is not only going after China, it’s targeting Canada, Mexico and
Europe, in threatening or hitting them with tariffs. The only way for them to
respond is competitive devaluation.
The ‘stubborn child’
The latest in the Trump versus Fed Chair Jerome Powell clash is an
accusation by Trump that the Federal Reserve is behaving like “a stubborn
child” in refusing to cut interest rates, in response to other countries’
dovish monetary policies.
His contention is that if only the central bank were to slash interest
rates, make the Fed’s objective a weaker dollar, the economy would be
stronger.
The problem right now for the Federal Reserve, is it’s not clear whether
the economy is booming or busting. Last week’s decision by the Fed to keep
interest rates unchanged, while paving the way for a cut in July, sent the
S&P 500 to a new record high. At the same time though, US Treasury yields
sunk to three-year lows. The former indicates a booming economy while the
latter is screaming recession, Zero
Hedge writes, in explaining the “alligator jaws” in the graph
below:
The problem boils down to one simple observation: on one hand stocks
are telegraphing substantial market upside and, at least in theory, a booming
economy, while bond yields - at 3 year lows - are screaming
recession.
We have reached a point where the consequences of the Fed's actions
are dire in either case, resulting in either recession or loss of Fed
credibility and independence:
In the case of unresponsive Fed it is a recession, while in the case
of an accommodative Fed it is the loss of central bank independence and
potentially another round of trade wars and even more pressure on the Fed to
cut rates with further markets addiction to stimulus and possibly higher
inflation etc.
Changing the rules
Back to the currency war, while we’re not yet racing to the bottom, the US
Commerce Department has just been appointed new powers that certainly appear
to take the fight with China in this direction.
France24
reports on a proposed new rule that allows the United
States to impose tariffs on any country it determines is manipulating its
currency.
The publication explains that, while previous presidents and lawmakers
“have floated plans to go after governments that manipulate their exchange
rate to compete in the global trading system,” none have followed through
because they were thought to be a violation of global trade rules.
A careful reading of the France24 story reveals a startling fact: under
the new rules, the US Commerce Department is being given a wide scope of
power to decide whether or not a country is manipulating its
currency to the detriment of the United States.
Right now, the US Treasury produces a report every six months on whether
any country is manipulating their currency to the disadvantage of the United
States. A finding of currency manipulation could lead to trade sanctions -
although none has been named since 1994 when the Clinton administration
slapped the label on China.
Under the new rules, that power would be given to the Department of
Commerce, which “could impose tariffs to offset the weaker exchange rate
against the US dollar,” states France24 - the same quid pro quo the US is
demanding of China during current trade negotiations. If the EUR has
depreciated 20% against the USD, no problem, immediately slap a minimum 20%
tariff on imports to the US.
And now for the real kicker:
According to the proposal, Commerce said it would
defer to Treasury's evaluation of whether a currency is undervalued, “unless
we have good reason to believe otherwise.”
In other words, the list of 21 trading partners that the Treasury
Department said should face scrutiny over their currencies are now, or are
after June 27th, open to getting tariffs equal to, or likely slightly more,
then their currency has been devalued.
Commerce doesn’t have to investigate further. Or at the very least, it’s
ambiguous as to what the department has to do. The Treasury’s
finding ‘of undervalued’ could conceivably be enough to move forward with
trade sanctions.
The plan “would grant the Commerce Department excessive discretion.” Mark
Sobel, a former Treasury department officer quoted by France24
The proposal is currently receiving public input but is due to become law by
June 27. If it does the Commerce Department has been granted sweeping
jurisdiction over exchange rates and implementation of tariffs.
Courting catastrophe
It doesn’t take a whole lot of rumination to conclude where the Trump
administration is going with this: Where governments before it were too
timid, too much of a team player maybe, to act on powers the Treasury
Department has had since the 1980s, in leveling a finding of currency
manipulation on a trading partner, Trump has gifted this power to the
Commerce Department.
Commerce is a “Cabinet-level agency” of the federal government, which
among its duties, negotiates bilateral trade agreements. Note that for
2020, Trump
asked for $12.2 billion for the Department of Commerce, a billion dollars
more (+9.3%) than was budgeted in 2019.
