Are we on the brink of a Currency War?

FOR the past few years, the US has accused China of playing dirty in the international marketplace by artificially undervaluing the Yuan, saying it’s manipulating its currency by subsidising its exports.

Other countries complain they have been pulled into the fray, as victims of a broader battle to remain competitive in a marketplace that has set new rules of engagement via currency manipulation.

While the US pushes China to raise the value of its currency (so, among other things it can reduce its huge trade surplus with the world’s fastest growing economy), Japan, South Korea and Indonesia among others have intervened unilaterally in recent weeks to curb their currencies’ advances.

To manage their trade deficit, the US is proposing to set up a target to rebalance global growth and realign or adjust exchange rates. But there is a growing fear that the current economic recovery is currently too brittle to support such a move, as export growth in many developed and emerging markets is largely due to the comparatively low value of their currencies - a deadlock that may lead to US back to the ‘solution’ of protectionism.

Let us not forget that in the 1930s, this same protectionism led to a collapse of trade that set off the Great Depression. And this being mulled, once more, by a country where it will take nine years to replace the US jobs lost during the recession, and with another five million jobs needed for its expanding population.

The US is surviving by printing more and more currency and through overseas borrowing. It has to impose huge taxes and prick inflated values where and whenever they balloon. Whereas, China has engaged the US in vendor capital, providing the money that helps finance the huge US fiscal and trade deficits, allowing Americans to buy more and more goods with the purported ability to make choices free from fiscal constraints.

What’s it doing with all of this money? The short answer is: saving it. China’s reserves have crossed US$2.6 trillion and are growing by almost a billion dollars a day, as they buy US dollars and sell yuan to keep their currency artificially low, with little evidence of movement to the upside.

The yuan has barely budged against the dollar since June, rising less than three per cent, after being fixed for two years before that. China argues that letting the yuan rise any faster would throw its export industry workers out of the domestic labour market, but at the same time, the undervalued yuan has already driven millions of Americans out of work, and Japanese too. Europe has been voicing its own concerns.

Indeed, there is a chance of the European Central Bank coming out with a Euro quantitative easing package, which may in turn throw fuel onto the fire of a currency war. The Europe crisis could play havoc in the overall markets once more and especially in sectors that have a direct exposure to the Euro region.

The fact is none of their industries can compete with China’s artificially low prices. And trade deficits with China continue to advance as a consequence: in August, the US trade deficit with China hit a record US$28 billion.

Money and words may well be the only weapons deployed in this war so far, but the collateral damage to the trading allies of the US and China - and to people around the world - is tangible.

The threat the US is using against these countries is if they don’t raise the values of their currencies, the Federal Reserve will continue its policy of quantitative easing: flooding the markets with cheap money and thereby hanging exporting nations who compete with one another.

Detractors say the Americans’ reasoning for China to raise the value of its currency is a smokescreen because the developing nation’s underpriced exports aren’t really competing with anything the US produces. Either way, when countries try to reduce the value of their currency, they have to do it by buying US dollars, which drives the greenback’s value up.

Japan’s central bank has spent billions selling the yen and buying US dollars to try to slow down the rise in its currency. It spent $24 billion for an effect that lasted 72 hours a few weeks ago, and there are reports it is considering doing it again.

Brazil too is preparing more moves to defend its currency. “We are ready to take further measures if there is a new appreciation of the real,” said Guido Mantega, the finance minister, in December. “With the situation in Europe under stress we expect to see a continuation of the currency war in coming months.”

So, as traders, we’re bracing for another shake-up as we enter the next decade - with turbulence, turbulence and more turbulence forecast across the forex landscape.

Mike Baghdady is the world’s foremost expert on Price Behaviour and a 33-year veteran of the global financial markets, spending the pinnacle of his career as Head Trader on the New York Board of trade trading floor until its merger with the InterContinental Exchange. A key market analyst, syndicated columnist and commentator for financial television stations, Mike began his career in New York as an apprentice to Alan Shaw, President of the Market Technicians Association 1974-75 and widely considered to be the father of modern Technical Analysis learning. Mike won the World of Trading 2009 live trading competition in Frankfurt. He now runs the London-based trading school Training Traders