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Business Times Singapore Investment Roundtable
Currency war threat not over yet
Besides liquidity, inflation and protectionism are also stalking global economy; but Asia will emerge on top from rebalancing

William R. Thomson
Dec 1, 2010

PANELLISTS

Masahiro Kawai: Dean of the Asian Development Bank Institute (ADBI), Tokyo and former World Bank chief economist for East Asia

Mark Mobius: Executive chairman, Templeton Asset Management

Robert Lloyd George: Chairman, Lloyd George Investment Management, Hong Kong

Ernest Kepper: President, Asia Strategic Investment Associates Japan

William Thomson: Chairman of Private Capital, Hong Kong, director of Finavestment, London

MODERATOR

Anthony Rowley: Tokyo correspondent for The Business Times

FOR the moment, Ireland’s sovereign debt crisis (and other crises looming in the eurozone) has pushed the threat of currency wars off the front page. But it has not gone away. What we have seen so far are only the first skirmishes in a “phoney war”. As the flushing liquidity that is prompting these clashes grows to a tidal wave, inflation and protectionism are other spectres that are stalking the global economy.

These are the sobering predictions of economic and investment experts invited by The Business Times to give their views on 2011. But they are all of a view that Asia will emerge uppermost from global economic rebalancing. Meanwhile, investors need to hedge against uncertainty by going for gold and other tangible assets.

Anthony Rowley: Welcome to this Business Times Investment Round Table, and a special welcome to our new guest, Masahiro Kawai, dean of the ADBI. Kawai-san, let me begin by asking you whether you think currency wars can be averted and, if not, which currencies are likely to be most bruised – or unscathed – by the battle.

Masahiro Kawai: They can be avoided provided policy responses of non-US economies are conventional, such as currency market interventions and capital inflow controls. The most reasonable response for emerging economies would be to limit short-term capital inflows, to allow currency appreciation and to strengthen supervision so that inflows will not create a build-up of systemic financial risks like real estate bubbles. In Asia, this would be easier if economies, including China, Asean countries and others, allow currency appreciation collectively. But if such responses are not adopted, countries with flexible exchange rates and free capital mobility could be hit the hardest, as their currencies would be forced to appreciate.

Quantitative easing, or so-called “QE2”, by the US Federal Reserve is generating a lot of concern among emerging economies that it will induce competitive US dollar depreciation and hence can have beggar-thy-neighbour impacts on these economies. Differential speeds of recovery among advanced and emerging economies such as those in Asia have been creating capital inflows to the emerging markets and QE2 is adding pressure.

Mark Mobius: I agree. Currency wars can be averted only if countries allow more flexibility in their currency regimes. Unfortunately, that does not seem to be possible given the stance of a number of them. No currency will escape being impacted by continuation of the present situation. There will be both winners and losers and it hard to predict which in the short term.

William Thomson: As is so often the case, the decision on whether currency wars can be avoided is mainly in the hands of Americans. It seems most unlikely (they can be avoided) since the US has a policy goal of doubling exports over a five-year period. A cheaper dollar is an essential element in this process, especially against Asian currencies. A second US objective is to avoid deflation at all costs and make sure there is some inflation in the system. This means further quantitative easing on a scale yet to be determined. The Fed has announced an additional US$600 billion through June 2011. When added to the US$300 billion refinancing of maturing mortgage bonds, the total QE so far is US$900 billion – sufficient to finance all the budget deficit in that time frame. What comes after is uncertain but if Goldman Sachs is to be believed, the final amount of QE required could total over US$4 trillion in coming years.

The worst-hit currencies are likely to be what I call the three “ugly sisters”: the dollar, the pound and the euro. All are heavily indebted, with ageing populations and troubled banking systems. The euro remains a lopsided construct in a non-optimal currency area. Problems remain with the “PIGS” countries where the real issues have yet to be dealt with. The “winners” should be those of commodity- producing countries and export giants such as Canada, Australia, China, South-east Asia, Norway and possibly some Latin American countries such as Chile.

Ernest Kepper: The currency war declared by the US has massive implications and cannot be averted. The US can win, since it has all the ammunition it needs – there is no limit to the dollars the Federal Reserve can create. Understand that this option is not available to other central banks as the dollar is the recognised reserve currency, in lieu of gold. Currency wars are nothing more than price wars, which could turn into a new bubble somewhere down the road. Once one or two big countries start a price war everyone has to join in, either to protect their currency reserves balance or like Brazil and others to stop their currencies from going up so fast.

