James Rickards, author of ‘Currency Wars: The Making of the Next Global Crisis’, told the RBS Macro Conference in London that the world was witnessing the early blows of a battle that could last for years but which no one would win.
He said the US Federal Reserve, Bank of England and Bank of Japan had implicitly agreed to simultaneously weaken their currencies by turning on the printing presses and so gain an advantage over emerging market rivals.
“In the 1930s, countries devalued sequentially, like thirsty soldiers passing around the canteen. Today the US, Japan and the UK are saying ‘let’s all ease together, lets not fight currency wars among ourselves but fight them with the rest of the world’”.
Despite intense focus on the weak yen this year, Rickards said Washington was actually giving Tokyo a “pass to trash its currency” because of its geopolitical importance to Washington and also Tokyo’s willingness to soak up growing supplies of US Treasuries that China was now buying in smaller quantities.
Rickards said the whole aim of the currency wars was not as many believed a competitive devaluation to boost export sales, but a tactic to induce consumer spending by increasing inflation through pricier imports.
If inflation climbs above nominal interest rates then consumers are incentivised to borrow rather than save as real interest rates become negative. The ‘stick’ to encourage spending is then an ‘inflation shock’ of higher-than-expected price rises that create almost a panic buying mentality.
Such a tactic would backfire disastrously, Rickards said.
“The Fed thinks monetary policy is a thermostat to be dialled up or down. That idea is deeply flawed,” he said, likening it instead to a nuclear reactor that was unstable and which could not be reversed if it went into melt down.
The Federal Reserve, he said, was prioritising its unemployment-fighting mandate and would allow inflation to rise upwards of 4 per cent. But its efforts to then rein in rising prices would fail and inflation would start to spin out of control on the back of growing consumer confidence and faster spending patterns.
A similar process over the 1970s ended with US inflation rising to 15 per cent by 1980.
“I don’t think it will take 10 years this time,” said Rickards. “It could take as little as two or three years and end up with inflation around 9 per cent.”
In contrast to the situation 33 years ago however, the sheer complexity of the global monetary system this time meant it would be far more difficult to control the causes of inflation.
The consequences would be dire.
“The risk of a generalised collapse of confidence in paper money around the world is very high. Trade wars, social unrest, shooting wars, they are all possibilities”.
Leveraged to the hilt, the Federal Reserve would then have insufficient firepower to act effectively. The eventual crisis would lead to the end of the dollar standard, Rickards said.
“The next time this happens the Fed will not be able to bail out the world. Their balance sheet will go from USD800 billion to USD3 trillion now and to 5 trillion by the end of next year.
If this crisis hits in a couple of years, what’s the Fed going to do? Take the balance sheet to USD10 trillion? At that point the only clean balance sheet in the world is the IMF’s.
“In an acute financial panic, the IMF will re-liquefy the world with SDRs (special drawing rights) so they will be the world’s central bank and SDRs will be the global currency”.
For more RBS Insight content, click here
Disclaimer
The statements and opinions expressed in this article are solely the views of James Rickards speaking at an RBS Macro Conference in London on March 14, 2013 and do not necessarily represent the views of the Royal Bank of Scotland.
The contents of this document are indicative and are subject to change without notice. This document is intended for your sole use on the basis that before entering into this, and/or any related transaction, you will ensure that you fully understand the potential risks and return of this, and/or any related transaction and determine it is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. You should consult with such advisers as you deem necessary to assist you in making these determinations. The Royal Bank of Scotland plc (“RBS”) will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser or owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on RBS for investment advice or recommendations of any sort. RBS makes no representations or warranties with respect to the information and disclaims all liability for any use you or your advisers make of the contents of this document. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed.
Where the document is connected to Over The Counter (“OTC”) financial instruments you should be aware that OTC derivatives (“OTC Derivatives”) can provide significant benefits but may also involve a variety of significant risks. All OTC Derivatives involve risks which include (inter-alia) the risk of adverse or unanticipated market, financial or political developments, risks relating to the counterparty, liquidity risk and other risks of a complex character. In the event that such risks arise, substantial costs and/or losses may be incurred and operational risks may arise in the event that appropriate internal systems and controls are not in place to manage such risks. Therefore you should also determine whether the OTC transaction is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances.
RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding, or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein.
RBS is authorised and regulated in the UK by the Financial Services Authority, in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US, by the New York State Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the United States Securities Act of 1933, as amended. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC (www.sipc.org) member and subsidiary of The Royal Bank of Scotland Group plc. Dubai International Financial Centre: This material has been prepared by The Royal Bank of Scotland plc and is directed at “Professional Clients” as defined by the Dubai Financial Services Authority (DFSA). No other person should act upon it. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Professional Client”. This document has not been reviewed or approved by the DFSA. Qatar Financial Centre: This material has been prepared by The Royal Bank of Scotland N.V. and is directed solely at persons who are not “Retail Customer” as defined by the Qatar Financial Centre Regulatory Authority. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Business Customer” or “Market Counterparty”.
The Royal Bank of Scotland plc acts in certain jurisdictions as the authorised agent of The Royal Bank of Scotland N.V.
The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB