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Page added on May 11, 2016
The Coming War of Central Banks
Welcome to a currency war in which victory depends on your perspective.
History has shifted, and we’re leaving the era of central bank convergence and entering the era of central bank divergence, i.e. open conflict. In the good old days circa 2009-2014, central banks acted in concert to flood the global banking system with easy low-cost credit and push the U.S. dollar down, effectively boosting China (whose currency the RMB/yuan is pegged to the USD), commodities, emerging markets and global risk appetite.
That convergence trade blew up in mid-2014, and the global central banks have been unable to reverse history. In a mere seven months, the U.S. dollar soared from 80 to 100 on the USD Index (DXY), a gain of 25%–an enormous move in foreign exchange markets in which gains and losses are typically registered in 100ths of a percent.
This reversal blew up all the positive trades engineered by central banks: suddenly the yuan soared along with the dollar, crushing China’s competitiveness and capital flows; commodities tanked destroying the exports, currencies and economies of commodity-dependent nations; carry trades in which financiers borrowed cheap USD to invest in high-yielding emerging markets blew up as currency losses negated the higher returns, and global risk appetite vanished like mist in the Sahara.
The net result of this reversal is global markets have struggled since mid-2015, when the headwinds of the stronger dollar finally hit the global economy with full force.
In one last gasp of unified policy convergence, G20 nations agreed to crush the USD again in early March 2016, to save China from the consequences of a stronger yuan and the commodity markets (and lenders who over-extended loans to commodity producers).
That Shanghai Accord lasted all of two months. The engineered collapse has already reversed, and the USD is gaining ground, reversing the gains in risk assets, commodities and China’s export-dependent, debt-based stability.
The problem is there is no win-win solution to this foreign exchange battle. Japan and the Eurozone benefit from a stronger USD as the euro and yen weaken, but China loses as the USD soars.
Commodities lose when the USD gains, but the domestic U.S. consumer’s purchasing power increases as the USD strengthens.
It’s Triffin’s Paradox writ large: As the primary global reserve currency, The USD plays both a domestic and an international role, and each set of users has a different set of priorities.
No matter what policy the Federal Reserve pursues, there will be powerful winners and losers.
This sets up a war between central banks everywhere in which winning may be as disastrous as losing. The conventional central bank policy is to lower interest rates to weaken their currency, as a means of boosting exports.
But the unintended consequence of lowering rates is capital flight, as capital flees devaluation and negative returns and seeks higher returns elsewhere. This is a self-reinforcing process, as capital flight causes the currency to lose value, reducing the purchasing power and wealth of all who hold the currency. This motivates everyone who anticipates this devaluation to get their money out of the depreciating currency, which further weakens the currency which then triggers even more capital flight, and so on.
The only way to avoid the devaluation is to pull your cash out of that currency and put it into a currency that’s strengthening. For many, that currency will be the USD, due to its ubiquity and the liquidity of its capital markets.
Nations such as China are boxed into a lose-lose choice. If they lower rates to weaken their currency (to maintain a competitive export sector), they trigger capital flight, which weakens the domestic economy and creates a self-reinforcing feedback loop.
If they do nothing and their currency rises as other nations aggressively devalue their currencies, their export sectors whither as competing exporters take market share.
Any central bank that dares to raise rates will make their nation a magnet for capital seeking a higher return–both in yield and in currency appreciation.
The Fed is boxed in, too: if the Fed can’t raise rates after seven years of “growth,” then its credibility suffers. If it raises rates, that accelerates the capital flow into USD and the U.S., pushing the dollar higher, which then triggers mayhem in China, emerging markets, commodity markets and U.S. corporate profits earned overseas.
Welcome to a currency war in which victory depends on your perspective. If the USD continues strengthening, the winners will be those holding USD, as their currency will increase its purchasing power as other currencies devalue.
As I always note: no nation ever devalued its way to hegemony or empire.
