james g. rickards

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When Currency Wars Become Trade Wars…

Beggaring thy neighbour has consequences. Neighbours might turn around and bite back.

China and the United States are already locked in an intractable and multilayered currency war. That has not escalated much yet beyond a little barbed rhetoric (although if China want to get a meaningful return on the trillions of dollars of American paper they are holding, one can only suspect that there will be some serious escalation as the United States continues to print, print, print, a behaviour that China and China’s allies are deeply uncomfortable with).

But Brazil are already escalating.

Brazil flag face

The Washington Post notes:

When the Brazilian economy began to stall last year, officials in Latin America’s largest country started pulling pages from the playbook of another major developing nation: China.

They hiked tariffs on dozens of industrial products, limited imports of auto parts, and capped how many automobiles could come into the country from Mexico — an indirect slap at the U.S. companies that assemble many vehicles there.

The country’s slowdown and the government’s response to it is a growing concern among U.S. officials worried that Brazil may be charting an aggressive new course — away from the globalized, open path that the United States has advocated successfully in Mexico, Colombia and some other Latin American nations, and toward the state-guided capitalism that the United States has been battling to change in China. As the world economy struggles for common policies that could bolster a still tentative recovery, the push toward protectionism by an influential developing country is seen in Washington as a step backward.

“These are unhelpful and concerning developments which are contrary to our mutual attempts” to strengthen the world economy, outgoing U.S. Trade Representative Ron Kirk wrote in a strongly worded letter to Brazilian officials that criticized recent tariff hikes as “clearly protectionist.”

And Brazilian officials are very, very clear about exactly why they are doing what they are doing:

Brazilian officials insist the measures are a temporary buffer to help their developing country stay on course in a world where they feel under double-barreled assault from cheap labor in China and cheap money from the U.S. Federal Reserve’s policy of quantitative easing.

“We are only defending ourselves to prevent the disorganization, the deterioration of our industry, and prevent our market, which is strong, from being taken by imported products,” Brazil’s outspoken finance minister, Guido Mantega, said in an interview. Mantega popularized use of the term “currency war” to describe the Federal Reserve’s successive rounds of easing, which he likened to a form of protectionism that forced up the relative value of Brazil’s currency and made its products more expensive relative to imports from the United States and also China.

How long until other nations join with Brazil in declaring trade measures against the United States is uncertain, but there may be few other options on the table for creditors wanting to get their pound of flesh, or nations wishing to protect domestic industries. After all, the currency wars won’t just go away; competitive devaluation is like trying to get the last word in an argument. The real question is whether the present argument will lead to a fistfight.

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Bubbling Up

We’re getting dangerously close to a head and shoulders pattern in both manufacturing output, and the S&P500:


What does this graph tell us? Well in the last ten years we have seen little net gain in either. Each of the two slowdowns has been preceded by a blowout top in the S&P. This is symptomatic of excessive credit creation in the financial sector. The resultant credit crunches coming out of these bubbles would seem to have dampened industrial production. Is that a result of the credit bubble damaging the economy? No; the aftermath of a bubble (so long as it is not accompanied by war, and riots, and famine — in other words, the explicit destruction of capital stock) does not necessarily damage anything other than lending and confidence.

Was it a case then that industrial production — which climbed significantly in the preceding decade — got ahead of itself, and that we were simply producing more than we could consume? It would seem so, and that would certainly explain why the exuberant first attempt to reinflate the bubble failed, and we were drawn into a slump. This brings my thoughts back to this:

Who needs 5 TVs? Well, nobody, and that is the level of consumptive, home-equity-fuelled demand that we were (and are) trying to sustain (and expand upon). For the record, I have 2 TVs, which in itself is probably excessive, especially considering that I rarely watch them.

Then again, there are millions of people in America who need healthcare who aren’t getting it, mostly because (for whatever reason) they can’t afford it. There are homeless kids whose parents have taken to eating rats. Surely that kind of demand would be more sustainable than another speculative stock bubble, another boom in consumption fuelled by home equity, and more TVs, McMansions, iThingies and vacations for urbanites and exurbanites?

I suppose it is that logic that leads well-meaning liberal politicians down the avenues of reflation: economic stimulus, as well as condoning the Fed’s money printing escapades. The problem is that the money always seems to end up in more speculative equity bubbles. I have shown empirically that the more money America has printed (both in terms of expanding the monetary base as well as in terms of fractional credit creation), the more unequal America has become.

