Policymaker's Guide To Playing The Global Currency Wars

Tyler Durden's picture

G4+CHF can fight the currency wars longer and more aggressively than small G10 and EM countries can.  However, as Citi's Steven Englander notes, it also takes a lot of depreciation to crowd in a meaningful amount of net exports. His bottom line, GBP, CHF and JPY have a lot further to depreciate.  In principle, the USD can easily fall into this category as well, but right now the USD debate is focused on Fed policy – were it to become clear that balance sheet expansion will end well beyond end-2013, the USD would fall into the category of currency war ‘winners’ as well. Critically, though, the reality of currency wars is that policymakers do not use FX as cyclical stimulus because of its effectiveness; they use it because they have hit a wall with respect to the effectiveness of fiscal and monetary policies, and are unwilling to bite the structural policy bullet. The following seven points will be on every policymakers' mind - or should be.

Via Steven Englander, Citi: “Do you only know how to play? Or can you shoot as well?”

Policymakers who are indifferent to the consequences of depreciation or balance sheet expansion are likely to win the currency wars.  They can stay the course with respect to liquidity expansion, a run-up in domestic asset prices and CPI inflation to a greater degree than policymakers with more orthodox policy preferences and less damaged economies. Countries that are more constrained because of concerns about domestic asset markets or  inflation can ‘play’, but it is much harder for them to ‘shoot’.

Currency war winners typically have economies that face headwinds from excess government or private sector debt and that have been unresponsive to conventional monetary and fiscal tools, so it is hardly a sign of strength. However, it does give their policymakers a degree of credibility with respect to their policy stance.

(The quote above is from Sergio Leone’s “Once Upon a Time in the West”.)


1)      Countries with deflation can stimulate for longer than countries where rising inflation rapidly becomes a policy issue.


If your price level is falling as in Japan or Switzerland, the vulnerability to inflation just isn’t there. So your credibility in voicing indifference to, or desire for, a weaker currency is pretty high.  If you are afraid that a weaker currency or m liquidity provision will lead to higher inflation, you will be unwilling to stay in the game. At a minimum you will have to balance any competitive advantage against the domestic negatives.


2)      Being poor puts you in a more vulnerable position


Food and commodity prices will respond quicker than services or high value added products to any global liquidity surge. Food and commodities are a bigger share of EM consumer baskets than DM consumer baskets, so the first wave of any inflationary pressures will be felt more acutely in countries that are food and commodity intensive. DM consumption and production is service intensive, which tends to be more inertial with respect inflationary pressures.


3)      Caring about inflation puts you at a disadvantage


EM countries and G10 countries with an orthodox policy framework seem more attached to inflation targets than are G10 countries.  There is relatively little discussion of alternative policy frameworks, temporarily breaching long established inflation norms, nominal GDP targeting or any of other heterodox policies that are under discussion.  If you care about inflation more or less in real time, you have to tighten sooner than if you see room to overshoot.


For example, nominal GDP targeting has been discussed in academic circles for forty years or longer. It has been discussed in policy circles for almost as long, but was a complete nonstarter when a nominal GDP target would mean tightening. Now that nominal GDP is far below targets in much of the G4, it is gaining traction on the view that it allows you to be bad in the short term without compromising long-term credibility.  In practice the asymmetry in the willingness to adopt it as a policy target means that investors will view it as indicating willingness to overshoot long-term inflation targets in the short term, while giving a somewhat less than binding promise to adhere to them in the long term.  Such a loss of credibility may not be unwelcome, If it is accompanied by aggressive CB balance sheet expansion, it achieves the goal of a weaker currency.


When central bankers in the same speech discuss: i) disappointing economic outcomes; ii) the need to for net exports to grow significantly; and 3) revising the policy framework, the odds are that the revised policy framework will be more rather than less expansionary and give at least a wink and nod to measure that will will weaken the currency significantly.


4)      Caring about domestic asset price inflation puts you at a disadvantage


The Fed is encouraging, or at a minimum, extremely tolerant of domestic asset price inflation. Ask yourself whether they would like the S&P at 1600 and housing prices 20% higher.  Japan and the UK are seen as moving in the same direction.  The logic is that domestic asset price inflation will make households feel wealthier and encourage spending.


A 20% run-up in home prices will be much less welcome in Canada, Australia or China, and many other countries where asset prices are already high relative to activity and income.  Even in countries where CPI inflation is low, there is concern that liquidity and low real interest rates are bidding up home prices and consumer borrowing. Unlike in their G4 counterparts, policymakers in these countries have to be mindful that excessive domestic asset market exuberance may carry negative long-term consequences.  We saw in 2008 that currencies move quickly when the shock is big enough, while balance sheet adjustment takes places slowly and painfully.


