Are Competitive Devaluations Starting?

In a world of floating rates, driving the value of one’s currency down takes a bit of doing, but as China (since 1994) and Japan (circa 2003) have demonstrated, central banks can lower currency prices. And trashing one’s currency is part of the standard program recommended for countries facing deflation.

The preferred method these days appears to be quantitative easing. Futures on the Canadian dollar have fallen 3% on expectations its central bank will move to quantitative easing.

Ambrose Evans-Pritchard, who despite his fondness of apocalyptic pronouncements, has been been for the most part right in calling this downturn, argues the world is moving toward beggar thy neighbor currency debauchment.

From the Telegraph:

Swiss consumer prices fell 0.4pc in March (year-on-year). Swiss CPI will be minus 1pc at least by July, nearing the level where spending psychology changes. By the time you have a self-feeding spiral, it is too late.

“This is something that we must prevent at all costs. The current situation is extraordinarily serious,” said Philipp Hildebrand, a governor of the Swiss National Bank…..even the SNB’s hard men have thrown away the rule book, taking emergency action to force down the exchange rate of the Swiss franc.

Here lies the danger. If other countries try to export deflation by this means, we will face a second phase of the global crisis. Taiwan is already devaluing. Korea, Singapore, and Sweden all seem tempted to follow. Japan is chomping at the bit.

“We don’t fully realise in the West what a catastrophic collapse Japan has suffered,” says Albert Edwards, global strategist at Société Générale. “The West has dumped a large part of its economic downturn onto Japan by devaluing against the yen.”
This is about to go into reverse as Tokyo hits the ping-pong ball back across the net. “As the unfolding collapse in the yen gathers pace, the West will see its green shoots incinerated to dust,” he said.

Japan’s industrial output fell 38pc in February (year-on-year), mostly concentrated into the last four months. No major economy imploded at this speed in the 1930s. The country has been hit by a double shock. As an export power it has taken the brunt of Anglo-Saxon belt-tightening: as the world’s top creditor it is cursed by a “safe-haven” currency that soars in moments of danger – largely because the Japanese bring home their wealth till the storm passes. Normally, Japan can cope. This time, the yen’s rise has pushed the economy over a cliff.

The yen must come back down to earth, and soon, or Japanese society will start to disintegrate. If necessary, the Bank of Japan will force it down by intervention, as occurred in 2003-2004.

Will China stand idly by as Japanese unleashes a shock to the global system through competitive devaluation? That depends whether you think China’s spring recovery is the real thing, or an inventory build-up before the next downward slide. The Communist Party says 20m jobs have been lost since the bubble burst. This cannot be tolerated for long.

It is remarkable that China’s fall into deflation has attracted so little notice. China’s CPI was minus 1.6pc in February. The country has built too many factories producing goods that the world cannot absorb. The temptation is to shunt this excess capacity abroad. A faction of the politburo is already itching to devalue the yuan.

Of course, Britain has already played the currency card. That is different. The pound’s fall, though welcome, is a side-effect of the Bank of England efforts to stem the credit crunch. There has been no currency intervention.

Crucially, Britain has a current account deficit. Many countries toying with devaluation are exporters with surpluses – 15.4pc of GDP for Singapore, 8.4pc for Switzerland, and 6.1pc for China. If these countries refuse to let their imbalances correct, world demand must implode….

Ultimately, I suspect this crisis may mark the moment when the Swiss franc loses its safe-haven role. Credit default swaps (CDS) measuring risk on five-year government debt have reached 127 for Switzerland, higher than Britain at 118. Norway has the world’s lowest CDS at 48, reflecting its status as a petro-democracy.

Switzerland’s banks are over-leveraged. Loans to emerging markets equal 50pc of GDP (half to Eastern Europe). Banking secrecy is dying. Fortunately for the Swiss, they have built up $700bn in net foreign assets for a rainy day. Improvident Britons are less lucky. But that is another story. What we risk now is a game of deflation “pass-the-parcel” worldwide. The economic establishment was caught off guard from 2003 to 2007 because it overlooked the way that Asia’s unbalanced relationship with the West was feeding a credit bubble.

It may be caught again as the same warped structure leads to a chain of (panicked) devaluations.

Enjoy the “bear-trap” rally on global bourses this spring. But remember, we have only just begun to see the mass lay-offs and hardship caused by this slump. The politicians will act to save their skins. Markets may not like the result.