Charles Hugh-Smith of OfTwoMinds blog
18 Comments on "The Coming War of Central Banks"
joe on Wed, 11th May 2016 11:49 am
Very concerning. Worth noting that this dichotomy is almost a sunk cost to the economy, one which wont resolve itself without the establishment of a new global agreement about how to organise global currencies. China has to bare a massive load in this regard, they cant continue in as they are, they need to reform or history will reform them. Nor can the US continue , it must share the world with everyone, sadly Americans have to suffer pain as well, by becoming poorer.
http://www.globalpetrolprices.com/Venezuela/gasoline_prices/
Its worth noting that since oil is priced in dollars and the massive overcharges the most of the world pays, oil is litterally, the US gets its oil for free when it increases rates and demand for dollars goes up. China is paying 1/3 more per litre and its priced in dollars! Thats a huge cost to them.
The issue of interest rates could force the world into a death struggle unless we can agree to a new system of trade, right now the new global empires, EU, China, SE Asia, South America are basically poised to slug it out in a race to the interest rate bottom, that leaves the US on top, and uncompetitive. Without Obama and support to car builders and the MIC the American industry would not exist. Dont know how Trump or Billary will save it in tbe next credit crunch which is sure to arrive the very second the global central banks turn off the money taps.
So what next?
Well, everything is changing. Religions are changing, politicians are changing, money is changing, nations are changing. The US built its model for the next century on two pillars, NATO and the dollar. Both today look both strong and vulnerable, like a middle aged boxer, that is still potent and powerfull but we know we are all waiting for the next big thing to come along. Renewables will certainly both ease the pain of collapse as hospitals will be able to keep machines on for less than a few thousand a day, but we may not be building many new machines for a while after collapse begins.
Saudi has begun to prepare for collapse, they know that the dollar is not going to last forever, nor is oil, but they hope to outlast both.
Davy on Wed, 11th May 2016 12:32 pm
“The problem is there is no win-win solution to this foreign exchange battle.” Yea because it is a “Prisoners dilemma”. Self-interest will rule once the floor drops out. There is little likelihood this world today is capable of cooperation even when that is the best approach.
What should be done? An Engineer and forced crisis initiated by limiting oil to the economy. This is the only way you will slow down economic activity and force localization. This is the key and that is to slow things down and force localization. Make people poor and force them to do survival activity not playing at the beach. This will mean loss of life because there is no way of avoiding this with any option. It is only the degree and duration that will change per the different options. The problem is this plan C (C is for collapse) is an even more remote prospect than a currency agreement. This forced slowdown is in the pike but it may take a few years until we get closer to the dead state of oil and or the economy just gives out.
onlooker on Wed, 11th May 2016 2:00 pm
The problem as I see it is they’re is no appetite either among the elite decision makers or the masses to power down or force collapse. Quite the contrary look at China and India obliviously continuing the American dream lifestyle over there. If people had the courage and foresight to truly look at the comprehensive predicament we are in and if the people in positions of power were also on board with confronting completely our true situation perhaps. But I just do NOT see that at all.
dave thompson on Wed, 11th May 2016 2:07 pm
Capitalism only understands the language of more, no matter what country you are from. Once more is no longer available capitalism as we know it will implode.
PracticalMaina on Wed, 11th May 2016 2:24 pm
I hope its a murder suicide. End the kleptocracy.
http://qz.com/681025/big-poultry-workers-are-literally-peeing-their-pants-so-that-americans-can-have-cheap-chicken/
PracticalMaina on Wed, 11th May 2016 2:30 pm
To the farmers market, screw supporting these companys. Some slightly more positive news to offset how sickening people in the food processing industry are treated. Germany is still making progress with Energiewende http://qz.com/680661/germany-had-so-much-renewable-energy-on-sunday-that-it-had-to-pay-people-to-use-electricity/
onlooker on Wed, 11th May 2016 2:31 pm
Yep, this is standard fare for Capitalism and the kleptomaniacs and plutocracy who demand profits at any costs to humans, animals and the Earth. I too hope in all goes to hell!
makati1 on Wed, 11th May 2016 7:03 pm
I’m waiting for the coming implosion of America as it finally meets it’s end. Anyone who can follow what is going on in the world can see American desperation everywhere. Attempts at starting WW3 is being blocked by the other two major powers, for now.
