A Brief History of Currency Wars

by Jim Rickards | June 05, 2015
Currency wars are one of the most important dynamics in the global financial system today.

A currency war is a battle, but it’s primarily economic. It’s about economic policy. The basic idea is that countries want to cheapen their currency. Now, they say they want to cheapen their currency to promote exports. Maybe it makes a Boeing more competitive internationally with Airbus.

But the real reason, the one that’s less talked about, is that countries actually want to import inflation. Take the United States for example. We have a trade deficit, not a surplus. If the dollar’s cheaper it may make our exports slightly more attractive.

It’s going to increase the price of the goods we buy — whether it’s manufactured good, textiles, electronics, etc. — and that inflation then feeds into the supply chain in the U.S. So, currency wars are actually a way of creating monetary ease and importing inflation

The problem is, once one country tries to cheapen their currency, another country cheapens its currency, and so on causing a race to the bottom.

Of course, I started talking about this year ago in my first book, Currency Wars. My point then is the same today: The world is not always in a currency war, but when we are, they can last for five or ten, fifteen and even twenty years. They can last for a very long time.

There have been three currency wars in the past one hundred years. Currency War I covered the period from 1921 to 1936. It really started with the Weimar hyperinflation. There was period of successive currency devaluation.

In 1921, Germany destroyed its currency. In 1925, France, Belgium and others did the same thing. What was going on at that time prior to World War I in 1914? For a long time before that, the world had been on what’s called the classical gold standard. If you had a balance of payments, your deficit, you paid for it in gold.

If you had a balance of payment surplus, you acquired gold. Gold was the regulator of expansion or contraction of individual economies. You had to be productive, pursue your comparative advantage and have a good business environment to actually get some gold in the system — or at least avoid losing the gold you had. It was a very stable system that promoted enormous growth and low inflation.

That system was torn up in 1914 because countries needed to print money to fight World War I. When World War I was over and the world entered the early 1920s, countries wanted to go back to the gold standard but they didn’t quite know how to do it. There was a conference in Genoa, Italy, in 1922 where the problem was discussed.

The world started out before World War I with the parity. There was a certain amount of gold and a certain amount of paper money backed by gold. Then, the paper money supply was doubled. That left only two choices if countries wanted to go back to a gold standard.

They could’ve doubled the price of gold — basically cut the value of their currency in half — or they could’ve cut the money supply in half. They could’ve done either one but they had to get to the parity either at the new level or the old level. The French said, “This is easy. We’re going to cut the value of the currency in half.” They did that.

If you saw the Woody Allen movie Midnight in Paris, it shows U.S. expatriate living a very high lifestyle in France in mid-1920s. That was true because of the hyperinflation of France. It wasn’t as bad as the Weimar hyperinflation in Germany, but it was pretty bad. If you had a modest amount of dollars, you could go to France and live like a king.

The U.K. had the same decision to make but they made it differently than France did. There, instead of doubling the price of gold, they cut their money supply in half. They went back to the pre-World War I parity.

That was a decision made by Winston Churchill who was Chancellor of Exchequer at that time. It was extremely deflationary. The point is, when you’ve doubled the money supply, you might not like it but you did it and you have to own up to that and recognize that you’ve trashed your currency. Churchill felt duty-bound to live up to the old value.

He cut the money supply in half and that threw the U.K. into a depression three years ahead of the rest of the world. While the rest of the world ran into the depression in 1929, the U.K. it started in 1926. I mention that story because to go back to gold at a much higher price measured in sterling would have been the right way to do it. Choosing the wrong price was a contributor to the great depression.

Economists today say, “We could never have a gold standard. Don’t you know that the gold standard caused the great depression?”

I do know that — it was a contributor to the great depression, but it was not because of gold, it was because of the price. Churchill picked the wrong price and that was deflationary. The lesson of the 1920s is not that you can’t have a gold standard, but that a country needs to get the price right. They continued down that path until, finally, it was unbearable for the U.K., and they devalued in 1931. Soon after, the U.S. devalued in 1933. Then France and the U.K. devalued again in 1936. You had a period of successive currency devaluations and so-called “beggar-thy-neighbor” policies.

