Albert Edwards On Terminal Competitive Devaluation, The Nuclear Option, And How The Fed's Policies May Start An All Out War

The recent intervention by the BOJ has quickly become the most contentious decision in global economic circles, with many wondering now that the world economy is off on a course of radical currency devaluation, who will be next, and how far will this game continue? If Albert Edwards, whose latest piece rhetorically asks (and answers) "what do devaluation, high unemployment, inequality and food prices spell?  C-H-A-O-S" is correct, this could be the beginning of a rapid descent in which central banks around the world are all forced to use the nuclear option: ceaseless FX devaluation, but one coupled with an endless increase in the money supply a process which can only have one outcome - that predicted recently by Eric Sprott when he said that "we are now paying for the funeral of Keynesian theory." However, the biggest threat is that this most recent invocation of the nuclear option is coming at a time when the world is least prepared to handle it - social imbalances are at unprecedented levels, and if, as many predict, the price of key food products is about to surge (courtesy precisely of these failed central bank policies) to a point where the great unwashed end up on the wrong side of hungry, from there, to armed conflict, the line is very, very thin.

Edwards looks first at the immediate reasons that prompted Shirakawa to do what he did.

Since 2009 a cyclical recovery has been met with further yen appreciation which has been tolerated by the Japanese authorities. But with the leading indicators now topping out, yen strength is no longer tolerable (see chart above) - commentators who rightly point out that the real trade-weighted yen is not that strong have missed the point. It is the change in the currency as well as its level that helps determine export growth. A rise in an undervalued currency to a less undervalued level will still hit exports and can cause a recession.

The Japanese economy is decelerating. The PMI usually proves to be quite a good early warning of changes in the cyclical wind and it has begun to turn down decisively. (The current downturn may look moderate compared to 2008, but remember GDP contracted peak to trough by 8% during this period, one of the worst GDP declines of any industrialized nation.) The current downturn in the PMI is sufficiently bad to start ringing alarm bells - see chart below.

As expected, Japan is merely the beginning, however in a non-zero sum world of competitive currency devaluation. And because he is right, and fiat is all relative to itself, except to absolutes such as gold, those calling for a local peak in gold prices may want to reevaluate their assumptions.

Our economists made a very interesting point in the Economic News,17 Sept. They believe the BoJ?s actions may be the start of a more general period of competitive devaluation; with the US authorities tacitly allowing the US dollar to decline in an environment of QE2 (no wonder gold looks so perky!). The good news is that this is not the zero sum gain that most commentators suppose. For if all central banks are printing money to drive their currencies downward, exchange rates may not change, but the money supply does. It is easier for the US to ?guide? down the dollar with its burgeoning current account deficit, and to the extent bond yields rise as foreigners back away, the Fed will just keep printing money to hold them down!

Looking at history, the one most prominent example of coordinated devaluation was during the Great Depression, which was accompanied by the confiscation of gold. Arguably, back then it kinda, sorta worked in principle (for other reasons) if not in theory, with the argument being that devaluation can prevent deflation.

This may or may not stimulate economic activity ? I do not have the certainty of Mervyn King. But one key lesson from the 1930?s was that raising interest rates to stay on the gold standard was a mugs game (see chart below). The UK quickly came off gold, devalued and enjoyed a shallower depression than most other industrialized nations. The US followed shortly after.

Edwards takes a critical detour into a topic well-known to Zero Hedge readers: the Fed's free range authority to buy not only dometic but foreign debt (who needs FX swaps when the Fed can buy Irish debt). At least we have Ben on record telling Ron Paul he has not done so... yet.

Apparently devaluation works to head off deflation. No less than Ben Bernanke told us so in his Nov 2002 speech Deflation: Making Sure "It" Doesn't Happen Here - link. He said “The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.

“I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange…Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. US CPI inflation went from -10.3% in 1932 to -5.1% in 1933 to +3.4% in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”

Hence Bernanke openly stated back in 2002 that the end game, especially when all else fails (fiscal deficit too high and QE shown to be impotent), is to print money to drive down the dollar. This is default in all but name. Investors ignore this at their peril.