This graph highlights the real outcome of all the Obama-Bush-Bernanke economic interventionism:


Corporate profits bounced back right away, while unemployment and underemployment are just as high as when the contraction “finished”. I have made a habit while writing this blog of badmouthing John Maynard Keynes, but at least under a genuinely Keynesian scheme the unemployed people are given jobs (albeit on borrowed money, and albeit not necessarily productive ones) and the unemployment rate falls. All we get today is platitudes about the unemployment rate being sticky; more hopium, more promises that if we just wait long enough and hope hard enough things will get better.

So all that the Obama-Bush-Bernanke interventionism has really produced is more slush for the corporatocracy. It’s just corporate socialism hidden behind a facade of pithy egalitarianism. There is no recovery, only superficial reflation bubbling over a stew of hurt.

And — like most head and shoulders patterns — this third top is even more unsustainable than the last two.

Want proof?


Credit creation has continued to expand above and beyond the productive capacity of the economy. That is a bubble, if ever I saw one.

So what next? Well — like most head and shoulder patterns — the final “shoulder” tends to be followed by a crash. Now, I recognise we are not dealing with an equity, so the crash may not be in terms of price level. It may be geopolitical, or inflationary, or ecological, or some black swan. It may be this year (moderately unlikely, but plausible) or sometime down the line. Who knows?

Hold onto your seats.

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Brazil Slams the West’s Currency War

Mitt Romney is not the only global figure to unleash allegations of currency manipulation. In fact, most of the allegations are aimed at America and the West.

From Reuters:

Brazilian President Dilma Rousseff slammed rich nations on Thursday for unleashing a “tsunami” of cheap money that threatened to “cannibalize” poorer countries such as her own, forcing them to act to protect struggling local industries.

Rousseff’s words amounted to some of the highest-profile criticism to date of efforts by the European Central Bank, the Bank of Japan and others to spur their economies through low interest rates and cheap loans.


I just want to flag up Henry Kissinger’s words from his recent Foreign Affairs piece:

The current world order was built largely without Chinese participation, and hence China sometimes feels less bound than others by its rules. Where the order does not suit Chinese preferences, Beijing has set up alternative arrangements, such as in the separate currency channels being established with Brazil and Japan and other countries. If the pattern becomes routine and spreads into many spheres of activity, competing world orders could evolve. Absent common goals coupled with agreed rules of restraint, institutionalized rivalry is likely to escalate beyond the calculations and intentions of its advocates. In an era in which unprecedented offensive capabilities and intrusive technologies multiply, the penalties of such a course could be drastic and perhaps irrevocable.

Competing world orders could evolve? No; competing world orders are a reality, and it seems like Latin America — most obviously Argentina and Venezuela, but now also Brazil, and perhaps even Colombia and Mexico — are moving closer toward the emerging ASEAN bloc, and away from the West.

Ironically, the emerging currency war is as much as anything else a side-effect of Bernanke’s admitted preoccupation with fluffing and puffing up U.S. equities.

And it looks like he’s going to be getting a hand.

From Bloomberg:

The Bank of Israel will begin today a pilot program to invest a portion of its foreign currency reserves in U.S. equities.

The investment, which in the initial phase will amount to 2 percent of the $77 billion reserves, or about $1.5 billion, will be made through UBS AG and BlackRock Inc., Bank of Israel spokesman Yossi Saadon said in a telephone interview today. At a later stage, the investment is expected to increase to 10 percent of the reserves.

Zero Hedge prognosticates:

In other words, while the Fed’s charter forbids it from buying US equities outright, it certainly can promise that it will bail out such bosom friends as the Bank of Israel, the Swiss National Bank, and soon everyone else, if and when their investment in Apple should sour.

Luckily, this means that the exponential phase in risk is approaching as everyone will now scramble to frontrun central bank purchases no longer in bonds, but in stocks outright, leading to epic surges in everything risk related, then collapse and force the Fed to print tens of trillions to bail everyone out all over again, rinse repeat. We say luckily, because it means that the long overdue systemic reset is finally approaching.

Developing nations have a legitimate concern: Western central banks will throw liquidity around to no end to save the status quo. And that means that developing nations will themselves feel they have to compete in order to remain competitive. It’s messy.