The Unlikely Benefit from the Currency War on the Australian Dollar

Currency Wars author Jim Rickards is bullish on three currencies, but you might only guess one.

They’re gold, the euro and the Australian dollar. More on that in a moment.

The Wall Street veteran was in Sydney this week and spoke to a hundred or so Port Phillip Publishing subscribers in a special ‘Strategy Session’.

His position hasn’t changed since he published his book last year.

The world is in a currency war. The combatants are the United States, Europe and China.

With their domestic economies struggling, all of them are trying to devalue their currencies to increase their exports.

As his book lays out, the problem for the world is that the failing US dollar is the reserve currency. Practically everything pivots off it.

But devaluing the dollar erodes trust in paper money, and unintended consequences will collide with complex systems. So prepare for some huge shifts as international finance and global capital start to unbalance.

Until recently the only credible alternative to the US dollar was the euro. But right now no one is sure if it’s even going to survive.

The old global financial system is dying. The only question is how the new one will come about.

Currency Wars Are Nothing New

The cycle to currency devaluation goes something like this. With consumers looking to pay down debt or unwilling to spend, there is weak demand. In the face of weak demand, there’s less investment.

Governments can only spend so much in their vain attempts to prop up a struggling economy. That leaves one area of potential growth possible – exports. The fastest way to boost exports is to make them cheaper.

But it’s really a covert way to ‘steal’ growth. The world as a whole is no better off. And eventually there’s a retaliation.

The catch is no one can win. Depreciating your currency does not work in the long term. It has never worked. And the major problem with trade wars is that they can lead to shooting wars.

That doesn’t mean politicians won’t try it.

The precedents for this were set last century. Rickards says this is the third currency war since 1900.

The first was from 1921-1936, in the aftermath of the First World War.

The second was 1967-1987 after the Bretton Woods system broke down.

At that time, US President Richard Nixon told America’s trading partners to revalue their currencies higher against the US dollar or the US would tax every foreign product coming into America. An agreement saw the US dollar devalued against such currencies as the yen, mark, franc and sterling.

From Currency Wars:

‘[It] was extremely popular in the United States and led to a significantly rally in stocks as investors contemplated higher dollar profits in steel, autos, aircraft, movies and other sectors that would benefit from increased exports or fewer imports, or both…Unfortunately, those euphoric expectations were soon crushed. Less than two years later, the United States found itself in its worst recession since World War II, with collapsing GDP, skyrocketing unemployment, an oil crisis, a crashing stock market and runaway inflation.’

Faith in the US dollar took a trashing in the seventies, with high inflation that cut its purchasing power in half. There was a genuine fear of a run on the dollar. Foreign investors started to pull their money out of the United States.

One of the symptoms of this panic was the super spike in the gold price. Gold ran from the mid-$600’s to a peak of $850 in four days.

The other effect was huge capital flows that fled to smaller, and supposedly safer currencies such as the Canadian dollar and German mark. This caused those currencies to rise in value too.

This is happening to the Australian dollar now.

Australian Dollar Benefits from Global Turmoil

Today, Australia has a similar problem to the Swiss. Money has flowed into the Swiss franc, mainly from investors diversifying out of the euro. This put pressure on Switzerland’s exporters as their goods became prohibitively expensive.

So the Swiss central bank continues to deliberately intervene in the market to sell francs and buy euros and other foreign currencies to hold down the value of the franc. This maintains the peg with the euro.

It also means Swiss foreign exchange reserves are growing – plenty of which are Australian dollars. Bidding from central banks like this is one factor behind the strength in the Aussie dollar.

Usually a currency forms its value based on fundamental things like money supply, terms of trade, foreign reserves and, in the case of Australia, commodity prices.

With commodity prices down and the terms of trade worsening, you’d normally expect the Australian dollar to fall from these bearish indicators.

The ‘risk off’ trade causes capital to flee Australia to the perceived safety and huge liquidity of such markets as the US dollar or Japanese yen.

Jim Rickards says that right now those factors are irrelevant. The fundamentals get shoved aside.

The big players that direct global capital think Australia is the place to hide as the currency storm worsens.

And he warns that the Australian dollar might get even stronger. This would mean new all-time highs measured against the US dollar and the euro.

That means no relief for Australian manufacturers or tourism operators, who prefer a weaker currency.

And it also means more gold for your Aussie dollars while it lasts…

Gold Bound to Be a Part of New System

‘The path of the dollar is unsustainable and therefore the dollar will not be sustained.’

That’s the first line of Jim Rickard’s conclusion to Currency Wars. His opinion is that the US dollar is in terminal decline. That means the anchor of the global financial system is lost. This will result in volatile and unstable markets (and societies) with diminished world trade until a new system emerges.

He doesn’t rule out complete chaos beforehand. In fact, Rickards suggests it’s more likely than anything else. What he means is that the system will simply cease to function properly. Emergency controls could be put in place.

Of course, it’s not the only possibility, but even an attempt to stabilize the current dollar against gold considering the inflated money supply would rerate gold much higher than today’s price.

For the moment though, gold is getting cheaper in Aussie dollar terms. Rickards advice is to use the strength in the Aussie dollar to diversify into the currency most likely to survive intact in the new financial system coming.

Sounds like a smart move to us.

Callum Newman
Editor, Money Weekend

The Most Important Story This Week…

For a long time Kris Sayce, editor of Money Morning and Australian Small-Cap Investigator, has had a negative outlook on green energy, including solar energy. Then something happened to change his view. Government cost cutting removed subsidies.

This impacts on the entire industry. In sounds counter intuitive, but it’s a blessing. Now, solar and alternative energy might have a significant role to play in the energy landscape. Investors prepared to take a stake could see very healthy profits. See what he says in Why I’ve Done a U-Turn on Solar Energy.

Other Recent Highlights…

Merryn Somerset Webb on China’s Economy and the Mother of All Property Bubbles: “Local governments have also taken out huge loans backed by land grants to finance their increasingly extreme-looking infrastructure projects, while on some estimates a good 50% of China’s GDP is linked to the Chinese property market one way and another. That makes it pretty much the biggest emerging market property bubble ever.”

Jeffrey Tucker on The Amazing Ethanol Scam in the USA: “Everyone blames the drought, as if the market can’t normally handle a supply change. The real problem is that the corn market is fundamentally misshaped by government interventions that have made a mess of this and many more markets. The distortions are never contained, but spread and spread.”

Dr. Alex Cowie on Are Gold Stocks About to Turn?: “With such drastic falls, gold stocks now look ridiculously cheap…Of course, I’m not the first to make that claim. Many, including myself, have had their fingers burnt trying to call the bottom for gold stocks this year. But there are growing signs that the worst is now behind us.”

Peter Krauth on The Dumb Money Hates Silver, It’s Time to Go Long: “I’ll show you, right now a number of technical, seasonal, and sentiment indicators are pointing upwards for this volatile metal. This could well be the critical turning point silver investors have been waiting for. One of these indicators is the resilient price of gold. Let me explain.”

Comments are closed.