The following is an excellent excerpt from the book “CURRENCY WARS: The Making of the Next Global Crisis” by James Rickards from Chapter 7 “The G20 Solution” on page 134 and I quote: “By June 2011, however the United states was emerging as a winner in the currency war. Like winners in many wars throughout history, the United States had a secret weapon. That financial weapon was what went by the ungainly name “quantitative easing,” or QE, which essentially consists of increasing the money supply to inflate asset prices. As in 1971, the United States was acting unilaterally to weaken the dollar through inflation. QE was a policy bomb dropped on the global economy in 2009, and its successor, promptly dubbed QE2, was dropped in late 2010. The impact on the world monetary system was swift and effective. By using quantitative easing to generate inflation abroad, the United States was increasing the cost structure of almost every major exporting nation and fast-growing emerging economy in the world all at once.
Quantitative easing in its simplest form is just printing money. To create money from thin air, the Federal Reserve buys Treasury securities from a select group of banks called primary dealers. The primary dealers have a global base of customers, ranging from sovereign wealth funds, other central banks, pension funds and institutional investors to high-net-worth individuals. The dealers act as intermediaries between the Fed and the marketplace by underwriting Treasury auctions of new debt and making a market in existing debt.
When the Fed wants to reduce the money supply, they sell securities to the primary dealers. The securities go to the dealers and the money paid to the Fed simply disappears. Conversely, when the Fed wants to increase the money supply, they buy securities from the dealers. The Fed takes delivery of the securities and pays the dealers with freshly printed money. The money goes into the dealers’ bank accounts, where it can then support even more money creation by the banking system. This buying and selling of securities between the Fed and the primary dealers is the main form of open market operations. The usual purpose of open market operations is to control short-term interest rates, which the Fed typically does by buying or selling the shortest-maturity Treasury securities—instrument such as Treasury bills maturing in thirty days. But what happens when interest rates in the shortest maturities are already zero and The Fed wants to provide additional monetary “ease”? Instead of buying very short maturities, the Fed can buy Treasury notes with intermediate maturities of five, seven or ten years. The ten-year note in particular is the benchmark used to price mortgages and corporate debt. By buying intermediate-term debt, the Fed could provide lower interest rates for home buyers and corporate borrowers to hopefully stimulate more economic activity. At least, this was the conventional theory.
In a globalized world, however, exchange rates act like a waterslide to move the effect of interest rates around quickly. Quantitative easing could be used by the Fed not just to ease financial conditions in the United States but also in China. It was the perfect currency war weapon and the Fed knew it. Quantitative easing worked because of the yuan-dollar peg maintained by the People’s Bank of China. As the Fed printed more money in its QE programs, much of that money found its way to China in the form of trade surpluses or not money inflows looking for higher profits than were available in the United States. Once the dollars got to China, they were soaked up by the central bank in exchange for newly printed yuan. The more money the Fed printed, the more money China had to print to maintain the peg. China’s policy of pegging the yuan to the dollar was based on the mistaken belief and misplaced hope that the Fed would not abuse its money printing privileges. Now the Fed was printing with a vengeance.
There was one important difference between the United States and China. The United States was a slack economy with little chance of inflation in the short run. China was a booming economy and had bounced back nicely from the Panic of 2008. There was less excess capacity in China to absorb the new money without causing inflation. The money printing in China quickly led to higher prices there. China was now importing inflation from the United States through the exchange rate peg after previously having exported its deflation to the United States the same way.
