Jim Rickards’ message in this week’s Strategic Intelligence Australia update is simple.
Currency wars aren’t back. They never left us!
His analysis is that we’re in a new phase of the Currency War which began in 2010. The last few years were just a lull.
Countries are back to devaluing their currencies to try and gain an exporting edge in global markets.
Of course, that’s a fool’s game. Try manufacturing without importing resources. Try mining resources without importing manufactured goods.
You probably heard about the wild swings in the Japanese currency over the last seven days. First it plunged, then it recovered its plunge. Then it fell again. Then it surged 3% in a day! And who knows what’ll happen by the time you read this.
It might look like Japan is trying to devalue its currency to gain a competitive edge in global markets. And if they are, it’s working. Japanese stocks are going bananas ever since the yen began its downtrend.
Unintended consequences are…well…predictable!
The trouble with currency devaluation is that it cannot create wealth. It can only redistribute it.
Every investor should know that any benefit to one sector must cost someone else.
There is no free lunch.
Frederic Bastiat put it best about 200 years ago:
‘In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects.
‘Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.
‘There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.’
Indeed. But how can we take advantage of this currency dynamic happening now?
Personally, I moved to Japan for a few months this year. My wife is Japanese, by the way.
I can tell you that my cost of living has plunged alongside the value of the yen. I earn in Aussie dollars and British pounds so I’m finding everything so much cheaper than Australia, that’s for sure.
Tourism here is booming too. But it’s not all good news…
A canary drops dead in Japan
I’m not so sure that deliberate currency policy is behind the drop in the yen.
The source of currency instability is an unintended consequence of the Bank of Japan’s other policy.
Instead of raising interest rates to rein in inflation, the BoJ decided to keep interest rate low.
To be clear, this is an extraordinary move. Inflation is way above the target. And interest rates are at just 0.1%. It’s a recipe for disaster. So, why the policy?
It’s simple. The Japanese government’s debt is so large that the central bank cannot raise interest rates. Not without sending the government broke.
And so the BoJ decided to keep rates on hold while watching the inflation rate soar for Japanese savers. This shows up in foreign exchange rate markets too. Hence the plunge in the yen.
To sum up, someone forgot to tell the Bank of Japan about the unintended consequence of their policy. They can’t support the government financially without trashing the value of the currency. And now the BoJ is having to clean up their own mess to cover it up.
A global problem
Japan may well be the most extreme and obvious example of all this. But it’s the same story in the US, UK, eurozone and many other places around the world.
Government debts are so large that higher interest rates are not affordable. And so central banks might not be able to raise rates far enough to rein in inflation.
That’s why so many countries’ currencies are falling in value. It’s where the unintended consequences of this policy show up.
Where does Australia stand in all this?
Australia’s debt to GDP ratio remains remarkably low. We also have a fiscal surplus. So we’re not stuck in the same interest rate trap.
This means the Reserve Bank of Australia can raise interest rates to reign in inflation. And, I suspect, that’ll be an extreme tailwind to the value of the Aussie dollar in coming years.
If commodity prices turn, we can expect our currency to fly. This will undermine the value of your foreign investments and make life difficult for Aussie exporters.
However, if you fancy a trip to Japan, you’ll be living very well indeed. And any stock that uses a strong Aussie to import – say a retailer, for example…can get better margins too.
It might be time to adjust your portfolio accordingly. For some further ideas to take advantage of the opportunities in today’s market, go here.
Until next time,
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Nick Hubble,
Editor, Strategic Intelligence Australia
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