The current road to ruin started when TPTB organized the Federal Reserve in 1913. The destruction of America has been going on ever since. The idea of a One World government and economy, run by the Empire, was the plan. It obviously failed. Even the EU, one of it’s earliest ‘successes’ is on the verge of breaking up into it’s original countries. The major non-Western powers are blocking it’s consolidation in every direction. Large countries are breaking up into even smaller countries and eventually will be just regions or even tribes,, IF humans last long enough. That is how I see it today.
energy investor on Wed, 11th May 2016 11:12 pm
I am sure we would be much happier if we were content with our lot.
Beware what you wish for folks. Some of you certainly won’t get a good outcome.
Live long and prosper 🙂
Sissyfuss on Wed, 11th May 2016 11:18 pm
Wow! CHS and his two minds,(really just right and left hemispheres) sees the worlds problems in the sphere of financial machinations. What a relief! All this time I was so concerned with population overshoot, resource depletion, and an ever more hostile climate. Thanks for taking a load off, Charlie.
Cloud9 on Thu, 12th May 2016 6:48 am
In many parts of the world, the result of the reset will look like Somalia. Grand schemes aside, there are not enough of the necessary raw materials to maintain the current trends. Food is the commodity that matters and the last effort of the nation states will be to determine who eats and who starves. It will be interesting to see how the collapse plays out in various economic and cultural systems. Banking and fiat are of little importance in a failed state. I have no doubt the oligarchs will eat each other on the way down.
onlooker on Thu, 12th May 2016 7:01 am
I understand what your saying Energy investor. We in the rich countries are still afloat thanks to the System. However, for how much longer? I doubt too much longer. So, my view is I will be happy when the System collapses though I may personally suffer the consequences it is for the best for all life now and into the future.
Davy on Thu, 12th May 2016 7:34 am
LOL, without comment!
“Donald Trump Is Considering Newt Gingrich for Vice Presidential Role”
http://www.bloomberg.com/politics/articles/2016-05-12/donald-trump-said-to-weigh-newt-gingrich-for-vice-presidential-role
joe on Thu, 12th May 2016 8:16 am
With Trump its like, is he mad, or smart. Somtimes you know, sometimes you dont. I think Trump has had his day now. But to pick an establishment figure as a fop to unity will cost him the election. Being half revolutionary is like being half rotten. He really needs a curveball now, then take another look at him and see. How bout Trump/Gore? That would really impress me.
makati1 on Thu, 12th May 2016 8:56 am
That is, IF the FBI doesn’t have the balls to indite Hilary before the election, Trump, just might lose.
At this point, if he does lose and it appears to be rigged, it is the beginning of revolution in America.
Either way the FBI may still take her down before it gets to voting. I wonder who would step into her dirty shoes? LOL
JuanP on Thu, 12th May 2016 8:57 am
Joe “How bout Trump/Gore? That would really impress me.” I had never entertained that combo, it is an interesting idea.
JuanP on Thu, 12th May 2016 9:08 am
Onlooker “The problem as I see it is they’re is no appetite either among the elite decision makers or the masses to power down or force collapse.” I completely agree. I have been looking for decades for evidence to convince me that this is not so to no avail. It is what we are. We are our worst enemies.
And people who hope that an economic slowdown or less fossil fuels will keep us from frying the biosphere simply don’t understand human nature. If a person can light a fire with wood, sticks, grass, peat, BS, and whatnot, humanity can burn the biosphere. Add to that Climate Change and increasing wildfires and the results are obvious.
onlooker on Thu, 12th May 2016 10:02 am
Yes Juan, runaway climate change seems now to be baked into the pie so to speak. It will be the nail in our coffin.