While the yuan revaluation was going slowly in late 2010 and early 2011, inflation in China took off and quickly passed 5 percent on an annualized basis. By refusing to revalue, China was getting inflation instead. The United States was happy either way, because revaluation and inflation both increased the costs of Chinese exports and made the United States more competitive. From June 2010 through January 2011, yuan revaluation had moved at about a 4 percent annualized rate and Chinese inflation was moving at a 5 percent annualized rate so the total increase in the Chinese cost structure by adding revaluation and inflation was 9 percent. Projected over several years, this meant that the dollar would decline over 20 percent relative to the yuan in terms of export prices. This was exactly what Senator Chuck Schumer and other critics in the United States had been calling for. China now had no good options. If it maintained the currency peg, the Fed would keep printing and inflation in China would get out of control. If China revalued, it might keep a lid on inflation, but its cost structure would go up when measured in other currencies. The Fed and the United States would win either way.
While revaluation and inflation might be economic equivalents when it came to increasing costs, there was one important difference. Revaluation could be controlled to some extent since the Chinese could direct the timing of each change in the pegged rate even if the Fed was forcing the overall direction. Inflation, on the other hand, was essentially uncontrolled. It could emerge in one sector such as food or fuel and quickly spread through supply chains in unpredictable ways. Inflation could have huge behavioral impacts and start to feed on itself in a self-fulfilling cycle as merchants and wholesalers raised prices in anticipation of price increases by others.
Inflation was one of the catalysts of the June 1989 Tiananmen Square protests, which ended in Massacre. Conservative Chinese counted on a steady relationship between their currency and the dollar and a steady value for their massive holdings of U.S. Treasury debt, exactly as Europe has enjoyed in the early days of Bretton Woods. Now they were betrayed—the Fed was forcing their hand. Given the choice between uncontrolled inflation with unforeseen consequences and a controlled revaluation of the yuan, the Chinese moved steadily in the direction of revaluation beginning in June 2010, increasing dramatically by mid-2011.
The United States had won round one of the currency wars. Like a heavyweight boxing match between the United States and China, it was round one of what promised to be a fifteen-round fight. Both boxers were still standing; the United States had won the round on points, not with a knockout. The Fed was planted in the U.S. corner like a cut man ready to fix the damage. China had help in its corner too—from QE victims around the world. Soon the bell would toll to start round two.
When the principal combatants use their weapons in any war, noncombatants soon suffer collateral damage, and a currency war is no different. The inflation the United States had desperately sought not only found its way to China but also to emerging markets generally. Through combination of trade surpluses and hot money flows seeking higher investment returns, inflation caused by U.S. money printing soon emerged in South Korea, Brazil, Indonesia, Thailand, Vietnam and elsewhere. Fed chairman Bernanke blithely adopted a “blame the victim” approach, saying that those countries had no one to blame but themselves because they’d refused to appreciate their currencies against the dollar in order to reduce their surpluses and slow down the hot money. In the anodyne language of central bankers, Bernanke said: “Policy makers in the emerging markets have a range of powerful. . . tools that they can use to manage their economies and prevent overheating, including exchange rate adjustment. . . . Resurgent demand in the emerging markets had contributed significantly to the sharp run-up in global commodity prices. More generally, the maintenance of undervalued currencies by some countries has contributed to a pattern of global spending that is unbalanced and unsustainable.”
This ignored the fact that many of the commodities that residents of those countries were purchasing, such as wheat, corn, oil, soybeans, lumber coffee and sugar, are priced on world, not local, markets. As consumers in specific markets bid up prices in response to Fed money printing, prices rise not only in those local markets but also worldwide.
Soon the effects of Fed money printing were felt not only in the relatively successful emerging markets of East Asia and Latin America, but also in the much poorer parts of Africa and the Middle East. When a factory worker lives on $12,000 per year, rising food prices are an inconvenience. When a peasant lives on $3,000 per year, rising food prices are the difference between eating and starving, between life and death. The civil unrest, riots and insurrection that erupted in Tunisia in early 2011 and quickly spread to Egypt, Jordan, Yemen, Morocco, Libya and beyond were as much a reaction to rising food and energy prices and lower standards of living as they were to dictatorships and lack of democracy. Countries in the Middle East strained their budgets to subsidize staples such as bread to mitigate the worst effects of this inflation. This converted the inflation problem into a fiscal problem, especially in Egypt, where tax collection became chaotic and revenues from tourism dried up in the aftermath of the Arab Spring revolutions. The situation became so dire that the G8 meeting in Deauville, France, in May 2011, hastily arranged a $20 billion pledge of new financial support to Egypt and Tunisia. Bernanke was already out of touch with the travails of average Americans; now he was increasingly out of touch with the world.
