Who Wins the Currency War: Emerging Markets versus the Big Four?

In the horse race of life, the horse named self-interest will always win by a nose.

When things are going well, generation abounds.

Cast your minds back to the time before Lehmann Brothers collapsed and recall what the hot topic was at that time. It was ‘global warming’ which for environmental marketing purposes was re-branded to ‘climate change’ (a far more non-specific title).  Climate change was described in 2007, by then PM aspirant Kevin Rudd, as ‘the greatest moral, economic and environmental challenge of our generation’.

Prior to the 2008 meltdown on Wall Street, the world was enjoying a period of prosperity. The share market had delivered 20%-plus returns for four consecutive years. The property market was booming. China was hitting its stride and the mining sector was awash with money and jobs. The federal government had paid down its debt.

Collectively society was on a high. We could afford a more generous outlook. Why not save the planet, we can afford to. Rudd tapped into this mood of generosity and played it for all it was worth (especially with younger voters) in the lead up to the 2007 election. Rudd’s hyperbolic statement bears testimony to this.

Personally I thought starvation, genocide, child abuse, political persecution, radical religious views and running a giant Ponzi welfare scheme ranked slightly higher as moral and economic challenges. But heck I’ve always had an odd sense of values.

Anyway there’s nothing like a good financial upheaval to reveal true character. When push comes to shove and good times turn bad, self-interest kicks in. Society had an abrupt mood change.

To hell with climate change, we’re worried about our job, our investments and holding onto our home. I can’t afford to pay a carbon tax or any other levy or surcharge for that matter. We can’t afford generosity.

Where’s the great moral, economic and environmental challenge these days? Buried on the occasional back page. Hardly mentioned. Why? Because society is more interested in the ‘now’ — jobs, loan affordability, funding a retirement.

When push comes to shove, self-interest kicks in.

This will happen again when the global deflationary pressures force countries to adopt a ‘beggar thy neighbour’ approach to save their domestic economies.

The easiest way to make your exports cheaper and imports prohibitively expensive is to devalue your currency. An Aussie dollar at US$0.50 cents would effectively double the cost of US goods from the price they were a couple of years ago. Conversely Americans could buy twice as many Aussie products compared to two years ago.

American imports fall and our exports rise. Great outcome for our manufacturing base.

Let’s do it.

Not so fast. Japan may not like us getting a bigger slice of that action. So they drop the yen. Whoa hang on, Europe is not going to give up its ground that easy, they lower the euro. Chinese manufacturers are not going to sit idly by either, down goes the yuan.

What about Brazil, Chile, Argentina, India, Indonesia et al? The politicians and bankers in these countries will also be under pressure from their communities to do something.

This folks is what a currency war looks like. Each country trying to make their products cheaper to overseas consumers…because each country needs revenue to pay for the massive debts they took on in the good times.

Today Jim Rickards explains just how destructive this process of ‘beggar thy neighbour’ will be for the global economy and more importantly, emerging markets.


Vern Gowdie

Editor, Markets and Money

Who Wins the Currency War: Emerging Markets versus the Big Four?

Jim Rickards, Strategist, Strategic Intelligence

For better or worse, emerging markets have become roadkill in the currency wars.

Perhaps ‘collateral damage’ is a better term for it, since collateral damage is used to describe innocent victims of fighting among hostile adversaries.

All wars produce collateral damage, and the currency wars are no exception.

The major adversaries in the currency wars are the US, China, Europe and Japan.

Each of these four economic powers is confronted with the same dilemma. There is too much debt in the world, and not enough growth.

If growth were strong, the debt would be manageable and countries wouldn’t care much if one player tried to manipulate its currency. But growth is not strong; it’s weak. And getting weaker all over the world.

And sovereign debt just keeps growing.

It’s easy to make fun of countries like Japan that have debt-to-GDP ratios over 200%, but the US and China are not that far behind and are catching up fast.

The whole world is beginning to look like Greece.

The key to solving the sovereign debt problem is nominal growth, which consists of real growth plus inflation.

If nominal growth is rising faster than your deficit, then the debt-to-GDP ratio goes down and your sovereign debt is viewed as sustainable.

The opposite is happening.

Deficits persist in the major economies, but nominal growth is weak. In fact, nominal growth in some countries, including the US and Japan on occasion, is actually negative, in part because inflation has turned to deflation.

Real growth is important, but when it comes to paying your debts, nominal growth is what counts, because debt is paid in nominal dollars. In a world of deflation, nominal growth is actually lower than real growth. The world of sovereign debt management has been turned upside down.

The major economic powers are fighting deflation by devaluing their currencies.

A devaluation raises the price of imports such as energy, commodities and manufactured goods.

These higher import prices feed through the supply chain and put upward price pressure on finished goods and competing products.

The problem is that not everyone can devalue at once; countries have to take turns.

China had a weak yuan policy in 2009. By 2011, the US had engineered a weak dollar. Beginning in late 2012, Japan orchestrated the weak yen with Abenomics.

By mid-2014, it was time for the weak euro, which was achieved by the ECB using negative interest rates and quantitative easing. The major economies keep passing the currency wars canteen, hoping that everyone can get just enough relief to keep the game going.

Still, robust global growth is nowhere in sight.

Where does this leave emerging markets?

Unfortunately for them, emerging markets are simply not large enough or important enough to factor into the calculations of the major economic powers.

It’s not that the big central banks don’t care; it’s just that there are limits to what they can do. The US, China, Japan and Europe, the ‘Big Four’, account for almost two-thirds of global GDP. All of the other developed economies and the emerging markets combined account for the remaining third. As far as the Big Four are concerned, the rest of the world are just along for the ride.

When the Big Four fight the currency wars, sometimes they win and sometimes they lose.

But the emerging markets always lose. The emerging markets have been painted into a corner and cannot escape the room.

Here’s why.

When an emerging-market currency weakens, capital leaves the country and heads for strong-currency areas such as the US. This capital flight causes declines in asset markets such as stocks and real estate.

A weak currency in an emerging-market economy also makes it harder to pay off dollar-denominated corporate debt. This can lead to debt defaults and even more capital flight.

In a worst case, you can have a full-blown emerging-market meltdown of the kind that happened in 1997–98.

But when an emerging-market currency strengthens, its exporters suffer, and its tourism sector can be hurt also. This is happening in Korea today.

The relatively strong won has the Korean economy on the brink of recession because they are losing export competitiveness to Japan, Taiwan and other competitors.

So a weak currency causes capital flight and asset crashes, and a strong currency causes recession and hurts exports.

Emerging markets are between a rock and a hard place, and they will stay there as long as the Big Four are fighting the currency wars.

One solution to this dilemma is a resumption of strong economic growth in the Big Four. In a world of strong growth and stable exchange rates, emerging markets can prosper with exports of commodities and manufactured goods as well as tourism and services.

But strong growth is not in sight.

Another solution is capital controls. But capital controls are discouraged by the IMF and are viewed as a sign of desperation.

Neither strong growth nor capital controls are on the horizon right now, so emerging markets will remain in this ‘heads you win, tails I lose’ posture relative to the Big Four.

Emerging market economies don’t have the right type of weapons to defend themselves in currency wars.

The emerging markets stand to lose both ways.


Jim Rickards

Strategist, Strategic Intelligence

 Ed Note: the above article first appeared as a Strategic Intelligence weekly update

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James G. Rickards is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. mist for West Shore Group.

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