The Keiser Report: Currency Wars and Devaluation

This is a great episode of The Keiser Report, where the hosts discuss how the global economy is drowning in central banking.  Max Keiser then interviews Jim Rickards, the best-selling author of "Currency Wars", who suggests not only are western central banks and bullion banks suppressing
gold prices, but so are the Chinese, who are buyers of physical gold.   While western central banks are printing trillions of currency units, the Chinese are accumulating gold at discount prices.

http://rt.com/shows/keiser-report/episode-449-max-keiser-731/

Deflation: Making Sure "It" Doesn't Happen Here - Ben Bernanke

Anticipating Fed monetary policies are key to formulating investment theses.  The link below is a peak into Fed Chairman Ben Bernanke's thoughts on fighting deflation before he became Chairman.  It serves as a road map for policies the Fed has since deployed to counteract the financial crisis, including Quantitative Easing (purchase of Treasury bonds and mortgage-backed securities) and Operation Twist (selling short-term Treasuries and buying long-term Treasury bonds).  See the excerpt below on FDR's dollar devaluation when he confiscated gold in 1933 (emphasis in boldface is mine).

For those with time constraints, the key take away is the Fed's monetary policies are inherently inflationary, and explicitly devalue the USDollar.  In other words, as long as these policies are in place, gold--priced in dollars, can only go up.

Contrast that to new Treasury Secretary nominee Jack Lew's declaration that the US Treasury will maintain its "strong dollar policy."  Whatever.

http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior). Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities. There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt. 

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Fiscal Policy
Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money. 

 Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

Venezuela Launches First Nuke In Currency Wars, Devalues Currency By 46%

http://www.zerohedge.com/news/2013-02-08/venezuela-devalues-its-currency-32

Japan's Chain Of Events: Stagnation -> Monetization -> Devaluation -> Stabilization -> Retaliation -> Hyperinflation

http://www.zerohedge.com/news/2013-01-21/japans-deja-vu-chain-events-stagnation-monetization-devaluation-stabilization-retali

China Focus: Office established to handle forex reserve loans

The Chinese are hedging their gargantuan dollar exposure.  By lending out their huge dollar reserves, they will effectively devalue the dollar, while using said dollars to accumulate assets to counterbalance dollar devaluation.

Why is this important to Americans?  Expect higher import prices--and higher prices on everything.

http://news.xinhuanet.com/english/china/2013-01/14/c_132102317.htm

Japan lashes out over depreciating dollar and euro

Anybody still have doubts about whether a currency war of devaluation isn't taking place?

http://www.gata.org/node/12080

How can they notice Swiss franc's devaluation and not gold's too?

http://www.gata.org/node/10445

Currency war threatens

http://finance.yahoo.com/news/End-to-currency-dispute-apf-206553150.html?x=0

Differences that threaten the outbreak of a currency war persisted after a weekend meeting of global finance ministers, who left without resolving what to do.

Various nations are seeking to devalue their currencies as a way to increase exports and jobs during hard economic times. The concern is that such efforts could trigger a repeat of the trade wars that contributed to the Great Depression of the 1930s as country after country raises protectionist barriers to imported goods.

"Currency disputes can easily become trade disputes," cautioned Canadian Finance Minister Jim Flaherty.

Currency Rumble Royale

When a country's currency is devalued relative to other countries' currencies, the expected result is that individual country's exports are relatively cheaper compared to the other countries'. Hence, the motivation behind central banks devaluing their currency is to stimulate exports and by extension, the domestic economy. However, this devaluation is a zero-sum game, because as one country's exports increase, another country's exports decrease, relatively-speaking. And when all countries attempt to boost their exports by devaluing their currencies, it becomes a competitive currency race to the bottom, destroying the wealth of their citizens.

Why is that? How can the stimulation of a country's exports be destructive to the wealth of its citizens? Because even though exports to other countries are cheaper, and since the value of the local currency is cheapened, imports and domestic items are more expensive. A debased currency causes price inflation in the local economy; it takes more local paper currency to purchase items like food, water, energy, and shelter. Everybody suffers diminished purchasing power. Inflation is a hidden tax, reducing the standard of living for everyone, especially the lower and middle classes.

But sovereign nations are doing exactly that--manipulating their currencies lower to keep their factories humming and capping unemployment. China doesn't want the yuan to appreciate by 40% relative to other currencies (specifically the USDollar) because 200 million jobs are at risk. So they peg their yuan to a USDollar that is being systematically destroyed by the Fed, which accommodates an overspending Congress. In other words, it is the Fed that is manipulating the USDollar, as China piggybacks the yuan on the USDollar.

But US politicians need a scapegoat, and the Chinese are a convenient target. In fact, Japan intervened and devalued the yen last week, raising the ire of officials in the Euro zone and the US. And they also triggered trade war rhetoric with China. All told, more than 25 countries devalued their currencies recently, as they each attempt to fix their impaired domestic economies. It is analogous to mass mutual currency suicide, as the wages and purchasing power of their citizens are structurally destroyed.

That's why the last man standing in this currency war will be precious metals. Precious metals are scarce and carry a finite supply--they cannot be created by a printing press. They must be discovered and mined, which takes 10 - 15 years. The easy discoveries are long gone, and ore quality (ounces per ton) has deteriorated. Miners must wander off to geopolitically unstable regions to find it, dig deeper, satisfy tougher environmental constraints, invest more in the local communities, and expend higher costs for energy, water, and labor to produce smaller quantities of the metals. Hence, supply is shrinking, even while investment demand is soaring.

See disclaimers in the side bar.

Disclosure: long precious metals and long mining equities.