It remained to be seen whether the G20 could divert the United States from its runaway fiscal and monetary policies, which were flooding the world with dollars and causing global inflation in food and energy prices. For its part, the United States sought allies inside the G20 such as France and Brazil to apply pressure on the Chinese to revalue. The U.S. view was that everyone—Europe, North America and Latin America—would gain exports and growth if China revalued the yuan and increased domestic consumption. This may have been true in theory, but the U.S. strategy of flooding the world with dollars seemed to be causing great harm in the meantime. China and the United States were engaged in a global game of chicken, with China sticking to its export model and the United States trying to inflate away China’s export cost advantage. But inflation was not confined to China, and the whole world grew alarmed at the damage. The G20 was supposed to provide a forum to coordinate global economic policies, but it was starting to look more like a playground with two bullies daring everyone else to chose sides.
In the run-up to the G20 leaders’ summit in Seoul in November 2010, Geithner tried to paint China into a corner by articulating a percentage test for when trade surpluses became excessive and unsustainable from a global perspective. In general, any annual trade surplus in excess of 4 percent of GDP would be treated as a sign that the currency of the surplus country needed to be revalued in order to tilt the terms of trade away from the surplus country and toward deficit countries like the United States. This was something that used to happen automatically under the classical gold standard but now required central bank currency manipulation.
Geithner’s idea went nowhere. He had wanted to target China, yet, unfortunately for his thesis, Germany also became a target, because the German trade surplus was about as large as China’s when expressed as a percentage of GDP. By Geithner’s own metrics, the Germany and the rest of Europe wanted, given the precarious nature of their economic recoveries, the structural weakness of their banking system and the importance of German exports to Europe’s job situation. Finding support in neither Europe nor Asia, Genthner quietly dropped the idea.
Instead of setting firm targets, the Seoul G20 leaders’ summit suggested the idea of “indicative guidelines” for determining when trade surpluses might be at unsustainable levels. The exact nature of these guidelines was left to a subsequent meeting of the finance ministers and central bank governors to work out. In February 2011, the ministers and governors met in Paris and agreed in principle on what factors might be included as “indicators,” but they did not yet agree on exactly what level of each indicator might be tolerated, or not, within the indicative guidelines. That quantification process was left for a subsequent meeting in April and the entire process was left up to the final approval of the G20 leaders themselves at the annual meeting, in Cannes in November 2011.
Meanwhile, the empowerment of the IMF as the watchdog of the G20 continued apace. In a March 2011 conference in Nanjing, China, attended by experts and economists, G20 president Nicolas Sarkozy said, with regard to balance of payments, “Greater supervision by the IMF appears indispensible.”
Saying that the G20 process moves forward at a glacial pace seems kind. Yet with twenty sovereign leaders and as many different agendas, it was not clear what the alternative would be if a global solution was to be achieved. This is the downside of Geithner’s theory of convening power. The absence of governance can be efficient if the people in the room are like-minded or if one party in the room has the ability to coerce the others, as had been true when the Fed confronted the fourteen families at the time of the LTCM bailout. When the assembled parties have widely divergent goals and different views on how to achieve those goals, the absence of leadership means that minute incremental change is the best that can be hoped for. By 2011 it appeared that the changes were so minute and so slow as to be no change at all.
The G20 was far from perfect as an institution, but it was all the world had. The G7 model seemed dead and the United Nations offered nothing comparable. The IMF was capable of good technical analysis; it was useful as a referee of whatever policies the G20 cold agree on. But IMF governance was heavily weighted to the old trilateral model of North America, Japan and Western Europe, and its influence was resented in the emerging markets powerhouses such as China, India, Brazil and Indonesia. The IMF was useful; however, change would also be needed there to conform to new global realities.
