MACRO INSIGHTS - March 2013
The Currency War being heralded by the media is not what it appears. Remember:
"Strategy is something that happens TO YOU while YOU ARE LOOKING the other way!"
As in the game of chess, which taught warriors of yesteryear about strategy and how the elements of cunning and positioning delivered 'check mate', this game is about understanding the strategy being slyly carried out. Currency Wars may be an old game, but it is a very different battlefield today, utilizing quite a deceptive strategy in this modern era of FIAT Currencies.
This is also a war being fought out of necessity. Rather than be destroyed by over indebtedness, it requires weakening sovereigns combatants to strike first before it is too late and their debt quickly erodes existing strategic advantage. It involves taking full advantage of the malinvestment and mispricing, which presently shrouds the difference between price and value. As Warren Buffett is fond of saying: "Price is what you Pay, Value is what you Get". Never has this been more true than in today's Bond and Currency Markets.
AN OLD GAME - NEW BATTLEFIELD
Currency Wars are an element of the Beggar-Thy-Neighbor game, but they are only one side of the game. Currency Wars are the export component of what is part of historically a Trade War. The other side is the import element which is more easily identifiable as part of a Trade War because it typically involves easily recognizable trade barriers and protectionism. Today the later elements are highly restricted by the regulations of the recently established World Trade Organization (WTO).
BEGGAR-THY-NEIGHBOR
The latest barrage in Currency interventions was perfectly predictable, as was the inevitability of what would be labeled "Currency Wars".
Prior to the dot.com bubble this eventuality was identified and laid out by some luminaries such as the Comstock Fund. A chart that they published then, and have steadfastly defended to this day, is show to the right. It is a chart that has hung on my office wall for well over a decade.
The area circled in red identifies the natural process that the cycle of deflation has lead to: Competitive Devaluation which we are experiencing today, then to Protectionism and Tariffs, then to full scale Beggar-Thy-Neighbor.
In our 2010 Thesis paper "Beggar-Thy-Neighbor" (available at gordontlong.com) we used this idealized cycle as a framework to consider the major new developments associated with the rapid advancement of Globalization, Structural Trade Imbalances, Currency Swaps and the US dollar's growing exposure as the world's Reserve Currency.
It then led us to outline that the Financial Crisis would evolve quickly into a Global Economic Crisis and then a Political Crisis, as monetary malpractice associated with unsound money practices would lead to moral hazard and unintended consequences and then to malinvestment, mispricing and dysfunctional markets. This is exactly where it has led us.
By consequence we knew this would lead to dramatic expansion of monetary bases and central bank balance sheets. Throughout 2011 we ended almost every Global Insights audio broadcast with "Don't worry, They'll print the money!". It was perfectly predictable, as is the road map for the next stage which now lays in front of us.
To understand the Currency War currently in play, we need to appreciate how the situational landscape will be different in this latest reincarnation of a Currency War. Then we can discuss who the combatants will be and what will be steering strategy.
NEW BATTLEFIED - This Time It Really is Different
After WWI the French went to great length and expense to construct the magnificent and impregnable Maginot Line between Germany and themselves. It was never tested. Hitler reinvented warfare with the Blitzkrieg and highly mobile armor. He quickly flanked the Maginot Line and was in Paris before the French could get their 'strategically positioned' troops off the Maginot Line. Warfare is fought that way. It is always about startling new changes in the "rules", usually due to revolutionary technology advancements and an unexpected new strategy that capitalizes on them.
This war is no different. It is about TECHNOLOGY and STRATEGY once again.