The US has depreciated the dollar roughly 13 per cent against the other major currencies since June. The intent is clear: The Fed is enacting “easy money” policies to debase the dollar and reduce the value of foreign debts, while representing the falling dollar as the outcome of a policy to boost inflation and spur the economy and increase employment. Devaluation will be achieved by flooding currency markets with dollars, providing the kind of destabilising opportunities that fit perfectly computerised currency trading, short selling and pure profit-seeking financial manipulation.

Such speculation is a zero-sum game. Someone must lose – and the emerging market countries will. So, countries like Brazil, Thailand and South Korea are taking defensive measures. In the 1997 Asian crisis, Malaysia blocked foreign purchases of its currency to prevent short-sellers from covering their bets by buying the ringgit at a lower price later, after having emptied out its central bank reserves. The blocks worked, and other countries are now reviewing how to impose such controls.

The currencies to own in this situation are Singapore dollar, Norwegian kroner, Australian and Canadian dollars, based on their natural resource economies. The renminbi is his most undervalued currency today. All you have to do is to forecast the next salvo in the currency wars, and to position yourself to take advantage of it. We are going to see extreme volatility going forward.

Robert Lloyd George: I believe that as we approach the end of 2010, we are moving inexorably towards a world currency regime, probably with some component of gold, or gold standard, as was suggested by Robert Zoellick, president of the World Bank. The US dollar is clearly losing its credibility as the anchor of the world monetary system at an even faster rate as Ben Bernanke embarks on QE2. This global currency may take a form similar to the euro, with the weaker currencies, such as the US dollar being co-opted into a harder currency regime, as the deutschmark dominated the euro when it was established. The yen, euro and renminbi will form the core of this new world currency. The currencies that are likely to be less affected by “currency wars” would be of course the Swiss franc, Norwegian kroner and the commodity currencies such as the Australian dollar and Canadian dollars, Brazilian real and perhaps the Russian rouble.

Anthony: So, is there another tidal wave of liquidity on the way given Ben Bernanke’s commitment to 2 per cent annual inflation in the US, and how much of this liquidity is likely to wash up on the shores of Asia? How real is the threat of future inflation from all this liquidity and what does it imply for equity, bond and and real estate markets in Asia and elsewhere?

Mark: There is a continuing wave of liquidity but there is evidence that the rate of increase is declining. Looking at the success of IPOs (initial public offerings) in Asia with almost half of emerging market IPOs and secondary issues taking place here it is clear that a lot of the liquidity – perhaps as much as a half – is finding its way to Asia.

Masahiro: Liquidity creation by the US at this point, when many emerging economies are growing in a robust way, can be the source of future inflation and asset price bubbles in emerging economies. Commodity price increases as in the case of gold, metals, minerals, energy and food – would create inflationary pressure globally and particularly in emerging economies.

William: A tidal wave of liquidity has been clearly flagged by the Fed’s actions. Only the ultimate size is in question. If, as seems likely, there is policy paralysis in the US after the mid-term elections, monetary policy will be the only game in town over the next two years. Do not believe the talk about a 2 per cent inflation goal. The true goal is much higher since they hope to diminish the real value of debt and support asset prices, especially housing. But the policy of inflation requires deception to be effective. Inflation is on the way as commodity prices and devaluation work their way through the system. In fact it is here already but official statistics do not properly capture this fact.

Asian nations have a choice: either let their currencies appreciate, or suffer a property and equity bubble, or put in place currency and lending controls. I expect we will get a combination of all three over the next two years. More generally, as long as interest rates are negative in real terms we will get equity bubbles elsewhere too. Property is more problematic since banks are being restrictive with their mortgage lending and unemployment remains high.

Ernest: By promoting a weaker dollar, the US is creating dangerous inflationary pressures that will have negative repercussions globally. As a consequence of QE2 – central bankers will be forced to intervene in currency markets, institute ad hoc controls and resort to protectionist policies to protect their exporters. This can only mean a more drawn-out and difficult global recovery.

Arbitrageurs and speculators are swamping Asian and other emerging market currency markets with low-priced dollar credit to make predatory trading profits at the expense of Asian central banks which are trying to stabilise their exchange rates and keep asset prices from rising by selling their currency for dollar-denominated securities.