All deflationists especially those with blogs and audiences - please, please read this very carefully. It tells you the blueprint for the endgame word for word.

Next, Edwards confirms what many suspect: that Japan was merely a victim of China's cunning policy to get Japan to intervene due to its own inability to devalue its currency without angering the US.

But back to the current BoJ intervention: our Chief Economist, Michala Marcussen, thinks that the Chinese, in starting to buy Japanese assets, have pushed up the yen and effectively forced the BoJ to intervene. She writes, “China may thus be the big winner from Japan’s intervention; winning on three levels (1) diversifying reserves (albeit still only a small amount) and reducing its exposure to the US dollar, (2) escaping the title of currency manipulator, and (3) placing Japan in the hot seat ahead of the G20, thus detracting attention away from itself." -? link.

I would contend that China is now playing a very, very dangerous game. With the US trade deficit deteriorating again (see top right-hand chart above), and ? much to my surprise - the Chinese trade surplus widening, patience is rapidly running out in the US with China?s currency policies. I believe we are now nearer to an outbreak of trade war than at any time since the 1930s. Any downturn in the global economy back into recession would almost certainly guarantee such a result, as the political pressure to do something mounts.

Yet even without a trade war or competitive devaluation, any descent back into outright recession will result in intolerable social stress. We had previously highlighted the extreme levels of income inequality that prevailed even before this crisis.

In addition to the inequality, absolute levels of poverty have been exacerbated by this recession. The US Census Bureau last week published a report showing that 43.6 million people were living below the poverty line, a 50-year high- link.

For those curious why we posted the BIS report on core differences between Japanese and US households, hopefully this explains it (and those who wish to reread it, may do so here). Going into a double dip, a redepression, or a brand new recession, whatever the semantics, with the current level of developed world inequality is recipe for social disaster, and possible civil war.

Inequality, unemployment and poverty are all at crisis levels in the immediate aftermath of this financial and economic debacle. To put it into a human context, one snippet caught my eye. David Rosenberg of Gluskin Sheff believes conditions now are so bad that they can be reasonably described as a depression. He reported a few weeks back that “In a depression, radical changes occur in terms of social norms and spending behavior. In recessions people don’t cancel their life insurance policies – as one example. But in a depression, tragically, this is what happens – almost 35 million Americans (a third of US households) now have no such coverage, up from 24 million five years ago. This reflects the focus by households to pay down debts at all costs and how companies have bolstered profits, by eliminating benefits (see ?More Go Without Life Insurance’ ? WSJ 29 Aug -? link)."

Many commentators, including myself, believe it is no accident that before this crisis inequality in the US and the UK reached extreme levels. Many believe there is a causal relationship from extreme levels of inequality to the crisis. How? Central bankers, by pursuing policies thatallowed the middle classes to borrow against rising asset prices, kept them consuming despite the stagnation of their incomes and hence disguised the effect of government policies that allowed the rich to acquire virtually all of the gains in GDP growth. - link.

Additionally, this is not merely a horizontal event, but a vertical one, as one class steals from the future of all other classes.

And in the process of ?robbing? the middle classes and now still attempting to keep asset prices artificially high, they are also robbing our children of the ability to buy a house at an affordable price. Yet central bankers still see QE as key to maintaining the illusion of prosperity and stoking consumer spending! I will write more about the role of high levels of inequality in causing the recent crisis in a future paper (James Montier has passed me some interesting papers). But with youth unemployment rocketing in recent years (can you believe it is 40% in Spain), policymakers had better start manning the barricades for the backlash. For as my mother used to say "?the devil makes work for idle hands”.

Lastly, to provide all the ingredients for social upheaval, not only is social inequality at all time records, but soon, courtesy of the very same policies adopted by the central banks, the great unwashed mass may soon have little if anything to eat.