In late 2008 and early 2009, the G20 was able to coordinate policy effectively because the members were united by fear. The collapse of capital markets, world trade, industrial output and employment had been so catastrophic as to force a consensus on bailouts, stimulus and new forms of regulation on banks.
By 2011, it appeared the storm had passed and the G20 members were back to their individual agendas—continued large surpluses for China and Germany and continued efforts by the United States to undermine the dollar to reverse those surpluses and help U.S. exports. Yet there was no Richard Nixon around to take preemptive action and no John Connally to knock heads. America had lost its clout. It would take another crisis to prompt unified action by the G20. Given the policy of U.S. money printing and its inflationary side effects around the world, it seemed the next crisis would not be long in coming.
That crisis arrived with a jolt near the city of Sendai, Japan, on the afternoon of March 11, 2011. A 9.0 earthquake followed quickly by a ten-meter-high tsunami devastated the northeast coastline of Japan, killing thousands, inundating entire towns and villages, and destroying infrastructure of every kind—ports, fishing fleets, farms, bridges, roads and communications. Within days the worst nuclear disaster since Chernobyl had commenced at a nuclear power plant near Sendai, with the meltdown of radioactive fuel rods in several reactors and the release of radiation in plumes affecting the general public. As the world wrestled with the aftermath, a new front arose in the currency wars. The Japanese yen suddenly surged to a record high against the dollar, bolstered by expectations of massive yen repatriation by Japanese investors to fund reconstruction. Japan held over $2 trillion in assets outside of the country, mostly in the United States, and over $850 billion of dollar-dominated reserves. Some portion of these would have to be sold in dollars, converted to yen and moved back to Japan to pay for rebuilding. This massive sell-dollars/buy-yen dynamic was behind the surge in the yen.
From the U.S. perspective, the rise in the yen relative to the dollar seemed to fit nicely into the U.S. goals, yet Japan wanted the opposite. The Japanese economy was facing a catastrophe, and a cheap yen would help promote Japanese exports and get the Japanese economy back on its feet. The magnitude of the catastrophe in Japan was just too great—for now the U.S. policy of a cheap dollar would have to take a backseat to the need for a cheap yen.
There was no denying the urgency of Japan’s need to cash out its dollar assets to fund its reconstruction; this was the force driving the yen higher. Only the force of coordinated central bank intervention would be powerful enough to push back against the flood of yen pouring back into Japan. The yen-dollar relationship was too specialized for G20 action, and there was no G20 meeting imminent anyway. The big three of the United States, Japan and the European Central Bank would address the problem themselves.
Under the banner of the G7, French finance minister Christine Lagarde placed a phone call to U.S. Treasury secretary Geithner on March 17, 2011, to initiate a coordinated assault on the yen. After consultations among the central bank heads responsible for the actual intervention and a briefing to President Obama, the attack on the yen was launched at the open of business in Japan on the morning of March 18, 2011. This attack consisted of massive dumping of yen by central banks and corresponding purchases of dollars, euros, Swiss francs and other currencies. The attack continued around the world and across time zones as European and New York markets opened. This central bank intervention was successful, and by late in the day on March 18 the yen had been pushed off its highs and was moving back into a more normal trading range against the dollar. Legarde’s deft handling of the yen intervention enhanced her already strong reputation for crisis management earned during the Panic of 2008 and the first phase of the euro sovereign debt crisis in 2010. She was the near universal choice to replace the disgraced Dominique Strauss-Kahn as head of the IMF in June 2011.
