Currency Wars, the book

James Rickards’ recent book, Currency Wars: The making of the next global crisis, is worth reading if you are interested in a history lesson of international monetary politics. As you can probably tell from the title, the book’s central thesis is that currency values are primarily the result of domestic and internationally coordinated policy decisions, and in times of stress, the lack of coordination results in a race to the bottom, and a disastrous economic outcome for all nations involved.

Given the current global agenda is competitive devaluation, the insights from this book, and more importantly, the idea that looking at history for lessons in the current global economic malaise, is extremely important.   I want to use this review to pick up on some of the theoretical and political points.

In the book, Rickards questions the theoretical proposition that devaluing the currency is a useful tool to stimulated demand in a recession, particularly if government and private spending are constrained. In practice, he argues, this theoretical outcome is rare, and provides a number of examples to make his point.

I was disappointed that Rickards didn’t expand his theoretical position about the impact of currency devaluation on domestic demand.  While cross-border trade can be a large component of economic activity, it is the country’s net trade position that determines the impact on domestic demand of a currency devaluation.

Countries with large external deficits (in particular trade deficits) will actually see a short-term decline in demand from devaluation.  Imports are a larger share of GDP compared to exports, so the increase in prices from devaluation won’t be offset by an increase in demand from the external sector.  However, for a country with large trade surpluses, steady devaluation can sustain a high level of aggregate demand.

On the flip side, countries with large trade deficits will appear more wealthy if their currency appreciates.  Therefore, we see that trade balances ‘naturally’ become entrenched over time as surplus nations benefits from low currency, and deficit countries benefit from a high currency, and any adjustment away from this path becomes more and more painful.

History shows that the ultimate end-game of international power plays, of which trade balances, currency manipulation, and domestic capital accumulation become both the cause, and the preparation for, is conflict (or international bargaining under the threat of war).

All of this is one reason that for much of the 20th century currencies were tightly regulated by international agreements – from gold standards, to Bretton Woods, to the Plaza Accord and many other treaties and agreements.

Given these important observations – lock in effects, and the history of agreements – I found it odd that Rickards failed to mention Keynes’ proposition for dealing with accumulations of foreign debt and the lock-in effects of long term trade surpluses or deficits.

Keynes’ Bretton Woods proposals sought to engineer a way around this impasse by requiring creditor nations to make room for debtor expansion by reducing their trade surpluses, funding foreign investment or rescheduling debt. But in 1944, America wouldn’t agree to such cramping of its style.

In our current global environment what does this all mean?

In Europe I expect the Euro to be defended even at a very high cost.  After political battles over fiscal policy are played out, I expect much tighter integration of European nations. With tighter integration, some long-term rebalancing may be possible, or may even not be required if intra-EU fiscal transfers become enshrined as a kind of EU national welfare policy.  Of course I note that we live in a complex system, and that in times of crisis, the crowd is not so wise, and other paths are possible, even is less ‘logical’.

In the US, we can expect the trade deficit to continue growing, regardless of their efforts to devalue to the US dollar.  For every attempt to do so, other major economies will fight back.

China’s massive accumulation of capital and ongoing trade surpluses will be seen as a threat to the established dominant Western powers, especially the US.  Whether they bring the international community together to further nudge China to revalue the Yuan, or whether this situation unwinds into playground bullying tactics, I don’t know.

The big lesson though is that rebalancing is a multi-decade project that requires commitment and cooperation from both sides.  Surplus nations will take a short term hit from reduced export demand and a higher currency, and deficit nations will take a short term hit from a lower currency and the decreased demand that results.

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Comments

  1. Yes, even though what happened last time is not necessarily what will happen next, history is still very important in that it provides a first approximation guide.

    “After political battles over fiscal policy are played out, I expect much tighter integration of European nations.”

    I disagree. I think the citizens of EU (in the creditor nations that is) are wising up as to what it *really* means, and will sooner or later stop buying the sugar-coated version of “integration” advertised by the politicians. It is hard to quantify what it will take, but a first approximation will be something like;
    1. dig out the old East Germany from the history book
    2. multiply it by a large number (say, 100)
    3. start throwing money at it until it looks more or less like the eastern part of Germany todayA

    • Cognitive Dissonance

      But let us first look in our own back yards…….I see a nation of people ready to believe anything too

      There media, like our own, will be very uncritical of the internal problems but happy to finger out everyone else’s

      Hell I went to a BBQ the other weekend and was staggered by the people that are thinking about buying 500k odd 2 bedroom apartments to ‘do-up’ and hope to sell them for more…..”you know as an investment”…….I was very careful to keep my big mouth shut.

      People will come to believe what they need to believe, when they need to believe it

      • “People will come to believe what they need to believe, when they need to believe it”

        True.

        As to my earlier EU comment, I am not saying we are there yet. But sooner or later, once the cost of keep throwing money at East Germany x100 starts hitting the hip pockets of the tax payers….

      • Do you recall Tony Abott’s reaction to the introduction of the flood levy last FY?

        Now imagine the introduction of Greece levy, Portugal levy, etc. in EU.

        I am pretty sure that EU is not short of politicians who can Abott.

        • Cognitive Dissonance

          Fair, people have limits no doubt about it, especially if they can see changes in their own lives or that of their friends and families.

          I don’t have a clue how people will react, but I do have a hunch that the governments (and the unelected ones) are going to take the easy option and the central bank will live up to its promise.