For one idea of what might drive the poor to breaking point in the coming years, read my colleague Dylan Grice?s excellent report on the likelihood that we will see a structural spike in higher grain prices from these already high levels - link! For he notes that the grain markets today are at a very similar level of tightness to the oil market in the early 1970?s when the US turned into a substantial oil importer. This made the market very vulnerable to a supply shock (such as the 1973 Arab embargo), in a way that it wasn?t in 1967. China is in that same situation today for grains (see chart below). If the devil makes work for idle hands, history is full of examples of what happens when those same hands are owned by the poor and hungry.

So for all those who have been wondering if Mike Krieger, and recently Nic Lenoir's anger at visualizing precisely the scenario where the Fed's ongoing disastrous policies result in social and/or global war are overblown, the answer is no. We are getting to the point where absent a dramatic intervention in the Fed's all or nothing gamble on preserving Keynesianism will almost certainly result in armed conflict. And if those who know and understand this do not act, nobody else will. The ability to postpone that most critical intervention in this generation's lifetime is ending. Very soon we will have only ourselves to blame for not having done the right thing. We hope by then it is not too late.

Comments

[tip e. canoe]

ever read Vurt?

[Seer]

Corporations are a product of the State and will wither away and die when the State collapses.  But yes, there will be ruling classes scattered about; let's just hope that there's never again the concentration like now: not likely given the decline in resources (people will be less tolerant of freeloading).

[Incubus]

"Old George Orwell got it backward. Big Brother isn't watching. He's singing and dancing. He's pulling rabbits out of a hat. Big Brother's holding your attention every moment you're awake. He's making sure you're always distracted. He's making sure you're fully absorbed... and this being fed, it's worse than being watched." - Chuck Palahniuk

[Milestones]

"The game of history is played by those at the top and bottom oner the head s of those in the middle." Eric Hoffer "The True Believer". 1956

[newstreet]

Here's what you do.  Read ZH and all the other trading sites.  Get the general feel of opinion, then go the other way.  You will be sure to win.

[tip e. canoe]

win at what?

[newstreet]

Here's what you do.  Read ZH and all the other trading sites.  Get the general feel of opinion, then go the other way.  You will be sure to win.

[Implicit simplicit]

So what is the consensus feel now?

[WaterWings]

That can work when fundamentals of growth are strong and economic indicators are not falsified. We are in a systemic collapse. If you are in the game you risk going down with the ship.

[Sophist Economicus]

" Central bankers, by pursuing policies that allowed the middle classes to borrow against rising asset prices, kept them consuming despite the stagnation of their incomes and hence disguised the effect of government policies that allowed the rich to acquire virtually all of the gains in GDP growth"

Uhhhm, is this like the 'devil made me do it?'   Was good till here...

[dot_bust]

Well, the Federal Reserve (the big banks) knows that currency devaluation will lead to hyperinflation and then astronomical food prices. So, they know average Americans will then bring out the pitch forks. And do you know why? Because the ultra-rich believe that laissez faire means less for you is fair for them.

[Horst Wessel]

The power elites still see China being a winner at anything as a joke. They still think of America as the light and China as pagan scum. We paid them homage by letting them build our junk that our productive workers don't want to waste their time on. But hey on the bright side if this is 1933 all over again at least we have a few years left before the big war :)

[JR]

“There is no means of avoiding the final collapse of a boom brought about by credit expansion...” - Ludwig von Mises, 1949

Interest rates are lower than they’ve been in 50 years. So if printing to devalue is the answer, why doesn’t Bernanke just drop rates to -5% or maybe -15% and then we’ll have boom times.  I mean, if a little is good, why not really pile it on. 

The reason they’ve been this low for this long is because it’s an artificial transfer of the sound money part of the economy--savings, treasuries, small businesses resources, stagnant wage income, insurance policies, fixed pensions, equity appreciation--to high risk so the banks can get their hands on the value.

So, right! Ben. What we need is lower rates! That’ll fix this for everybody! And we can all ride this economy 100 mph straight into a brick wall. 

“The boom can last only as long as the credit expansion progresses at an ever-accelerated pace,” said Mises in Human Action.  “The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market.  But it could not last forever even if inflation and credit expansion were to go on endlessly.  It would then encounter the barriers which prevent the boundless expansion of circulation credit.”