It is critical to recognize that never has a Currency War been fought within the context of the following situational conditions:
Modern Global Fiat Currency Regimes
Unprecedented Sovereign Debt Levels
Historic Total Global Debt Levels (Public & Private)
Untested "Unlimited" / "Uncapped" Monetary Policies
Trade Restrictions of the World Trade Organization (WTO)
Interconnected, Globalized Dependencies
THE BELLIGERENTS
As I mentioned earlier, this Currency War is being fought out of necessity. Rather than be destroyed by over indebtedness, it requires weakening sovereigns combatants to strike first before it is too late, or their debt will quickly erode their existing tenuous strategic advantage. They must be the aggressor even against their former allies if they are to survive. They must do what they have preached against others doing before they are destroyed by those who are also being forced into the same compromising position. Political leaders only understand the necessity of survival, not a loyalty that would outlasts their brief elected tenures.
HOW THE BELLIGERENTS TIP THEIR HAND
| FINANCIAL REPRESSION: | Belligerents will force Negative Real Interest Rates |
| INTERVENTION: | Belligerents will Intervene the Most in Foreign Exchange Markets |
| MOTIVES: | Belligerents will gain the most from a Weak Currency (Debt AND Trade Deficit Levels) |
WHO ARE THEY
The Currency Cartel who control over 90% of the Globally Exchanged Currencies,
Those that have already demonstrated the Greatest Rates of Debasement which has forced the rest of the world to react.
BUSHFIRE BATTLES
MORTAR & MISSILE FIRE
The mortar and missiles being launched from the belligerents are one of 'hot money', money that overwhelms the smaller recipient countries and is incredibly disruptive financially, economically and politically.
The hot money typically forces the recipient to counter in ways which produces destabilizing domestic inflation.
It normally forces controls such as: capital controls, trade controls, price controls and often wage controls to be implemented.
Bushfire battles are igniting everywhere around the globe. The underlying problem of liquidity pumping by the developed economies is increasingly causing widening distortions in the following hotspots:
JAPAN - Newly elected Prime Minister Shinzo Abe's "Abenomics" is expected to result in a transition from a strong to weak yen which will likely involve a devaluation of 30 to 40 percent.
ARGENTINA - Argentina has increased M2 by 215% in the last 3 years.
VENEZUELA - Venezuela has now been forced to devalue the Bolivar by32%.
EUROPE - Because of the ECB's reluctance to expand its balance sheet faster it has resulted in the Euro increasing to the point that exports are now being crippled from key EU export countries, countries that the peripherals desperately need to be healthy to be able to fund them.
SWITZERLAND - Inundated to such an extent from capital fleeing Euro, that it had to peg the Franc to the Euro.
THE ARGENTINEAN ROAD MAP
FOLLOWING THE ARGENTINEAN ROAD MAP
The developed world is clearly following the well trodden Argentinean Road Map. Whether intentional or simply the natural consequence of unsound money, the unfolding similarities are eerie.
Nationalized Private Pensions, plundering the retirement savings of the people.
Increased Tax Rates across the board-- income, VAT, import duties, etc. as well as an imposed new wealth tax.
Inflated Argentina's Money Supply, printing currency with wanton abandon; M2 money supply has increased 215% in the past three years.
Currency Devaluation - Driven the value and purchasing power of the currency down by 50%. Street-level inflation is now 30%+ per year.
Economic Reporting - Made a mockery of official statistics, comically understating the level of Argentine inflation and unemployment. The President even began punishing economists for publishing private estimates of inflation that didn't jive with the government figures.
Nationalization - Taken over control of one industry after another, most notably the nationalization of Spanish oil firm YPF's Argentine assets.
Imposed Export Controls of agriculture products from beef to grains, forcing growers to sell at artificially lower domestic prices.
Imposed Capital Controls, reducing the citizens' capability to dump their poorly performing currency and hold gold, dollars, Euros, or anything else.
Price Controls - Imposed a two month 'price freeze' on items in the supermarket, and encouraged retail consumers to rat out any grocer that doesn't abide by the government order.
Media Controls - Imposed controls over the media, most recently ordered an advertising ban in Argentine newspapers (weakening their financial position).
Currency Wars Lead to Capital Controls which lead to Export Controls, which lead to Price Controls, which lead to Media Controls, which lead to.... more AUTHORITARIAN CENTRAL STATE CONTROLS.
