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The Currency War Is Not New: It's Merely Escalating

By: Michael Ashton | Wednesday, February 13, 2013

A quick summary of where we are in the "global currency war:"

For several years now, global central banks have been engaging quietly in this war. Each central bank has been implicitly playing "beggar-thy-neighbor" by making its currency relatively plentiful, and therefore relatively cheaper, than its neighbors. In one case, that of Switzerland, the currency issue became explicit rather than implicit, though not to weaken its currency but rather to stop it from strengthening without bound (see Chart, source Bloomberg). It is instructive that, in order to accomplish this end, the SNB had to pledge to print unlimited quantities of Swiss Francs to sell - essentially saying that if it can't beat 'em, it would have to join 'em.

Swiss Franc

Now, in January some well-known asset managers muttered the 'currency war' phrase, and Japan's Economic Minister Akira Amari suggested that the Yen could fall 10% (and Japanese officials have implied that they are looking for such a move to help end deflation). Since then, both the G20 and the G7 have discussed whether countries ought to be engaging in currency adjustment as a means of confronting macroeconomic challenges. Searches for the term "currency war" on Google (see chart, source Google) have risen appreciably. But again, this isn't really new; what's new is that people are actually talking about it.

Currency War Searches

Earlier this month Adair Turner, chairman of the Financial Services Authority talked about "permanent monetary easing" and said that central bankers "may need to be a little bit more relaxed about the creation" of money. By permanent, he means that the central bank would print money with the express intention that the printing would never be reversed. Ignoring history, Lord Turner said "the potential benefits of paper money creation [to stimulate the economy] should not be ignored." Today, the Bank of England released its quarterly forecasts, showing policymaker expectations that inflation will stay higher than the Bank's target for longer than expected, and growth will be weaker than expected. Even less surprising, given talk about "permanent" easing, is that 10-year UK inflation swaps are now back above 3.40% (see chart, source Bloomberg). The first 30bps of this jump was due to the decision by the ONS to maintain the current definition of RPI for existing contracts (I mentioned this here), but some amount of it is probably due to the currency wars talk.

It bears noting too that the 10-year US inflation swap is within a handful of basis points of its post-Lehman highs.

The UK inflation market has been around longer than other inflation markets. Index-linked Gilts date back to the early 1980s. So I wonder whether we shouldn't be a bit more curious about how much of the rise in UK inflation expectations actually reflect a rise in global inflation expectations due to the currency wars that are (and have been) underway.

Because to some extent, the question of "who will win" the currency war is difficult to discern, and to some extent the question is moot. Like in the movie "WarGames," the only thing that has been certain since the currency war started a couple of years ago is that there will be a lot of scorched earth. The only real "winners" are debtors, relative to lenders.

War Games

Who will win? To change the analogy: if you're in a bay surrounded by people in boats who are pumping water in so that they can see who can sink his boat the fastest, the winner is the one who is wearing a life vest. All the others are just some varying grade of loser. Don't be the last one to grab a life vest.

 

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

Copyright © 2010-2014 Michael Ashton