If the G20 was like a massive army, the G7 had shown it could still play the role of specialforces, acting quickly and stealthily to achieve a narrowly defined goal. The G7 had turned the tide at least temporarily. However, the natural force of yen repatriation to Japan had not gone away, nor had the speculators who anticipate and profit from such moves. For a while, it was back to the bad old days of the 1970s and 1980s as a small group of central banks fended off attacks from speculators and the fundamental forces of revaluation. In the larger scheme of things, Japan’s need for a weak yen was a setback to the U.S. plan for a weak dollar. The classic beggar-thy-neighbor problem of competitive devaluations had taken on a new face. Now, in addition to China, the United States and Europe all wanting to weaken their currencies, Japan, which had traditionally been willing to play along with U.S. wishes for a stronger yen, found itself in the cheap-currency camp too. Not everyone could cheapen at once; the circle still could not be squared. Ultimately the dollar-yen struggle would be added to the dollar-yuan fight already on theG20 agenda as the world sought a global solution to its currency woes.”
Page 163 – Chapter 8 “Globalization and State Capital” and I quote: “Commodities include not only things like gold, oil and copper, but also the stocks of mining companies that own commodities—and indirect way of owning the commodity itself—and agricultural land that can be used to grow commodities such as wheat, corn, sugar and coffee. Also included is the most valuable commodity of all—water. Special funds are being organized to buy exclusive rights to freshwater from deep lakes and glaciers in Patagonia. The Chinese can invest in those funds or buy freshwater sources outright.”
(JAMES RICKARDS EXPLANATION OF WHAT A COMMODITY IS, IS EXACTLY CORRECT, EVEN TO THE POINT OF THE VALUE OF WHAT GOOD DRINKING WATER IS, WHICH IS JUST AS VALUABLE AS ANY OF THE OTHER COMMODITIES WHEN TRADING WITH ONE ANOTHER. THE ONLY DIFFERENCE IS THE ADVANTAGE OF CURRENCY BACKED BY GOLD AND SILVER, WHILE THEY ARE COMMODITIES, IT’S AN EASY WAY TO MAKE TRANSACTIONS BETWEEN COMMODITIES BECAUSE IT’S AN EASY CURRENCY TO CARRY. THAT’S WHY PRES FRANKLIN ROOSEVELT HAD THE MEETING AT BRETTON WOODS, NEW HAMPSHIRE IN JULY 1944. IT WAS IMPORTANT THAT THE DIFFERENT NATIONS LIVED UP TO THEIR RESPONSIBILITIES. THE PROBLEM CAME IN WHEN WORTHLESS DERIVATIVES DID AND IT WAS REALLY REVEALED IN THE ARTICLE IN THE FEBRUARY 9 – FEBRUARY 15, 2015 ISSUE OF BLOOMBERG BUSINESSWEEK ON PAGE 64 WRITTEN BY VERNON SILVER TITLED “THE GOLD IS THERE. THE GOLD IS NOT THERE. OR IS IT?” HOW COULD COUNTRIES BE SO DISHONEST WITH ONE ANOTHER THAT THEY DIDN’T EVEN KNOW WHERE THEIR GOLD RESERVES WERE. THIS IS THE GOVERNMENT LYING TO THEIR PEOPLE AND PROVED AGAIN JUST HOW INTELLIGENT PRES ROOSEVELT AND THE 44 COUNTRIES WERE WHEN THEY HAD THE BRETTON WOODS MEETING. ACCORDING TO CHAPTER 9 “THE MISUSE OF ECONOMICS,” ON PAGE 174, AND I QUOTE: THE FINANCIAL CRISIS INQUIRY COMMISSION REPORT: “WE CONCLUDE WIDESPREAD FAILURES IN FINANCIAL REGULATION AND SUPERVISION PROVED DEVASTATING TO THE STABILITY OF THE NATION’S FINANCIAL MARKETS. THE SENTRIES WERE NOT AT THEIR POSTS.”
LaVern Isely, Progressive, Independent, Overtaxed, Middle Class Taxpayer and Public Citizen and AARP Members