Rumors of Currency Wars Are Greatly Exaggerated

I knew Bill Gross. Bill Gross was a friend of mine. You, sir, are no Bill Gross.

I am tempted to paraphrase that famous line Lloyd Bentsen delivered to Dan Quayle during their 1988 vice presidential debate and throw it at Bill Gross himself.

The reason for this tantrum, if a blogger needs one, is Bill’s latest monthly investment outlook, titled, “Going to the Dogs.” It’s a very long essay about various dog breeds, but Bill’s key point, as Bloomberg summarizes in one sentence, is that “a global race to devalue currencies in an ‘undeclared’ war risks slowing growth instead of stimulating it.”

Unfortunately, Bill is not alone in making that assertion. Many others have said as much.

But the issue is that it is just not true.

Devalued Currencies Are the Result of Policy Choices

First and foremost, today’s presumed currency wars, as opposed to those of years gone by, are a consequence, as opposed to the primary motivation, of policy choices. Take the U.S. for example. When it implemented quantitative easing (QE) policies, the dollar softened, as it should. But the driver for the policy wasn’t the weakness of the dollar per se, it was a desire to ease financial conditions. The weaker currency was one of the transmission mechanisms but not the primary driver. And it worked, perhaps not as well as we would have liked, but we can all agree it got the U.S. onto a stable path.

I believe the same thing happened in Europe. A weaker euro was a consequence of the policy, not the primary driver. I would argue that European Central Bank (ECB) president Mario Draghi has to be commended rather than scolded for implementing this policy.

Further, in my opinion, in a demand-short world, where there is little political will for aggressive fiscal action on a global basis, the easing of monetary policy ought to be a universal goal. To say it is the cause of the global problems we face today, I believe, is putting the cart before the horse.

Consequences and Casualties of Easy Money Policies

To be sure, there is no free lunch anywhere. The easy money policy has consequences and casualties. Savers, and institutions that service savers, are very vulnerable in this framework. Nevertheless, they would be just as vulnerable, maybe even more, if the world fell into an economic depression. As a saver, I don’t like it any more than the next guy, but the hard reality is that without the easy money policy and the consequent “currency wars” the world would be a worse, not a better, place.

That brings me to my next point. In a world where capital is supposed to flow freely, the presumed “currency wars” are the transmission mechanisms to equalize demand and supply of goods and capital. And the currency markets are actually working the way they should. For example, if it were not for the current strong dollar, the Federal Reserve would be tempted to raise U.S. rates even though it would be a mistake on a global basis. However, the rise in the dollar has given the Fed a reason to be more deliberate and thoughtful than it would have been in the past. So score one for the positive side of currency wars.

What’s more, the real pain of the currency wars is being felt by the currency pegs, the Swiss franc and the Chinese renminbi (RMB), for example. Again, in a world of free floating capital, the presumed currency wars prove the point that two countries that have very different economic environments cannot have the same monetary policy for mercantile or political reasons alone. Pegs are just not going to work and they will be dismantled.

In that regard, two of the largest pegs in the world haven’t yet joined the “currency wars.”

I predict the RMB will join the battle in the not too distant future. In a slowing Chinese economy, monetary conditions will continue to tighten and the Chinese will be forced to buy yuans to maintain the peg. That needs to reverse. The Chinese need easing, and I believe removing the currency peg is the best thing they can do to achieve that.

Within the Eurozone, which is home to the mother of all currency pegs, individual countries such as Greece, Spain, Portugal, Italy, and others cannot devalue. The Eurozone may not join the currency wars in this generation.

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