Robert: If the Fed prints another US$600billion plus of liquidity, I would expect that 75 per cent of this will go offshore, and the large part to emerging markets, notably in Asia. There is a real danger of inflation reaching 10 per cent in countries as diverse at India, China, Indonesia, Philippines, Brazil, Argentina and other fast-growing resource producers. Our investment strategy is to run an inflation- hedging approach in buying oil and gas producers, mining houses, gold, silver, agriculture and real estate, especially in the Asian hemisphere.

Anthony: There is a great debate about global economic restructuring in which emerging-market economies supposedly will put more emphasis on domestic demand and less on exports and vice versa in advanced economies. How do you see this working out, and in what kind of time frame?

Masahiro: There is a view that export-led growth is bad. I don’t agree. Exports should be encouraged by all countries, and so should imports. All countries cannot produce net export surpluses, but they can enjoy export-led growth as long as imports rise everywhere. If each country shifts productive resources (capital, labour, knowledge, etc) to sectors where the country has comparative advantage, then the global economy will become more efficient in resource use. Also such export expansion creates more investment and jobs. Free trade should be protected.

Mark: Restructuring is happening right now and this is evident not only in China but in other emerging markets like Brazil. Unfortunately, the evidence will be difficult to detect since stronger emerging market currencies mean that these economies can import more with fewer dollars.

William: China has clearly signalled in its next five-year plan 2012-17 that it intends to increase the level of consumption in the economy from an incredibly low 35 per cent to around 45 per cent. A higher exchange rate is an important element in that transition but it must be done at a rate that does not ruin export industries. Social stability is the primary goal of Chinese authorities. It will require reforms in housing, education and the development of social safety nets. None of these can be accomplished overnight but I would expect clear progress to be made.

The US and the UK both recognise that their economies need rebalancing with more emphasis on manufacturing and less on financial services. That is hard to accomplish since they are simply not competitive at today’s exchange rates in most industries. I fear the US will become increasingly protectionist, especially after 2012 if the economy remains mired in stagnation. If things are not going their way, populist anger is likely to make them rip up the rule book as they did in 1933 and 1971. The end of empire is never pretty.

Robert: I believe it will take several years to achieve the restructuring of global imbalances, to make China save less and spend more and make Americans spend less and save more. But recession and unemployment in the USA have had a fairly rapid effect and with the falling dollar imports will slow down and exports hopefully will increase. In a completely free-floating currency regime, the self-correcting mechanism should have worked to correct the imbalances. But as we saw with the yen after the Plaza Accord in 1985, it does take up to five years.

Ernest: The ongoing shift of global output from developed economies to emerging economies, particular Asia, will bring a lot of volatility. Growth may be evident in the emerging markets but the volume is in the developed countries. It is unlikely that growth in emerging markets can make up for the lack of growth in the developed countries. The biggest challenge is that emerging markets achieve growth from productivity gains rather than from manipulation of their exchange rates.

Anthony: As wealth becomes more balanced globally under this process, how will it affect the relative importance of financial markets around the world. Where will the pools of capital be located in the future, and where and how are these likely to be deployed by portfolio investors?

Mark: More capital will be diversified globally instead of being concentrated in home markets. More will be in equities although fixed income will still be larger than equities.

Masahiro: Emerging Asia will be wealthier and a larger pool of savings will be created in Asia. The challenge is to make financial intermediation more efficient at the national and regional levels. Japan’s and China’s savings should be mobilised to finance productive investment in Asia.

William: The Asian financial markets can only grow in relative and absolute importance since that is where capital is increasingly generated and the tax and regulatory regimes are more attractive. London, New York and Switzerland will not disappear but Singapore, Hong Kong, Shanghai and possibly Mumbai will grow in importance on a regional and international level. Middle East regional markets are likely to become more important in their locality as their sovereign wealth funds become investors of last resort.

Robert: I expect that China will be 25 per cent of the world capital market within the near future. India follows close behind. The “Frontier Markets” in Africa, for example, will go from being less than 2 per cent to perhaps 10-15 per cent of world markets. Some 90 per cent of IPOs in the world are now taking place in emerging markets rather than in Europe or the US. Before 1800 China and India were the wealthiest nations in the world and by 2020 it will be true again.

Ernest: The global financial system has taken on a life of its own separate from meaningful trade and investment as dollar outflows do not create assets or provide tangible investment in plant and equipment, buildings, research and development. It is more the creation of debt, and its multiplication by mirroring, credit insurance, default swaps and an array of computerised forward trades.

Financial conquest is seeking today what military conquest did in times past. Countries on the receiving end of this US financial conquest are seeking ways to protect themselves. Ultimately, the only way to do this is to erect a wall of capital controls to block foreign speculators from destabilising currency and financial markets.