It is this kind of unilateralism, often born of hubris - one pictures a
gun-toting sheriff walking into a saloon looking to bust some heads - that
has got the US into trouble before. Trump may mean well in putting America’s
interests first, but the difference is that historically, the US has always
gone with the carrot and the stick. With Trump, it’s all stick. Here’s
Project Syndicate:
Far from displaying a capacity to persuade, as the title of his book
The Art of the Deal might imply, Trump is attempting to use raw power alone
to force his “America First” agenda on the rest of the world.
“Tariffs,” Trump recently gloated,
“are a beautiful thing when you’re the piggy bank, when you have all the
money.”
And yet the message of history is clear: by embracing force and eschewing
persuasion, the US is undermining its own authority – and courting
catastrophe.
Project Syndicate gives the following as examples of how the US drew its
pistol first, and asked questions later:
- In 1950 when General Douglas MacArthur, after driving North
Korean forces out of the South, heedlessly marched
north, where his forces and their allies encountered – and were
overrun by – Chinese forces.
- in 1964, when the US used attacks by North Vietnamese
torpedo boats on American destroyers in the Gulf of Tonkin as a pretext
for adopting a congressional resolution that
allowed President Lyndon B. Johnson, and then President Richard M.
Nixon, to escalate US military involvement in the Vietnam War. (The
parallels with the current situation in the Gulf of Oman are concerning,
to say the least.)
- in the 2000s in the course of the War on Terror, which
relied on massive force and shunned the strategic cunning favored by
many American diplomats, sowing instability throughout an
already-fragile Middle East.
It concludes:
For now, the US still has enough power to force countries to bend to
its will. But the world is already working to change that. There is a
growing push
away from dollar-denominated transactions. The European
Central Bank is promoting increased
use of the euro internationally, while China signs currency-swap
agreements to promote the renminbi.
We agree and have made the same argument in previous articles. Indeed, on
economic concerns, the United States under Trump seems bound and determined
to bully its way into the next financial crisis, blissfully ignoring the
economic warning signals while repeating the endlessly cliched, “Make America
Great Again”.
Columnist
Stephen Roach eviscerates the administration for its frequent policy
blunders and lack of historical knowledge - particularly of America’s
disastrous dalliance with protectionism:
Ignoring the cascading stream of direct and retaliatory taxes on
consumers and businesses that stem from a tariff war, Trump extols the
virtues of tariffs as “a
beautiful thing.” That is painfully reminiscent of the 1928 Republican
Party platform, which couched tariffs as “a fundamental and
essential principle of the economic life of this nation … and essential for
the continued prosperity of the country.” Trump ignores the lessons of the
1930s at great peril...
Trump’s vindictive bluster has steamrolled economic-policy
deliberations – ignoring the lessons of history, rejecting the analytics of
modern economics, and undermining the institutional integrity of the
policymaking process. Policy blunders of epic proportion have become the
rule, not the exception. It won’t be nearly as easy to spin the looming
consequences.
Conclusion
The United States came awfully close to attacking Iran a few days ago.
Thankfully Trump saw sense in standing down after being told 150 Iranians
would die. Sensibly, the commander in chief decided 150 dead wasn’t
proportionate to shooting down an un-manned drone. No kidding.
Now talk has shifted to the possibility, if not of a shooting war, of a
currency war. In these fragile times, when the yield curve is inverted and
flashing red for recession, when the economy is so weak that prices aren’t
even growing 2%, when investors are mindlessly piling into stocks like
Pavlov’s dogs and are happily locking into 10-year bonds with .22% real
yields, we have a problem, Houston.
The last thing we need is for the White House to devalue the dollar trying
to out-export China, the greatest exporting nation of all time, while taking
on Europe, and its sickly euro, in a second currency war front. We saw what
happened in Asia in 1997: hyper-inflation, mass unemployment, living
standards flushed down the toilet of debt, the IMF eventually having to bail
them out.
Everyone dissed Trump for imposing tariffs for reasons of “national
security” but the president has blocked that channel of criticism by imbuing
the Department of Commerce with the power to slap tariffs on currency
manipulators. I think we can all believe that order will come directly
from Trump himself.
Just another way that Trump is doing an end-run around conventional
politics in Washington to get things done his way. Unfortunately for
American’s their dollar just took another hard kick to it’s ‘Exorbitant
Privilege.’
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