5)      If the central bank is in the pocket of the Treasury, policymakers do not fear a backing up of rates

This is another ‘make me virtuous but not too fast’ situation.  If your central bank is financing a large portion of your deficit, you are not afraid of rates backing up.  In fact the more the CB protests that this is monetary policy, rather than monetization, the more committed it is to keeping rates from backing up.  The CB’s involved all argue for long term fiscal consolidation, but in practice they worry more about the risk of abrupt short-term fiscal tightening than about the absence of long term tightening.  So rates can stay low and unsustainable fiscal paths remain in place for a long period. And if investors don’t like this policy combination … they can always sell the currency.


6)      Setting a currency line in the sand is risky for countries with attractive countries


Policymakers with attractive currencies, such as AUD, CAD or high quality EM find the Swiss nuclear-option less attractive than at first glance.  If the RBA were to decide that 0.95 was the AUD ceiling, they would soon discover that there was a lot of willingness to sell USD, GBP, EUR and JPY and buy RBA.  Australian reserves would shoot up and the portfolio would consist of currencies that the global private and official sectors want to dump.  In addition the portfolio yield would be essentially zero, so they would be in a significant negative carry situation.


If they thought these currencies were good investment, they could just go out and buy them, but if they accumulate them as a result of pegging their currency, it is hard to argue that the accumulation is voluntary.  This has been China’s and other major reserve managers’ downside to their intervention versus the USD. At a certain point your reserves portfolio becomes big enough and bad enough to be an issue, even if competitiveness was the highest priority originally.


7)      Currency has become a clear policy target


Think of recent comments from UK, Swiss and Japanese policymakers. The openness with which the BoE, SNB and Japanese government now discuss the need to get an immediate boost from the export sector is striking. One can correctly argue that currency manipulation applies to many EM countries in greater or lesser degree, but few EM or small G10 countries have been as explicit as UK, CHF and JPY policymakers in their desire to make higher exports and immediate driver o a cyclical rebound.  It is very unusual for G10 policymakers to lean on a weaker currency as the cyclical ticket out of a downturn.  This is a big policy shift, given the effort to put in place rules of the game that all major G10 and EM countries signed on to.

The Table below shows how we see considerations 1) - 7) as they apply to the G4+CHF. We indicate where we think the issue conveys a significant advantage in the currency war with ‘*’.  In a couple of cases we use a question mark to indicate that we are unsure of how important the issue is.


Right now we see JPY, CHF and GBP as most likely to fall because of these considerations. USD may fall as well, given the equivalence that many global investors see between QE and outright currency manipulation, but they have been overtaken by smaller countries with bigger FX emphases. The most likely outcome still seems that the USD falls against currencies that have a normal policy framework. Were the Fed to decide that it needed an unambiguous dose of balance sheet expansion, it is likely that the USD would fall, but it is a secondary ‘currency warrior’ now that investors are debating when the Fed will halt currency expansion.

We include the EUR, but sovereign risk still seems to be the biggest driver. It is unclear now whether the ECB will keep expanding its balance sheet, and the inflation commitment looks stronger.

Note also that the more closed you are as an economy the harder it is get leverage from a weaker currency. So reliance by the US and euro zone on competitive depreciation would be unlikely to work. This might apply to JPY as well, but the Nikkei/JPY link gives currency depreciation a bit more leverage in stimulating activity (well at least in making Japanese feel richer, even as they get poorer).

For the sake of comparison we would invite readers to assess themselves how Australia, Canada, Norway, Sweden and major EM countries would far in our table.  There are very few countries that would get as many ‘*’s as GBP, CHF and JPY  -- or, for that matter, USD.

Finally, as an endnote we reiterate the other reality of currency wars.  Policymakers do not use FX as cyclical stimulus because of its effectiveness. They use it because they have hit a wall with respect to the effectiveness of fiscal and monetary policies, and are unwilling to bite the structural policy bullet.  In advanced economies the boost from a weaker currency is much less than advertized in Econ 101, with exporters often taking the higher margin in the hand than the higher export volume in the bush. So if currencies are going to stimulate growth they have to move a long way.

Taking our two propositions together we end up with the G4+CHF being better able to engage in currencies wars, even while needing big depreciations to generate any significant impact. Hence the surprise will be how much depreciation it takes for competitive devaluation to work, not how little.