The result was, of course, one of the worst depressions in world history. There was skyrocketing unemployment and crushed industrial production that created a long period of very weak to negative growth. Currency War I was not resolved until World War II and then, finally, at the Bretton Woods conference.

That’s when the world was put on a new monetary standard. Currency War II raged from 1967 to 1987. The seminal event in the middle of this war was Nixon’s taking the U.S., and ultimately the world, off the gold standard on August 15, 1971.

He did this to create jobs and promote exports to help the U.S. economy. What actually happened instead? We had three recessions back to back, in 1974, 1979 and 1980.

Our stock market crashed in 1974. Unemployment skyrocketed, inflation flew out of control between 1977 and 1981 (U.S. inflation in that five-year period was 50%) and the value of the dollar was cut in half.

Again, the lesson of currency wars is that they don’t produce the results you expect which are increased exports and jobs and some growth. What they produce is extreme deflation, extreme inflation, recession, depression or economic catastrophe. This brings us to Currency War Three, which began in 2010.

Notice I jumped over that whole period from 1985 to 2010, that 35-year period? What was going on then?

That was the age of what we call “King dollar” or the “strong dollar” policy. It was a period of very good growth, very good price stability and good economic performance around the world. It was not a gold standard system nor was it rules-based.

The Fed did look at the price of gold as a thermometer to see how they were doing. Basically, what the United States said to the world is, “We’re not on a gold standard, we’re on a dollar standard.

We, the United States, agree to maintain the purchasing power of the dollar and, you, our trading partners, can link to the dollar or plan your economies around some peg to the dollar. That will give us a stable system.” That actually worked up until 2010 when the U.S. tore up the deal and basically declared Currency War III. President Obama did this in his State of the Union address in January 2010.

Here we are and they’re still continuing. That comes as no surprise to me.

A lot of journalists will see, say, the weak yen, and they’ll say, “Oh, my goodness. We’re in a currency war.” And I’ll say, “Well, of course we are. We’ve been in one for five years. And we’ll probably be in one for five more years, even longer.”

Currency wars are like a see saw — they go back and forth and back and forth.


Jim Rickards
for International Man

The Ugly Truth Behind the Fed’s Quantitative Easing

By , Capital Wave Strategist, Money Morning

Editor’s note: In this groundbreaking analysis, Shah reveals how quantitative easing – a misguided multi-trillion dollar central bank policy and the greatest financial disruptor of our time – has distorted the global economy, made many traditional investments unprofitable, and stoked wealth and income inequality. But Shah says there are steps we can take to limit some of the damage – if we act now.

The growing income and wealth gap between the rich and poor, most of whom used to be called middle class, has many fathers. But behind the scenes one primary cause emerges. It’s the greatest financial disruptor of modern times: Quantitative Easing (QE).

While the jury’s out on whether QE will eventually be the step-ladder that lifts us out of the lingering Great Recession, as its proponents argue, the facts demand that the verdict on QE’s egregious enrichment of the rich and subjugation of everyone else is: “guilty.”

And the trouble won’t stop now that the United States has begun winding down its quantitative easing – the Eurozone and Japan each have massive QE programs.

Here are the facts. Policymakers and struggling middle class and poor people must take a strong stand to fight this financial plague. Here’s how…

A Chicken and Egg Story

Quantitative easing is the term America’s central bank, the U.S. Federal Reserve, came up with for its experimental policy of buying trillions of dollars’ worth of U.S. government bills, notes and bonds (Treasurys), and mortgage-backed securities (MBS) from banks.

This was new. Typically, when financial or economic troubles befall the U.S., the Fed lowers interest rates in order to make more money available to financial institutions and the public, providing liquidity to banks and capital to consumers and producers.

The Fed lowers interest rates by offering banks cheap loans. The idea is that if banks have more money to lend, lower rates will work their way into the economy and stimulate consumption and production.

When the credit crisis hit in 2008, the Fed lowered its target rate to zero, essentially making loans between banks free. But banks still wouldn’t lend to each other – they were afraid borrowing banks could go toes up at any time. Big banks were virtually insolvent.

The Fed’s response to this emergency? It cooked up QE.

The Fed was able to pump money directly into ailing banks by buying bank loans, Treasurys, and mortgage-backed securities from them.