The 20-year average real return on the stock market from 1928 to 1948 fell to zero; it was substantially negative after paying taxes on interest and dividends.

Said Fed historian, G. Edward Griffin: “During the nine years before the crash of 1929, the Federal Reserve was responsible for a massive expansion of the money supply.  A primary motive for that policy was to assist the government of Great Britain to pay for its socialist programs which, by then, had drained the treasury.  By devaluing the dollar and depressing interest rates in America, investors would move their money to England where rates and values were higher. That strategy succeeded in helping Great Britain for a while, but it set in motion the forces that made the stock-market crash inevitable.

“The money supply expanded throughout this period, but the trend was interspersed with short spasms of contraction which were the results of attempts to halt the expansion.  Each resolve to use restraint was broken by the higher political agenda of helping the governments of Europe.  In the long view, the result of plentiful money and easy credit was a wave of speculation in the stock market and urban real estate that intensified with each passing month…

“On October 29, the stock market collapsed. Thousands of investors were wiped out in a single day.  The insiders who were forewarned had converted their stocks into cash while prices were still high.  They now became the buyers. Some of the greatest fortunes in America were made in that fashion.”

[Seer]

Readers Digest version: perpetual growth (i.e. "sustainable growth") isn't possible on a finite planet, trying to get there only results in overshoot.

[bankonzhongguo]

All this War talk.  Silly.  The US exports half of it food overseas.  We are relatively apart from any physical invasion.  Huge untapped resources.  Still a fairly skilled work force.  Maybe 10 more years before that knowledge base is gone gone.  Massive strategic war resources.

It is worth noting though.  Take a look at retail food prices and commodity prices.  I went to Rally's (CA grocery chain) on the weekend.  Went to buy 2 liter of Coke for a barbecue.  Priced at $1.99.  INSANE.  All this food price jacking is fake.  Its just the middle man gouging prices.  Talk to Buffet.  Its probably his idea.

The Fed will print, but none of those dollars will ever make it to Citizens.  Do you see your wages going up soon? All those dollars being minted are really being used to paper Asia, Central America and Africa.  Trillions of investment dollars for the new century "middle class" markets.  Read some blogs and pictures of Detroit.  That is the abandoned future of America thanks to Bush AND Obama.

[Seer]

I wouldn't be so sure that this is some sort of intential fuck-with-the-masses thing.  I believe that it's the natural consequence of building unsustainable economies of scale, and that eventually the realization that the scarcity in the things that matter (food, water, shelter and energy) is REAL that that will trigger massive instability.

Paper money, or anthing that doesn't have immediate value as a consumable or an exchange of value (like PMs, bullets or whatever people really want), will become what it is, meaningless.

2/3 of the world's population lives on $3/day and here we are talking about 2 liter bottles of Coke for $1.99 as being an outrage?  As a farmer I'm figuring that eventually (probably sooner rather than later) Coke is going to be losing business to ME!

[GoinFawr]

Very nice sir. I hope you do end up taking your fair piece of market share. Arable land is king too.

Pardon me, I have to ask: You farm cola nuts?

jk

All the best

[Seer]

LOL... no, no cola nuts :-)

[sweetwater88]

Eric Sprott ?????...if gold goes to $2500 PHYS will still  be $11.33

[Bear]

What difference does it make what the price is? If the % change is there the actual number is immaterial.

[Geoff-UK]

Much easier for Bernake et al to stomp on the price of PHYS versus the price of gold writ large on the commodity exchanges.

Much more likely too, IMHO.  Close your IRA people and buy physical.  Time's short.

[shawnlee]

2/3 of the world's population lives on $3/day and here we are talking about 2 liter bottles of Coke for $1.99 as being an outrage? As a farmer I'm figuring that eventually (probably sooner rather than later) Coke is going to be losing business to ME!000-100 \ 000-203

[shawnlee]

What difference does it make what the price is? If the % change is there the actual number is immaterial.links of london