Have Currency Wars Begun?

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Over the last several months U.S. and Chinese government officials have volleyed back and forth criticisms of the other country’s monetary policies.  Just weeks ago the Bank of Japan formally intervened on the currency markets to weaken the yen.  Other central banks, including Brazil, Colombia, Peru, Romania, Russia, Serbia, South Korea, Switzerland and Thailand, have similarly acted to prevent their currencies from rising, not all successfully.  Australia, England and Israel are plotting strategies to push their currencies to levels that will keep their exports competitive.  Brazil’s Finance Minister Guido Mantega declared that currency wars have begun.

This is more than an arcane footnote in pages of the financial press.  History has not been kind to the equity markets of countries caught in the maelstrom of currency crises.  When countries with conflicting objectives undertake beggar-thy-neighbor monetary policies, protectionism and trade wars frequently result.  Most notably in our own country, the competitive devaluations of the 1930s, plus actions like the Smoot-Hawley Tariff Act, provoked retaliatory actions with our trading partners that contributed to a halving of U.S. trade volumes.  The subsequent consequences for the stock market during the Great Depression are legendary.

The progress of competitive currency devaluations is extremely hard to predict, even among normally friendly trading partners.  We can see among our European allies how contentious is the issue of a common rescue of overindebted nations within the European Union.  And this is among countries trying to protect a common currency.  Contentiousness can grow exponentially when far more disparate national objectives are introduced into the equation.

We have all learned to our great dismay over the past decade the extent to which excess leverage can multiply adverse effects in the equity markets.  The currency markets are far larger and are monumentally leveraged.  In a September 30 blog post, Graham Summers pointed out that the currency markets trade over $4 trillion per day on average.  At that rate, a mere nine days of currency trading would equal the market capitalizations of all the world’s stock markets combined.  At leverage rates that can magnify positions by 50 to one or 100 to one, mistakes or mere miscalculations by warring central banks could have disastrous consequences.

We cannot know how this growing currency war will conclude, but its size and leveraged nature offer myriad opportunities for untoward results.  As countries grow increasingly protective in a world of deficient consumer demand, a favorable outcome becomes increasingly unlikely.  It poses yet another big danger for the equity investor.

Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.