Economy Feb 11, 2013
"Devaluing a currency is like peeing in bed. It feels good at first, but pretty soon it becomes a real mess." - A line attributed to a senior official of the Federal Reserve of the United States
Central banks around the world have been on a money printing spree since the start of the financial crisis in late 2008. The Federal Reserve of United States has expanded its balance sheet by 220% since early 2008. The Bank of England has done even better at 350%. The European Central Bank came to the party a little late and has expanded its balance sheet by around 98%.
The Bank of Japan has been rather subdued in its money printing efforts and has expanded its balance sheet only by 30% over the last four years.
But now it seems to be getting ready to join the money printing party. Japan has had a deflationary scenario since 2009, meaning that prices have been falling. The Bank of Japan is now targeting an inflation of 2% and wants to reach the goal at an earliest possible date.
The plan is to print and flood the financial system with as many yen as required. As a higher amount of money chases the same amount of goods and services, the hope is to create some inflation.
When prices are flat or are falling or are expected to fall, consumers generally tend to postpone consumption(i.e. buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses as their earnings either remain flat or fall. This slows down economic growth.
On the flip side, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So by trying to create some inflation the idea is to get consumption going again in Japan and help it come out of a more than two decade old recession. With prices of things going up people are more likely to buy now than later.
Other than trying to get consumption going again there is another part to this story. When countries print money the idea is to cheapen their currency against other currencies and thus boost exports.
As the Bank of Japan starts printing yen to create inflation, there will be more yen in the market than before. And this will lead to a fall in the value of the yen against other currencies.
But the market does not wait for things to happen, it starts to react to things it expects to happen. Given this, the Japanese yen has been losing value against the dollar.
Three months back one dollar was worth 79.4 yen and now it is worth 93.5 yen. So how does this help Japanese exporters? Let us say a Japanese exporter sells a product worth $1 million. Earlier when he converted dollars into yen he would have got 79.4 million yen. Now with the yen losing value against the dollar he will get 93.5 million yen. Since the exporter's cost in yen remain the same, he makes a higher profit.
What the exporter can do now is cut prices in dollar terms and even then earn a higher profit. Lets say the exporter cuts the price by 10% in dollar terms and now sells the good at $900,000. When he converts this to yen he earns 84.1 million yen ($900,000 x 93.5). This is higher than the 79.4 million yen he had earned earlier.
By cutting the price in dollar terms the Japanese exporter becomes more competitive in the international market and thus can hope to sell a greater number of goods. This will lead to increased exports and and that will help economic growth. At least that's how things are supposed to work in theory.
The yen has also depreciated against the South Korean won. South Korea and Japan compete in several export oriented industries like automobiles and electronics. Around three months back one Japanese yen was worth 13.7 Korean won. Now it is worth 11.8 won. This has made the South Korean exports lesser competitive than Japan.
So for a brief while Japan might have a competitive advantage when it comes to its exports. But the thing to remember here is that money printing is not something that only Japan can indulge in. The South Koreans can also print as many won (their currency) as possible. Politicians in South Korea have lately been voicing their concerns on this and have talked about measures to stop the won from gaining value against the yen. Interestingly one yen was worth 11.6 won on February 4. Since then it has appreciated to 11.8 won.
The point here is very simple. Money printing is an idea which every country can implement. And countries will resort to it more and more in the years to come to protect their exports. In fact countries have already been voicing their concern on a rapidly depreciating yen. As Liam Halligan chief economist at Prosperity Capital Management pointed out in a recent piece "Germany, also, is deeply concerned about the yen's recent fall and the prospect of further weakness. With an eye on his country's all-important export sector, Bundesbank president, Jens Weidmann, recently mauled Tokyo's new affinity for loose money, referring to "alarming infringements" and an "end to central bank autonomy". Three months back one euro was worth 101 yen. Now its worth around 125 yen. This appreciation of the euro is bound to impact the exports of countries like Germany which use the euro as their currency.
Germany cannot cheapen the euro by simply printing it, like Japan is doing with yen because euro is used as a currency, by 16 other countries. Given that Germany cannot decide unilaterally to go ahead and cheapen the euro by printing it. A little under half of the German GDP comes from exports.
But other countries have no such problems. The Czech Republic is looking to cheapen its currency koruna and Sweden is looking to cheapen the krona. It won't be surprising that other countries around the world, specially the export oriented economies of South East Asia, soon join the money printing party, in order to ensure that their exports don't get uncompetitive.
Columnist Matthew Lyn of The Wall Street Journal's Market Watch writes "There are plenty of calls for a lower euro to ease the growing recession in Europe: Jean-Claude Juncker, the chairman of the Eurogroup of finance ministers, has started describing the euro as "dangerously high." And don't be surprised if the Federal Reserve starts trying to edge the dollar down as well as it tries to lift growth in the United States...So if the Bank of Japan, for example, manages to get the yen down in value, the Europeans and Americans will react rather than see the Japanese knock out their industries."
In short, the world is getting ready for a currency war, as countries try and print more and more money to hold the value of their currency against other currencies and thus ensure that their exports remain competitive.
Mervyn King hinted at it when he said " My concern is that in 2013, what we will see is the growth of actively managed exchange rates as an alternative to the use of domestic monetary policy." Even George Soros, the famed hedge fund manager, feels that a currency war is the biggest danger facing the global economy. ""I think the biggest danger is ... a currency war," Soros told CNBC.
This might lead to the collapse of the confidence people have in paper money. James Rickards author Currency Wars: The Making of the Next Global Crises feels that the "The biggest risk is the rapid collapse of confidence in paper money. They can't just keep printing...All major central banks are easing...Eventually so much money will be printed that this will lead to inflation. The endgame is collapse of the international monetary system - sometime sooner than later."
This really brings gold to the fore. As the threat of more and more paper money being printed increases it is likely that people will move more of their paper money into gold. And this will push up the price of gold. Rickard's long term price estimate on gold is $7000 an ounce, nearly four times the $1670 an ounce it is currently trading at. As he puts it " Gold could trade in a range between $3,000 and $10,000, Rickards says. "We're not going to get there all at once."
This is something that Lynn agrees with. As he writes "The more central banks try and manipulate the value of paper money the more investors will grow disillusioned with it. There is only one quasi-currency that nobody tries to devalue - only because they can't - and that is gold. If central banks engage in a round of competitive devaluations, then the value of any of paper currency measured in gold will only go up."
Gold has been more or less flat for a while now. The purported reason behind this is that the Federal Reserve of United States has been lending out gold to banks known as bullion banks which are in turn selling that gold so as to drive down its price. After they have slightly driven down the price they buyback the gold and thus make a profit. This benefits both the bullion banks as well as the Federal Reserve. The bullion bank wants to make money. And the Federal Reserve does not want the price of gold to go up.
If the price of gold goes up, its a reflection of the failure of the policies adopted by the Federal Reserve to get the American economy up and running again.
Vivek Kaul is a writer. He can be reached at firstname.lastname@example.org
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