When Brazilian Finance Minister Guido Mantega first warned of “an international currency war” in September, accusing some governments forcing down the value of their currencies in order to remain competitive, he seems to have struck a nerve. The US soon turned on China, claiming it was not letting the yuan rise freely. China responded by accusing the US of depreciating by stealth, highlighting the second round of quantative easing. In the meantime, emerging Asian countries, worried by the flood of foreign investment into their economies, threatened capital controls to stem the flow.
Some are arguing that this currency war threatens to undermine the global recovery. The matter was deemed to be so serious that it came to dominate the G20 meeting in Seoul, which ended with a vague compromise on currency devaluation and trade imbalances. But did the summit put the issue to bed, and just how worried should private investors be by the global situation?
Guy Monson, chief investment officer and managing partner at Sarasin, believes that the arguments over currency came to a head because currencies were a way for countries to keep their own domestic economies relatively stable without really having to face up to the core adjustments that were needed in the long-term.
“I think since the height of the credit crisis and the consequent move to emergency monetary measures, we have lived in a slightly fairytale world which has been big on talk and not really required much hard adjustment. We have lived in a world of quantative easing, of printed money, of a tolerance of very substantial budget deficits in the name of Keynesian stability.”
He says that we now seem to be moving to the second phase of the recovery, which will see hard adjustments having to be made in each of the local economic regions.
“The US have near double digit unemployment and a core CPI that is running at 0.8 per cent, dangerously close to technical deflation and showing all the dynamics of a Japanese-style mild but semi-permanent deflation. The Chinese are beginning to have to recognise that the super-normal fiscal stimulus to save growth has brought with it some imbalances in terms of loan provisions and inherent inflationary pressures. The Europeans have a relatively robust core but a fiscal problem in the periphery which was always going to need cross-border fiscal transfers as long as the weaker members remained in the euro.”
These three big factors, while impossible to ignore, were identified as things that could be done “tomorrow” under the guise that the whole economy was too fragile to see these issues being dealt with in an immediate manner, believes Mr Monson.
“Suddenly, and perhaps triggered by George Osbourne in the UK, there seems to be a view that you could talk about these things for so long but actually you have to establish a meaningful mid-term trajectory that will deal with them in real terms.”
He believes that the UK’s announcement of £81bn (€96bn) in spending cuts then mushroomed out into China and the other Asian countries who started to take the inflation issue more seriously, and the US saying that without a weakening dollar they had to resort to quantative easing to keep inflation positive. Meanwhile the Europeans finally acknowledged the Irish problem could not be bottled up, and recognised that it is probably the precursor to a similar programmes in Portugal, and possibly even Spain.
“I think that currency as the punch bag of the global economy has more or less run its course,” says Mr Monson. “When you read the G20 statement, away from some of the political posturing, it’s pretty straightforward. It says everybody must watch their global imbalances, surplus and deficit countries alike, and if that is all done in a reasonably unified framework, then actually the world economy can continue to grow. I am a bit more positive than many commentators, but I think we are putting a bit of inflation back into the system, putting a little bit of growth back in, but most of the individual regional players, but hook or by crook, are pulling the right levers.”
Alain Bokobza, head of global asset allocation at Société Génerale Corporate & Investment Banking, is also confident that the global situation should not deteriorate into a global currency war.
“Bernanke (chairman of the US Federal Reserve) has been careful when launching QE2 not to do too much, otherwise the dollar would have collapsed, or too little, triggering a sell-off of risky assets.”
But it is a certainty that zero or close-to-zero yield on US and other G8 fixed incomes assets will trigger a huge inflow into emerging markets, he explains, and that currency appreciation in developing world will be a long-term trend. He suggests emerging market bonds as a good way for investors to benefit from this rise as it is not easy to directly buy these currencies against the dollar as many of them are not freely quoting, having controlled or semi-controlled exchange rate-mechanisms.
