Wall Street Journal notices currency market manipulation

Section:

Maybe in a few years the newspaper will notice gold market manipulation as well. The Financial Times has started to.

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Currency War Will End in Apocalypse or Redemption

By Francesca Guerrera
The Wall Street Journal
Monday, February 4, 2013

http://online.wsj.com/article/SB1000142412788732476100457828368419589225...

"Devaluing a currency," one senior Federal Reserve official once told me, "is like peeing in bed. It feels good at first, but pretty soon it becomes a real mess."

In recent times foreign-exchange incontinence appears to have been the policy of choice in capitals from Beijing to Washington, via Tokyo. The resulting mess has led to warnings of a global "currency war" that could spiral into protectionism.

The roll call of forex Cassandras reads like a who's who of global finance and politics: German leader Angela Merkel, Federal Reserve Bank of St. Louis President James Bullard, Bundesbank President Jens Weidmann and Mervyn King, the outgoing governor of the Bank of England. And the list goes on.

The luminaries are wrong on a couple of points. The world isn't "on the verge" of a currency war, as they seem to think, but right in the middle of one. But -- and here's the good news -- there is a chance this confrontation might not end as badly as, say, the destructive devaluations that followed the Great Depression or even the turmoil of the Asian financial crisis of 1997-1998.

... Dispatch continues below ...



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Currency wars have been a staple of modern finance ever since the collapse of the Bretton Woods system of fixed exchange rates in the early 1970s. As Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co., says: "Most governments believe that their currencies are too important to be left to the markets." So policy makers have often tried to manipulate the value of their currencies by intervening in the markets.

In recent years, China stands out as the country that has done the most to keep its currency weak in order to boost exports. But it isn't alone. China's efforts have sparked what Fred Bergsten, senior fellow at the Peterson Institute for International Economics, calls "emulation and retaliation."

At their worst, these periodic crosscurrents of intervention have led to "beggar-thy-neighbor" policies -- self-defeating attempts to improve one country's economy at the expense of everybody else's.

The present situation is, however, fundamentally different. Most of the currency-market tensions aren't the byproduct of direct intervention or trade wars but of extreme monetary measures that are attempts to make up for nonexistent fiscal policies.

As developed countries like Japan and the U.S. try to kick-start their sluggish economies with ultralow interest rates and binges of money-printing, they are putting downward pressure on their currencies. The loose monetary policies are primarily aimed at stimulating domestic demand. But their effects spill over into the currency world.

Since the end of November, when it became clear that Shinzo Abe and his agenda of growth-at-all-costs would win Japan's elections, the yen has lost more than 10% against the dollar and some 15% against the euro.

These moves are angering export-driven countries such as Brazil and South Korea. But they also are stirring the pot in Europe. The euro zone has largely sat out this round of monetary stimulus and now finds itself in the invidious position of having a contracting economy and a rising currency—making Thursday's meeting of the European Central Bank a must-watch event.

The dirty secret is that using monetary policy to weaken a currency, whether voluntarily or not, is a shortcut to avoid unpopular decisions on fiscal and budgetary issues.

"I don't remember central banks being so deep in experimental mode," says Mohamed El-Erian, chief executive and co-chief investment officer of Pacific Investment Management Co. "It is equivalent to a pharmaceutical company that feels forced to bring a new medicine to the market even though it has not been properly tested."

How will it end? There are two results: apocalypse or redemption.

James Rickards, a veteran financier and author of "Currency Wars: The Making of the Next Global Crisis," predicts the former.

"People ask me who's winning. I say nobody," he told me. "I expect the international monetary system to destabilize and collapse. There will be so much money-printing by so many central banks that people's confidence in paper money will wane and inflation will rise sharply."

Breakdowns of the global foreign-exchange system have occurred with drastic regularity, but that doesn't mean this currency war will end in tears.

For a start, common sense could prevail, putting an end to the dangerous game of beggar (and blame) thy neighbor. After all, the International Monetary Fund was set up to prevent such races to the bottom and should try to broker a truce among forex combatants.

If that sounds naive, consider the possibility that this huge bout of monetary stimulus will succeed in engendering a solid recovery driven by domestic demand. Or that fiscal policy will finally be put to work.

Either outcome would take away a big incentive for competitive devaluations and prompt governments to bolster their currencies to avoid stoking inflation.

Growth cures a lot of ills. Even forex incontinence.

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