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  1. Francois

    "The politicians will act to save their skins."

    Hmmm! That is not the whole story. As Simon Johnson noted in his excellent article in The Atlantic, politicians will do (are doing) their best to help their friends and sponsors, the financial elites. These people are for the status quo, or at least, a return to a situation where they were the big dogs. This create a dangerous paralysis at a time where the slogan "Think Different" has never been so true.

    Apart from exercising sanity with the financial sector, as Yves has so rightly pointed out many times, IMO, there is only one way to remedy the current crisis, . We must invest in the 21th century infrastructure on a global scale. Systematic energy savings, R&D and implementation of alt-energy on a massive scale. This creates real jobs, helps us allocate physical resources more intelligently, (think of the myriad industrial uses of oil for instance) free up a lot of capital and opens the door to a much more sustainable economic growth without a corresponding depletion of resources. Think about it: if we were to implement such a grand project, we would find the means to do so and fix quite a few of the troubles we've got now.

    In this context, competitive devaluation should be seen as yet another attempt to skirt the fundamental long-term problems this crisis has exposed.

  2. Luke Lea

    Yves’s analysis seems about right to me. As for the need for a massive stimulus program of infrastructure spending, I advocate a nation-wide program to build New Towns in the Country in which parents work half-time outside the home and in their free-time help build their own houses, cultivate gardens, do their own cooking and eating at home and care for their own childrean and grandchildren in a traditional neighborhood setting complete with a neighborhood green.

    In other words, we common people — for I am one — must begin to do more things for ourselves and each other which now we pay others to do in our stead. It is precisely because we live in a post-industrial society that if we want time to live, work, and play we must substitute our own activities for those of the housecleaners, busboy and waitress, plumber, yardman, childcare worker, nursing home nurse, etc. We need also to spend less time and money and use energy going to and from work, which is easy to do in a small town.

    It is said that when a man marries his housekeeper the Gross Domestic Product goes up. In that sense we must reduce our GDP in a dozen different ways in the name of family, and friend, and the neighbor down the street.

    Employers should like this new arrangement because workers can work faster and more efficiently for shorter periods of time than for longer, just as in track and field the short-distance runners always run faster than the long-distance runners. With a fairly struck wage bargain, real hourly wages and annual return on investment could and should both go up together — by roughly 40 percent by early indications. We need corporate allies.

    Government help would be essential also in the carrying out of a such a nation-wide program, just as freeways and the FHA and home mortgage deductions were necessarcy to get suburbia rolling after WWII.

    Developers, too, will be needed, and can profit handsomely in the process — but only if it is understood that they are the servants and not the masters of this new little universe.

  3. Anonymous

    If the Swiss have $700b sitting idle (that’s a lot of cash now-a-days)
    I wouldn’t count them out of the ‘we are stable’ contest.

    Nice writing Smith. links to Martin Armstrong’s mathematical thoughts.

    (Fractional Reserve Banking follows a time line or you can only put so much credit/debt/cash in a system before it pukes)

  4. mft

    Yves, I’m usually critical of Evans-Pritchard, but this is an unusually good article. There’s practically no hyperbolic arm-waving and several good facts (Chinese deflation statistic, for example). Probably he “had his reporter hat on” for this article, as he likes to say.

    But seriously, I think most of us realize that the US really has only one good option left, and that is inflation. The trouble is, in the present circumstances that’s easier said than done! There are three ways for the US to generate ca. 10% annual inflation for several years (that’s what’s required):
    1) Printing money and dishing it out to the financial sector (quantitative easing, etc) – probably won’t work because the banks just hold onto the money.
    2) Tax cuts and welfare payments funded by printing money (QE variant 2). Probably not enough, as tax payers may save much of the money.
    3) The nuclear option – A BIG DEVALUATION. But how do you devalue the dollar? If the US starts selling dollars for yen, yuan and euro the Fed will accumulate foreign reserves, effectively ending the dollar’s unique international reserve role. That means THE END for US global dominance. Any other way? Really the only one is to get the Chinese to sell their dollars. But the Chinese don’t really want to do that. So here is the big question: HOW CAN THE USA ACTUALLY FORCE CHINA TO SELL ITS DOLLARS? There must be a way, don’t you think?