The banks eventually made out like bandits because in later rounds of QE they bought Treasurys and MBS in the open market, knowing they were just going to flip them to the Fed at inflated prices.

Fed purchases from big banks started in 2008 and continued throughout 2009. That wasn’t enough to save the banks. In 2010 the Fed stepped up its purchases under the banner QE2, buying $600 billion worth of assets that year. That still wasn’t enough.

Meanwhile, the economy, which had shown signs of perking up, slipped backwards. So in September 2012, the Fed began QE3, purchasing $85 billion a month of assets ($45 billion of Treasurys, $40 billion of MBS) for the next 24 months.

By the time it was done, the Fed’s balance sheet had ballooned from $750 billion in 2007 to more than $4.25 trillion dollars, and big banks were making record profits again.

The Greatest Wealth Redistribution Ever Conceived

The Fed’s ZIRP, or zero interest rate policy, restored banks’ balance sheets, grossly enriching them in the process. Low rates allowed corporations to borrow cheaply to buy back their shares and eventually raise dividends. Low rates allowed well-heeled speculators to margin and leverage their bets on rising financial asset prices.

Cheap money fed private equity companies and venture capital firms’ ambitions, backing start-ups like Uber, AirBnB, Snapchat, and others. Financial intermediaries, once again, reaped big fees from arranging loans, orchestrating mergers and acquisitions, and taking companies both public and private.

Pre-existing owners of financial assets and financial intermediaries have enjoyed a windfall at the expense of the middle class and the poor. And it was planned that way.

The Fed openly stated the purpose of QE was to create a “wealth effect” by lifting financial asset prices so people would feel wealthy and start consuming again.

Which works fine if you have a job, your wages are increasing, the value of your home is rising, your retirement assets are appreciating, and you are feeling well off.

But that’s not happening for the middle class and people who aren’t asset owners.

Savers and retirees are getting killed. Interest income on their hard-earned savings and on the fixed-income investments retirees need are close to zero. These people are being punished. The wealth they could be accumulating has been redistributed to everyone who has the means to borrow cheaply to acquire appreciating financial assets. That’s QE.

As a result of the credit crisis and Great Recession, the household sector, meaning the middle class, lost $11 trillion in wealth and 10 million jobs. The country lost an estimated $21 trillion worth of productivity. The Great Recession’s middle-class losers haven’t bounced back, but QE has made the rich even richer.

The Damage Might Be Permanent

French economist Thomas Piketty’s controversial 2013 bestseller, Capital in the Twenty-First Century, reduces the facts, figures, metrics, and statistics to a simple conclusion that explains why the wealth and income gap will keep widening: The rate of return on capital is greater than the rate of economic growth, globally.

That means the rate of return on capital and assets, especially financial assets, will grow faster than economic opportunities that help the poor and middle class.

So, what do policy-makers and the disadvantaged have to do? A lot.

The only way to upend this geopolitical and economic travesty is first to break up all the world’s big banks into much smaller players that will be more willing to serve all borrowers.

Breaking up big banks upends the argument that central banks are needed to bail them out when they implode, which is the only reason central banks really exist today.

Second, because they would no longer be needed, central banks should be shut down.

Third, policy-makers, meaning governments, should readdress their priorities to create more opportunities for more people to work and advance themselves.

I’m not talking about redistribution. I’m talking about simplifying the tax code to eliminate egregious shelters and to spread the tax burden appropriately among corporations, extraordinarily high earners, and the general population, eliminating provisions that discourage wasteful, unproductive financial intermediation and breaking down barriers to short- and long-term investment and entrepreneurship.

We will need fiscal policies designed to reduce government debt and automatically expand and contract the money supply and credit extension to levels appropriate to the rate of economic growth.

We need smaller, more effective regulatory regimes that don’t overburden businesses with inappropriate, over-the-top rules and regulations, but establish black-and-white rules along with fines and jail sentences for rule breakers, including corporate officers and managers.

That’s a lot to expect. I’m not holding my breath for any of it.

In the meantime, everyone who isn’t part of the entitled, fortunate, or criminal class of “haves” has to learn how to make what they can, save as much as possible, and learn how to play the markets, specifically the stock market.

The stock market is the have-nots’ only real way, other than by successful entrepreneurship, of creating enough wealth to live a decent to good life and be able to retire in comfort.