Anthony: Commodity-producing and exporting countries have been on a roll with their terms of trade improving dramatically. Can this last, and what is the outlook for industrial and agricultural commodities?

Mark: Yes it can last, given the growing global demand from the most populous emerging markets. There, of course, will be great volatility which sometimes will look like a bear market but it will be merely a correction in an on-going long-term bull market.

Masahiro: Emerging Asia’s growth will continue to raise commodity and energy prices. The US easy monetary policy will help these price rises further.

William: Commodity cycles typically run from 15 to 25 years and we are only 10 years into the present one. If we are talking about energy, oil demand continues to increase and new discoveries are inadequate. The emerging markets have a huge demand for commodities used in infrastructure and their food demands are growing. Prices are likely to be quite volatile reflecting cyclical and seasonal patterns but underlying growth is likely to remains strong as long as the global economy remains open and vital. But the West, especially the US, could lose faith in globalisation. I believe this is a valid fear. I see some unfortunate straws in the wind.

Robert: The commodity bull cycle will last until 2014, with agricultural commodities being particularly strong in the next three to four years, as they catch up in real terms with oil, gold and mineral prices.

Ernest: There are three broad and major areas of opportunity that will be generated from the Fed’s move to depreciate the dollar – currencies, precious metals and stocks and bonds in emerging markets. Precious metals and grains will continue their price growth until 2012 or so.

Anthony: Talking of precious metals, will gold go to US$2,000 an ounce or even beyond in the foreseeable future and what are the implications of central banks’ decisions to stop selling gold? What about other precious metals? Mark: Gold at US$2,000 an ounce is certainly possible and the same bullish scenarios can be given for such metals palladium and platinum as well as other metals.

William: US$2,000 an ounce is certainly possible in the next two to four years. Gold has appreciated about 20 percent per annum since the lows in the year 2000. Much will depend on the rate that the US devalues the dollar by printing more money. If some of the figures I mentioned earlier for QE happen then US$2,000 would seem to be a lead pipe cinch. Indeed, we could have a 3 or 4 in front of the price before the end of the cycle.

But, I do not believe trying to forecast the price is particularly useful. Gold is part of an insurance policy in a portfolio rather than a profit centre. I do believe that whilst bullion will still go up that quality gold mine shares will appreciate more. I also believe that silver will appreciate more than gold from here. Platinum will probably trade like gold but maintain a premium to it since it is rarer.

I found Robert Zoellick’s recent comments about defects in today’s international infrastructure and the need to consider some role for gold as a reference for the appropriateness of current policy interesting. This is the first time an establishment figure has indicated dissatisfaction with the post-1971 settlement. I suspect it is the opening salvo of a new and overdue debate.

More Shine? Gold is seen topping US$2,000 an ounce within the next six to 12 months, and get to US$5,000 per ounce by 2014. Investors are told to hedge against currency uncertainty by going for gold and other tangible assets.

Robert: I expect gold to top US$2,000 an ounce within the next six to 12 months, and get to US$5,000 per ounce by 2014. Central banks will be buying rather than selling and it is completely misleading to suggest that we are in a gold bubble because it has barely started and the real value is at least 4 times higher than its current price. The real value, adjusted for monetary inflation is at least US$5,000. Silver will probably outpace gold, in other words, it will probably exceed its US$50 an ounce high of 1980. Platinum, palladium and other precious metals will match or outpace gold.

Ernest: Gold should reach US$1,500 by year-end, surpass US$2,000 in 12 months or so, and will reach US$2,500 in around 18 months. The reasons why gold will go much higher are that central banks will continue to buy large quantities as the debt crisis goes global and Europe’s debt problems are getting deeper. Motivated by either fear or greed, investors are jumping into gold as they shift away from the US dollar.

Unless a new currency structure provides that each currency is backed up by something tangible – the same game is just being perpetuated. Honest money must be redeemable by something tangible or real – not just a warehouse receipt of some sort. That’s why investments in gold (oil is another tangible investment) are so important at this time for your portfolio.

Anthony: Thank you all for a stimulating discussion and allow me to wish you a prosperous New Year in 2011.

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Nov 29, 2010
William R. Thomson
email: wrthomson@private-capital.com.hk

William Thomson is Chairman of Private Capital Ltd. in Hong Kong and an adviser to Axiom Funds and Finavestment Ltd. in London.

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