TECHNOLOGY & STRATEGY
Let's now consider the new disruptive technology and strategy that can, and is being used.
Obviously, sovereign Cyberwar technologies are top secret and classified. We therefore don't know the details, so we can only speculate. We do know however many things, such as years ago, James Rickards was involved in Currency War Games with the US Military which front ended his acclaimed book on Currency Wars. Clearly its strategic importance within the context of financial technologies has been well understood for some time.
TECHNOLOGY
FINANCIAL TECHNOLOGY
"WEAPONS OF MASS DESTRUCTION" - (DERIVATIVES)
Currency SWAPS $67 Trillion
Interest Rate SWAPS $494 Trillion
COMMAND & CONTROL LEVERS - (HIDDEN CONTROLS)
Shadow Banking $67 Trillion
Trade Flows $3 - 4 Trillion of Currency Transacted per day
CYBER DISRUPTION - CYBERTHREAT - CYBERWAR (DISRUPTIVE AGENTS)
STRATEGY
To understand the strategy we only need to return to the Cycle of Deflation chart we started out with. For the cycle to finish and turn upward, the malinvestment and mispricing must be cleared. We require a market clearing event that resets prices and allows pricing power and investment to return to the markets.
The BELLIGERENTS UNDERSTAND AND & KNOW THIS IS THE ONLY WAY OUT - IT IS INEVITABLE!
When the capitalist system is working in an unrestricted fashion, this is normally and naturally achieved through:
Bankruptcy,
Debt Default,
Market Revaluation.
When this is understood (and none are presently considered an option because of the degree of leverage and rehypothecation exposure), then you are left with only have a limited number of options:
Push the day of reckoning out, hoping that growth will solve the problem ("Extend & Pretend", "Kick-the-Can", "Fake it Until You Make It").
Create Inflation to debase the value of the debt.
Financial Repression (Negative Real Rates).
Debase the Currency as a store of value.
The Central Bankers have tried #1,#2 and #3 over the last five years and they have failed to gain sufficient traction.
Rapid debasement of the Currency is now the required strategy.
DON'T BE FOOLED
"Strategy is Something That Happens TO YOU while you are LOOKING THE OTHER WAY"
- It's NOT about competitive TRADE ADVANTAGE! (though this would be a big positive.)
- It's NOT about ECONOMIC GROWTH! (though this also critically important).
Growth is shrinking globally and the Belligerents know it. Fighting over a piece of a shrinking economic pie is a zero sum game and the Currency Cartel is also keenly aware of this.
THIS CURRENCY WAR IS ONLY SECONDARILY A TRADE WAR.
This is about rapidly debauching sovereign debt through currency debasement before the inevitability of increasing interest rates cut the legs out from under the developed economies.
This is about walking away from sovereign debt and handing the bill to the foreign holders of the Currency Cartels fiat currency.
This about countering a highly successful Asian mercantile export strategy via slick scam of the sovereign currency version of "Too Big to Fail".
The central bankers are loading the Helicopters with only one purpose: to quickly bomb the value out of their debt through coordinated debasement of their currency.
Deceptive acronyms like OMF (Overt Monetary Funding) will soon join the lexicon to replace QE∞ and ZIRP.
The casualties will be the holders of the paper that the Currency Cartel will print ad infinitum.
Those holders, are pensioners and elderly who are dependent on the government for sound money policies. The government considers them easy prey.
Those holders such as foreigners who have accepted Cartel Currency in 'trade for kind', will also be raped. The government now considers them casualties versus valued trading partners.
All are signs of desperation of a trapped animal with no obvious way out.
The regimes currently running sovereign policy are likely to go down in history as some of the worst the world has ever seen.
The strategy is deceptive but illusionary.
This strategy, like the ones that preceded it, will fail miserably.
Part I: The Belligerents - 20 Minutes, 25 Slides
Part II: Bushfire Battles Blazing - 22 Minutes, 32 Slides
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