  5. Purple

    Alt-energy is not ready yet. It’s a noble investment, but not profitable right now, in the main. Without a legitimate source of new profit, the world economy will continue to deleverage.

  6. Anonymous

    While Albert Edwards claim that Japan has suffered a catastrophic collapse and the west has dumped its problems on Japan the method by which that imbalance is resolved may not be solely by Yen depreciation. Japan’s problems don’t just stem from an over valued currency but from a manufacturing predominance in goods which consumers can do without.

    Japan will be engineering some very low prices for its goods to increase demand, but it is more likely to achieve this through Cheaper imports of raw materials and through reversing its policy of distributed manufacturing. Non of which will bode well for the likes of Chrysler and GM but more importantly for all the small component manufacturers across the US. I expect to see Toyota and Nissan to struggle to keep plants open in the US when plants in Japan are in trouble. What happens to the Yuan I think will be key and I see china with little choice but to try to export job losses back to the US by devaluing.

    Meanwhile as most of the worlds banks seem to be getting back on a even keel, more potential storms look to be on the horizon for US banks and the US taxpayer. The questions about FHLB finances continue to come to light as reporters continue to delve into just what is going on with it and what is the exposure for the US tax payer after Bowsher the chairman of the FHLB resigned and refused to sign off the accounts.

    FHLB banks insolvent

    FHLB Countrywide Bailout was a warning

    FHLB Fannie and Freddie Opinion

  7. Swedish lex

    Countries indulging in competitive devaluations at the expense of their neighbours – a discipline in which Sweden excels – deserve tougher handling by their peers. It is strange that the EU does not intervene more.

  8. Terry

    I’m beginning to think that competitive devaluation will be to this emerging depression what protectionism was to the Great Depression.

  9. Anonymous

    Excellent post!

    A couple of points:

    1.) Buy and hold gold.

    2.) If you live in continental Europe, apply for immigration to the United States right away.

    3.) The Swiss and Norway are wise not to have much to do with the EU. Britain, Sweden, despite being EU members, they might as well not be.

    4.) About Europe:
    Europe is the new Japan. Last week’s resistance showed by Germany and France to embark upon truly relevant stimulus actions, indicates that Europe will follow the path of Japan. The difference is that Europe is in a far worse position than Japan was in the 90s.

    What will Germany do when Americans and Russians stop buying their overpriced, overrated BMWs and Mercedeses, and instead choose a Tata, a new-and-improved GM, an affordable Ford, or a trusty Toyota? And, what will the lazy had-been, stale-glory France do when American tourists stop dishing out thousands of their dollars to visit decrepit Parisians museums and pay $10+ for a cup of poorly brewed coffee served by a sour-faced French waiter, when they can just go to the Met, and drink better coffer in a friendlier atmosphere at their neighborhood Starbucks for a lot less money.

    What will France, Spain, Austria, Germany, and now the so-called “progressive” Netherlands do with their nationalist policies (in the case of France, Spain, and Austria bordering on the Fascist)? They despise, openly discriminate, and detest immigration, but at the same time enjoy a negative birth rate. They reject and humiliate Muslims based on their religion, while having lost all their Christian heritage and traditions. They believe in nothing except in their own arrogance. They enjoy their 32 hour work weeks, one-month vacation, subsidized healthcare and education, while expecting America to pay for their defense, Eastern Europeans to do all their work for them, and American stimulus programs to rescues their failing economies. What will happen to them, with these attitudes and policies? They will simply become Third World, very much like Spain, Greece, Italy, Portugal, and parts of southern France already are. France will eat cake (again), and Germany will eat their overpriced BMWs. Bon appetite!

    The arrogance of France and Germany continues despite the harsh reality that should have awaken them decades ago. Yesterday and today they have snubbed Turkey again. Very much like they snubbed Eastern Europe a few years ago. I sincerely hope aspiring EU members along with recent new Easter European members will soon recognize the total lack of benefit of being part of this joke called the European Union. And I sincerely hope Obama will soon realize the futility of dealing with them.

    Correction to the above: Europe is NOT the new Japan. Europe is the “new Zimbabwe with a twist,” namely it will sport poverty and massive social unrest, while maintaining a stable currency…LOL Yeah, the old Deutchmark in disguise…LOL

    5.) Meanwhile, America will rebuild its infrastructure, will somehow find a way to devalue its currency and thus erase/ease foreign debt, will forge new alliances with truly relevant powers like Turkey, Iran, Eastern Europe, and Russia, while distancing itself from irrelevant nations like France, Spain, Germany, or other stagnant had-beens.