          I can see Germany (maybe) leaving the Euro so the other dead beats can go on with ‘it’, the only thing I struggle with is Germanys trade will take a hit with its own new currency problems.

          The ECB must have unity, if say Greece or Ireland leave others will wont out too and the whole thing gets ugly………what if Greece leaves, takes it medicine, you can go there and buy a beer of 50c…….and the next year it started growing…..well that would be the final straw, the camel would hit the floor.

      • The BBQ set is in for a shock, “.. deficit nations will take a short term hit from a lower currency and the decreased demand that results.”

  2. Odd that the writer of this blog does not mention Rickards’s conclusions about the race to the bottom leading to war, and the role he sees for precious metals. Also missing is an acknowledgement that his fellow blogger, H&H, is encouraging the RBA to follow the competitive devaluation route.

    • “the writer of this blog does not mention Rickards’s conclusions about the race to the bottom leading to war..”

      I wrote –
      “History shows that the ultimate end-game of international power plays, of which trade balances, currency manipulation, and domestic capital accumulation become both the cause, and the preparation for, is conflict (or international bargaining under the threat of war).”

      But I really think that full scale international war is becoming less of a possibility over time, and that power struggles will play mostly out in the political sphere, with various trade and currency agreements/concessions.

      As far as precious metals, I don’t see them as coming back as defacto money and time soon. Rickards apparent attachment to gold I don’t believe is warranted. It’s just a metal. His basic premise is that dealing with debt requires devaluation, which means that gold will increase in $ value. Which is fine, but other assets should also increase in $ value. My view is that US government debts will never be paid, so his situation is unrealistic (it is in nobody’s interest – e.g.. the Yuan will increase if it sells US bonds).

      H&H and I probably both agree that the RBA and government should have a coordinated policy to dampen swings in the currency in both directions. The higher we allow our currency to get, the greater the domestic impact when it falls.

      • I think Rickards plays gold at USD7,500 and is very pessimistic about the long-term outcome for the US. Also thought he felt chasing the currency down ineffective over time, simply acceleration of race to the bottom and not guaranteed to rejuvenate economies over time?

      • Cameron, I’d agree on gold if all the central banks, BIS, and bullion banks removed it from their balance sheets. In a monetary system like we have there is monetary gold, and you can’t have it both ways. We need an honest monetary system, and while we don’t, gold will have some role. it’s more complicated than that, but gold does have a monetary use even in this post Nixon era.

      • My apologies for missing the reference to “conflict”, Rumple. I was scanning for “war”.

        Readers may wish to hear Rickards expounding on his book to Chris Martenson in this podcast from earlier this year.

      • You’re funny -NOT. What a remarable lack of
        understanding about Gold –“It’s just a metal”.

        It’s only the ULTIMATE method of payment when all others are rejected -AND Governments world wide have not yet been able to print Gold at will.

        Afraid everthing else you’ve written now suspect.

  3. I follow him now and haven’t read the book yet, but everything I’ve heard him say sounds reasonable.

    He’s in Sydney for the gold symposium in Oct if you want to quiz him.

  4. While we are on books, has anyone else read Critical Mass by Philip Ball?

    In particular, the section regarding states/companies usually end up in two opposing camps – Axis/Allied, any Format wars etc.

    In the book, researchers used “landscape models” to predict lowest energy configuration on axis/allied countries. The result almost exactly matched history.

    So has anyone done a “landscape model” of how EURO countries might be divided?

    • Probably Germany heading The Netherlands, Finland, Luxembourg, the Baltics, Austria.

      Maybe throw in Poland, Czech republic, Slovakia, Sweden.

      France, Italy & Spain form a nucleus of the rest.

      The former, sort of like how it would have ended up if peace remained in 1914.

  5. Rumple,

    RE – “Rickards apparent attachment to gold I don’t believe is warranted. It’s just a metal”

    Not sure I agree here. If gold is just a metal, why is it still at the base of the world’s monetary pyramid?

    Its use as money can seem redundant during good times, but in times of crisis, it acts as the final form of money.

    That’s why central banks still hold gold. To act as final reserve in case the other currency reserves they hold are no longer acceptable for extinguishment of debt.

    Its price may move up or down, but gold is always acceptable for extinguishment of debt.

    • Cognitive Dissonance

      Most professional financial types seem to be a bit coy about liking gold too much in public, not that I have an opinion to what people should think.

      Most of the time you don’t need it, its useless, you may even go backwards…look at long term graph. It is just sometimes, brief periods in time when you need to remove counter party risk and deceit……..the other 99% of the time the crowd tend to point and laugh with their new modern attitudes

      • Agree with your comments except “brief periods in time
        when you need to remove counter party risk and deceit…”
        and the part “the crowd tend to point and laugh with their new modern attitudes”

        Ten years ago I read some rivetting stuff about what was happening to our Financial world – sold the house & invested in Gold & Silver. All in our self managed superfund – No Tax now that retired – and BEST of all it shold easily double again from here! Alos when the A$ tanks which is a certainty from current levels ther will be icing on the cake.

        Still don’t own a house – will when prices drop. There will be a time to SELL Gold -it will be when all the late comers( the 99%) push the price up in a parabolic spike 🙂

  6. James Rickards is on a book promo campaign today obviously as he’s appeared on both Capital Account and Max Keiser on the same day.

    This guy is very good but you don’t need to read the book to know it’s fairly obvious currency wars have been going on for decades already, since before the Plaza Agreement in 1985..