The Biggest Loser Wins
Euro Pacific Capital, Inc.
Posted May 24, 2013
While the world's economies jockey one another for the lead in the currency devaluation derby, it's worth considering the value of the prize they are seeking. They believe a weak currency opens the door to trade dominance, by allowing manufacturers to undercut foreign rivals, and to economic growth, by fighting deflation. On the other side of the coin, they believe a strong currency is an economic albatross that leads to stagnation. But the demonstrable effects of currency strength and weakness reveal the emptiness of their theory.
A country that attracts investment from abroad (through stable and fair governance, low taxes, a growing economy, and a productive labor force) and produces goods that are in demand on the global stage will generally see a rising currency. In essence, this is the reward for a job well done. Strong currencies then help nations stay strong by conferring greater purchasing power to its citizens and businesses, which keeps input costs low, thereby enhancing international competitiveness. Strong currencies also encourage savings, keep real interest rates low, lower capital costs, and allow for greater productivity and higher real wages.
It is often argued that a weak currency confers advantages in foreign trade. But the edge only results from putting exports on sale. Any merchant will tell you that it's easy to sell more if you cut prices, but most would prefer charging full retail. However, exports are not an end in themselves, they are a means to pay for imports. The goal of an economy is not to work, but to consume. If citizens in one nation buy goods produced in another, they must pay with exports. When a nation's currency appreciates imports cost less and fewer exports are needed to pay. This means goods and services at home will be cheaper and more plentiful, and citizens won't need to work as hard to buy them. This is the definition of rising living standards.
But when it comes to relative currency valuations, the United States dollar exists in a world of its own. As the international reserve, the dollar is the de-facto beneficiary of any other country's intervention. When countries intervene, they do so specifically against the dollar. In addition, many countries, (China and Taiwan for instance) maintain a pegged relationship to the Greenback. Therefore in a world dominated by interventionist banks, the factors that push the dollar have been inverted. The dollar falls when fundamentals either improve abroad or deteriorate at home (both cases increase the propensity for intervention). The rest of the world's currencies compete on their own merit. As a result, it is not an accident that over the last decade Australia, New Zealand, and Switzerland, three of the world's strongest economies, have produced strong currencies.
Since 2001, all three have had generally appreciating currencies, accompanied by steadily rising exports, strong economic fundamentals, and low unemployment. From 2001 to 2012, the Kiwi Dollar appreciated by 98% against the U.S. dollar, but its exports in local currency terms increased by 40% (170% in U.S. dollar terms). Over the same time frame, the Aussie dollar appreciated by 103% and exports increased by 102% in local currency (and 305% in U.S. dollar terms). In Switzerland the story was the same, currency up 82%, exports up 53% in local terms and (and 175% in U.S. terms). Where exactly did they encounter export troubles due to their rising currencies?
At the same time, the strengthening currencies made few negative impacts on other aspects of economic performance. At the time when the Swiss bankers caved to international pressure in September 2011 and pegged its previously surging franc to the euro, their economy had shown some of the best economic performance on the Continent. More recently, Australia and New Zealand reported stunning job creation figures. Adjusted for population, the U.S. would have had to create more than 600,000 jobs per month to keep pace with Australia, and 900,000 jobs per month to match New Zealand (U.S. job creation has averaged about 169,000 per month over the last year).
These lessons have been wholly lost on the Japanese who are frantically trying (and succeeding) in severely devaluing the yen. Although Japan's export machine had not suffered from the yen's appreciation from 2001-2012 (up 30% in local currency exports and 98% in dollar terms), newly installed prime minister Shinzo Abe and his minions at the Bank of Japan believe a weaker yen is the key to renewed economic strength. But the collapse of the yen has helped push up both the Aussie and Kiwi dollars, which has spurred bankers in Australia and New Zealand into taking unneeded and ultimately self-destructive actions. In April they threw in their lot with the interventionists and cut interest rates to stop the rise of their currencies. But the moves fly in the face of the modern playbook which states that policy should be tightened during periods of full employment, strong growth, and surging real estate prices. The misplaced fear of a strong currency seems to trump all other concerns.
While there is little reason to believe that strong currencies stifle exports, there is ample evidence that they increase domestic purchasing power (which is a real test of economic success). In the United States, oil currently sells for about $97 per barrel, about 16% below the $113 high price seen in April 2011. And so while our economy falters, at least consumers are not saddled with surging energy costs. While the 20% devaluation of the yen since that high in 2011 has made Japan the champion of Keynesian economists, it also means that oil in Japan is currently selling for the highest price since the financial crisis of 2008-2009. And it's not just oil, the Japanese must pay more for everything they import. How this benefits the rank and file has yet to be properly explained.
The latest data confirms that the banzai attack on the yen has not helped Japan's trade position. The weaker currency led to higher import costs, resulting in the 10th month in a row of trade deficits. Although April exports rose 3.8 percent from a year earlier, the trade deficit widened to 879.9 billion yen ($8.6 billion), the worst April since at least 1979. But the falling yen is creating a clear and present danger in Japan's enormous bond market. In less than one month, yields on 10 year Japanese Government Bonds have more than doubled, approaching nearly 1%. While those rates may sound manageable for most countries, Japan has the highest debt to GDP ratio in the developed world. If they had to pay 2% (the same rate as its inflation target), the country would need to devote more than half of its tax revenue just to service its debt! Clearly this possibility is dawning on stock investors who pushed down the Nikkei by more 7% today.
Never in the course of history has a country's economy failed because its currency was too strong. It's a pathology that simply does not exist. On the other hand, the list of those ruined by weak currencies is extensive. The view that a weak currency is desirable is so absurd that it could only have been devised to serve the political agenda of those engineering the descent. And while I don't blame policy makers from spinning self-serving fairy tales (that is their nature), I find extreme fault with those hypnotized members of the media and the financial establishment who have checked their reason at the door.
A currency war is different from any other kind of conventional war in that the object is to kill oneself. The nation that succeeds in inflicting the most damage on its own citizens wins the war. The only real way to win is not to play.
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C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.