    Vinny GOLDberg

  10. Anonymous

    Hey Vinny,

    Don’t let your enthusiasm get ahead of you. All of Europe has had a sizeable immigration, legal and illegal in recent years. Not much different from the US on that. France has a positive birth rate. As for their “decrepit” museums, you clearly have not been in France in a long time.

    The US unemployment rate just passed France’s for the first time in a long time. They have their problems, but their banks are fundamentally sound, and they didn’t create a real-estate bubble.

    At some point, some reality has to creep into your fantasmagoric image of Europe. I love the USA too, but your spew does it a disservice.

  11. Anon1

    Vinny, as France and Germany accurately stated, they have already been spending a LOT of money on stimulus and they are sitting very pretty as a result. They have been CONTINUOUSLY spending stimulus money on their social safety net and social support structure, which is superb and working very well.

    I’d LOVE to have France’s social support structure (with a few tweaks based on lessons learned by France).

    We are Argentina over here while Germany and France are pretty solid so far, even with the problems. Can’t say the same for Britain which essentially followed the US model (thanks to Thatcher) into ruin.

    Swedish Lex: I am sympathetic to Japan and do NOT believe there should be any punitive action by other countries should Japan devalue the Yen. They are blown away in ways we have yet to reach here (but have a better safety net!).

    Let’s see, choose to save your society or save international trade relations? No contest, I would choose to save the society and defuse potential social unrest FIRST. That is the ultimate duty of ANY valid government, to NOT screw its own people for the sake of foreign business. Painful choice in other ways but the right one.

  12. Anonymous

    Like Groucho Marx would put it, “In Europe the food is terrible and the portions are small.”

    I’ll explain:

    I was born and was raised in Europe, although for over 25 years I’ve been calling the U.S. my home. I am in Europe right now, and for the past 2 years I have spent most of my time in Europe. Last time I was in France and Germany was in January.

    I really think the Western European infrastructure has been deteriorating rapidly these past several years, along with some of the major tourist traps like Paris. I used to love Paris, but now the place really needs a paint job and a scrub as it is looking more and more like Marseilles or Naples. I think France is so dependent on tourism, they need to seriously start cleaning up the place, because I doubt the export of Renaults will keep those lofty social programs going much longer.

    As far as Germany goes, it is in a far better position than France or the rest of southern Europe for that matter, but they too have been deteriorating these past few years. The autobahns, for one thing, are in terrible shape. It is actually becoming hazardous to drive on the German autobahns — repainting the lanes would be a nice start.

    In my opinion, the “European Dream” is well on its way out. It was 200 years too late to begin with, and the steps toward integration were just too half-baked to make any lasting difference. It’s too late now. Globalization is on its way out, and Western Europe is now just a bunch of small and relatively unimportant nations. It’s only the big dogs that matter now: the U.S., China, Russia, India, maybe Brazil. I think Turkey has a brighter future than France, Italy, or Spain.

    Honestly, I think Eastern Europe has a brighter future than the Western part of the continent. Eastern Europeans are much more down-to-earth, much more humble, more sound-minded, and more appreciative of what the U.S. did for them. All I see in places like France and Spain is a sense of entitlement and a holier than thou attitude.

    Eastern Europeans are also very well educated. The best mathematicians come from Romania and Hungary. Go to any top university in the world like MIT, Harvard, Yale, Stanford, or Princeton (all American universities, by the way), and the best and the brightest students are from Romania, Hungary, Bulgaria, Russia. These are truly smart people, and America is paying their tuition at these top universities, and when they graduates it gives them permanent residence followed by citizenship.

    France and Spain treats Easter Europeans like underdogs, and sends Ph.D.s and M.D.s to work in agriculture. Or, if they ever get to work in a university or hospital, they will always be subordinate to some ignorant Frenchman or Spaniard who gets the higher position simply for having the right sounding last name. Have you seen any decent research come out of France or Spain, ever? And if you do, it’s likely produced by foreigners and the head honcho gets to plaster his name on the study simply because he has seniority. I hardly see how that is conducive to progress.

    In French universities all they teach is just how wonderful is the French language, and how awful it is that that terrible English has made Victor Hugo’s tongue irrelevant.