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Groundhog Day's picture

We believe in a strong USD policy


Zer0head's picture

We actually think everyone should take a look at Banzai's buried post http://www.zerohedge.com/contributed/2013-01-27/fema-mein-kampf

kliguy38's picture

+1 Thanx Billy B  Remember all of you if you play the left/right paradigm...then you're playing into an inside straight

The Alarmist's picture

"We believe in a strong USD policy."

You need to diagram that sentence carefully ... what he meant is that he believes in having a strong policy for managing the USD, and that policy is to go balls to the wall to debase it.

Manthong's picture

- I’ll take “Rivers of Ink” for 200, Alex.

ParkAveFlasher's picture

It's a damn good thing the average American citizen didn't exhaust all that equity piled up in their homes, or we'd be in big trouble [rolls Buscemi eyes].

falak pema's picture

Now look what Bofa is saying about the great rush to assets : the first signs that the rally could reverse;

BofA: First Signs Of Correction Emerge - Business Insider

When you play the game of instant salivation type sensationalist media like BI does you better have 4 jacks in your hand to pull one out at each turn of the wind. 

4 one eyed jacks! 

AgShaman's picture

All countries should have a printing press....

If you are going to lie....tell a really big lie

youngman's picture

I think there are going to be currency wars...trade restrictions from affected countries....just like the 1930's....of course Bernanke studied this.....SOOOOOO....

What has me puzzled is that gold and silver just are not in the game yet.....its still a paper game...when I see PM´s jump $100 a day for gold...and $10 for silver...then I think we have started the 4th quarter....you are going to hear stories of Central banks buying PM´s...billlionaires.....hedge funds...pension funds...but even then the price will not move to much.....manipulated ....we need a failure in a COMEX delivery or a London problem to really change the game...the paper printers are going to really turn it on now....trillions....3 billion people are in this game...the other 4 billion are watching....its going to get interesting...what used to be an friendly country could become an enemy when it comes to their jobs

bank guy in Brussels's picture

Yes it will get ugly

And we have a big ugly affair in Europe coming as southern Europe finally revolts from the euro straitjacket that is choking them un-necessarily ... they need to have their 'loose money' rights back so they at least are not any worse off than the money-printing UK

The key hint of the future in the aritcle above is ... « ... the more closed you are as an economy ... »

That may be where we end up going ... resolving into somewhat regional 'trading blocks' that try to be self-sufficient internally, with every component, manufacturing, agriculture and energy, with somewhat matched or complementary economies

We could do that well in Europe in about 4 different sectors, with a smart alliance with Russia for energy ... Developing world blocks of countries could do so as well ... In the US they may well retreat into a giant North America Fascist State with Canada and Mexico under the jack-boot ...

lewy14's picture

The Euro doesn't need to expand balance sheet to depress the Euro and fight the (currency) war.

The fabulously modulated "sovereign risk crisis" is what the Eurocrats are doing in lieu of expanding balance sheet.

Next crisis inflection hits at EURUSD 1.37 to 1.42, tops.

eclectic syncretist's picture

This is how our central planners get it done bitchez.


King_Julian's picture

But we already have a casino for the insane gamblers! Harrumph!

Get the Borrow's picture

Great article, but why are policymakers so concerned about exports when the cost of those exports is reduced purchasing power for all holders of their currency?  Fuck the exporters!  There is nothing wrong with buying American/Domestic.  Add in the double whammy of increased import prices and you have the law of unintended consequences for everyone who is willing to actually see things for what they are

The Alarmist's picture

In addition to debasing your currency, you can also import millions of low-skilled migrant workers to do the work your local-born welfare class won't do so that your middle and upper classes don't have to pay an extra nickel for their grapes and lettuce.  Of course, that nickel will cost them at least another dollar in taxes for the services the migrants consume at the local hospitals and schools and in the crime statistics and at the welfare offices, but hey, it doesn't count if you can't directly observe it, right?

AgAu_man's picture

Bollocks! Unlike some, I do not suffer from Monetary ADD, nor inhale Fiscal Hopium.

The ONLY reason the Anglo-American Alliance keep the Game going, is because the Fed's fiat needs to keep its GRC status. Which allows them to keep the damn NWO crap going. Think only of the Top Level intent when projected out to 2030-2050. All else is 'negotiable' and TBD.

W T Effington's picture

Lets get real. The primary reason central banks are printing is because there are deficits to pay for. There is zero political will to cut deficits. That means more printing all around. When TPTB wage a war against mathematics, no one wins.