    I also don’t see true soul-searching in Western Europe. Even now, with this crisis, all I hear from France is how the crisis started in the U.S. They never seem to mention that their own Societe Generale made its crazy investments in Eastern Europe all on its own. Yet, Societe Generale received over 20 billion of U.S. taxpayer money through AIG. No, the average Frenchman has absolutely no ability to be honest with himself.

    OK, I am a psychiatrist, so I study people for a living. You can generalize about people, within certain limits, of course. I think the general attitude in much of Europe is “give us something for free.” The handout mentality. Europe got addicted to freebies after the Marshall Plan. Germany is an exception, because theGermans are actually creative people. But most of Southern Europe (Spain, Portugal, Italy, France, Greece) are simply used to living off of tourists that hand over their cash to see ruins the Romans build 2000 years ago or paintings Leonardo da Vinci made 500 years ago.

    However, the U.S. is very different. The U.S. actually is a creative nation. Silicon Valley, for instance, and the universities I mentioned above, plus hundreds of other American universities public or private.

    Granted, a large percentage of Americans are parasites living off of welfare, but America still has a large enough segment of the population that creates and produces like no others in the world. This segment will save America. However, I don’t see enough such people in nations like France, Britain, Italy, Greece.

    Finally, I know Europe better than most Europeans. I know America better than most Americans. America still is by far a better place to live. In contrast, life is hard in Europe. Everything in Europe is overpriced, salaries are terribly low, taxes are high, apartments are small and cold.

    Well, all of the above are my honest opinion, for what it’s worth.

    Vinny GOLberg

  13. Francois

    Not all forms of Alt-energy are ready. But wind sure is; Vestas' CEO told Barron recently that only the banks were an obstacle to a 25% y-o-y growth.

    In fact, despite the tight credit market situation, they will increase their head count from 1,300 to 4,000 at the end of 2009 in their main manufacturing plant in the US; hardly the stuff of experimental R&D outfit.

    Also, the few trade schools in the US that train windmill techs are completely overwhelm by the demand from the industry. GM alone wants to hire 3,00 of them during the next 18 months.

  14. Francois

    @ Vinny GOLberg:
    “Granted, a large percentage of Americans are parasites living off of welfare.”

    I’m sure you’ve got tons of facts and figures to support that, don’t you?

  15. Anonymous

    Hi Vinny,

    I live in Germany, and I like to do so pretty much. If live is better in the US, I’m very happy for you and the other Americans, that can enjoy their lives.

    When you describe aspects of sustainability of the current lifestyles, your ranting on Western Europe isn’t very realitic, though.
    One reason for this, is your believe in immigration. Immigration doesn’t necessarily enrich a country. Especially if you have a social safety net, immigrants may after a very short term of work simply end living from welfare.

    Immigration and generally population growth means
    – capital dilution: you need to build new streets, schools, houses, factories, etc. but as well create new ideas for new jobs. If the immigrants are less educated than the home population – and Turkish and Arabian immigrants to Europe are less educated, you have to build up new human capital as well
    – there are natural resources like water, attractive places for properties, locations for windmills, occasionally metals and minerals, beaches, …
    these natural resources are hardly increasable. The less people there are, the more of the natural resources for every single person.

    Another point you misanalyse is the dependency on cars and tourism. Actually overall Western Europeans tend to make more vacations elsewhere, than the other way around. How can you laud Turkey and critisise dependency on tourism?
    As well Mercedes and BMW aren’t most of Germanies export goods [of course you have to subtract the parts, that Germany imports to assemble the cars] And with regard to precursor products, there are as well German components in Chinese and Indian cars.

    Education in Western Europe by the way is overall the best in the world. There are few top universities, but the average Western European university is better than the American, and far better than Eastern European universities. You mention mathematicians. Never thought, the mathematics is a subject, that you can learn without tremendous investment in machinery, without the need for large science clusters, etc.?

    Eastern Europe, Turkey and the USA had one thing in common in the last years. Huge current account deficits. If Western Europe would be uncompetitive, than one should expects is currencies to devalue. But you speak of the US, that it may manage to devalue its currency (artificially)? Well, if the Europeans would be the last man standing in not manipulating our currency, the world should be grateful to us, to have at least one major currency, that works the way currencies should work. Against whom do you want to devalue otherwise?

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