Currency Wars: The Making of the Next Global Crisis (19 page)

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Authors: James Rickards

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China also had an interest in propping up the euro, but its efforts came with a political agenda. Europe is a huge export market for China as well as the United States, and to that extent China’s interests are the same as the United States. But China’s banks are not nearly as entwined with Europe’s as are America’s, which gives China more degrees of freedom in terms of deciding how and when to help. The European sovereign debt crisis offered China the chance to diversify its reserves and investment portfolios away from dollars and toward euros, to acquire leading-edge technology systems that had been denied it by the United States and to develop platforms from which it could engage in large-scale technology transfer back to China.
Germany welcomed the U.S. and Chinese support for the euro. As an export powerhouse, Germany might have been expected to favor a weak euro for the same reason that the United States favors a weak dollar and China favors a weak yuan: to gain an edge in the currency wars with a cheap currency that promotes exports. Germany, however, was not only an external exporter; it was an
internal
exporter within the European Union. For those eurozone exports, there was no currency consideration since both the exporter and the importer, for instance Germany and Spain, used the euro. If the euro were to collapse or members broke away from the euro and reverted to their old currencies at devalued levels, those markets might be lost.
Conventional wisdom had it that Germany anguished over support for Greece and Ireland and the other weak links in the euro chain. In fact, Germany had no attractive alternatives. The costs of a euro collapse far outweighed the costs of regional bailouts. Germany actually benefitted from the European sovereign debt crisis. The continued existence of the euro gave Germany a dominant position inside Europe while a somewhat weaker euro internationally enabled it to gain market share in the rest of the world. The sweet spot for Germany was a euro that was weak enough to help exports to the United States and China but not so weak as to collapse. Germany was successful in finding that sweet spot during 2010 despite the sturm und drang surrounding the euro itself.
With the self-interests of the United States, China and Germany all pointing in the same direction, there would be no doubt for now about the survival of the euro. That the banks were flush with rotten assets, that the periphery nations were running nonsustainable fiscal policies and that the people of Greece, Ireland, Portugal and Spain were facing austerity in order to keep the assembly lines moving in Seattle and Shanghai were all matters that could wait for another day. For now, the center held.
The Eurasian Theater
 
If the relationship between the euro and the dollar can be described as codependent, the relationship between the euro and the yuan is simply dependent. China is fast emerging as a potential savior of certain peripheral European economies such as Greece, Portugal and Spain based on Chinese willingness to buy some of their sovereign bonds in the midst of the European sovereign debt crisis. However, Chinese intentions toward Europe and the euro are based on self-interest and cold calculation.
China has a vital interest in a strong euro. The European Union surpasses the United States as China’s largest trading partner. If European turmoil were to result in countries such as Greece or Ireland leaving the euro, those countries would return to their former currencies at greatly devalued rates relative to the yuan. This would badly hurt China’s exports to parts of Europe. China’s interest in supporting the euro is as great or greater than its interest in maintaining the yuan peg against the dollar.
China’s motives in Europe include diversifying its reserve position to include more euros, winning respect or friendship among the European countries that it assists directly with bond purchases, and gaining a quid pro quo in connection with such purchases. This quid pro quo can take many forms, including direct foreign investment in sensitive infrastructure such as ports and power generation, access to sensitive European technology and the ability to purchase advanced weapons systems normally reserved for NATO allies and friends such as Israel. China’s interests in supporting the euro are not at all adverse to those of Germany, even though Germany and China compete fiercely for export business around the world.
By buying sovereign bonds from peripheral European states, China helps Germany to bear the costs of the European bailouts. By helping to prop up the euro, China helps Germany avoid the losses it would suffer if the euro collapsed, including catastrophic damage to German banks. It is a no-lose situation for China and one that secures its Eurasian flank while it fights the United States head-on. China’s main front in the currency wars is the United States, and it has so far avoided a conflagration on the Eurasian front. This is due both to European weakness and Chinese finesse.
The United States likewise supports the euro, and for the same reasons as China: a catastrophic collapse of the euro would weaken its value relative to the dollar and hurt U.S. exports that compete with European exports in markets of the Middle East, Latin America and South Asia. China and the United States not only want the euro to survive; they also want to see it gain strength relative to the dollar and yuan in order to help their own exports. Europe, China and the United States are united in their efforts to avoid a euro collapse despite their mixed motives and adversarial postures in other arenas.
This much unity of purpose probably means that the euro will muddle through the current crisis and remain intact for the foreseeable future, despite potential bond restructurings and austerity plans. Whether this balancing act can be continued and whether China’s charm offensive in Europe will be maintained remains to be seen. If the euro actually does collapse, China could suffer massive losses on its bond positions, a revaluation of the yuan and lost exports all at the same time. China may yet come into confrontation with Europe on a number of issues, but for now it is all quiet on China’s western front.
Global Skirmishes
 
Apart from the big three theaters in the currency war—the Pacific (dollar-yuan), the Atlantic (euro-dollar) and the Eurasian (euro-yuan) —there are numerous other fronts, sideshows and skirmishes going on around the world. The most prominent of these peripheral actions in the currency war is Brazil.
As late as 1994, Brazil maintained a peg of its currency, the real, to the U.S. dollar. However, the global contagion resulting from the Mexican “Tequila Crisis” of December 1994 put pressure on the real and forced Brazil to defend its currency. The result was the Real Plan, by which Brazil engaged in a series of managed devaluations of the real against the dollar. The real was devalued about 30 percent from 1995 to 1997.
After this success in managing the dollar value of the real to a more sustainable level, Brazil once again became the victim of contagion. This time the crisis did not arise in Latin America but from East Asia. This new financial crisis broke out in 1997 and spread around the world from Thailand to Indonesia, South Korea, and Russia and finally came to rest in Brazil, where the IMF arranged a monetary firewall with emergency funding as the Fed frantically cut U.S. interest rates to provide needed global liquidity. In the aftermath of that financial storm, and under IMF prompting, Brazil moved to a free-floating currency and a more open capital account, but it still experienced periodic balance-of-payments crises and required IMF assistance again in 2002.
Brazil’s fortunes took a decided turn for the better with the 2002 election to the presidency of Luiz Inácio Lula da Silva, known as Lula. Under his leadership from 2003 through 2010, Brazil underwent a vast expansion of its natural resource export capacity along with significant advances in its technology and manufacturing base. Its Embraer aircraft became world-class and catapulted Brazil to the position of the world’s third largest aircraft producer. Its huge internal market also became a magnet for global capital flows seeking higher returns, especially after the collapse of yields in U.S. and European markets following the Panic of 2008.
Over the course of 2009 and 2010, the real rallied from fewer than 2.4 reais to the dollar to 1.69 reais to the dollar. This 40 percent upward revaluation of the real against the dollar in just two years was enormously painful to the Brazilian export sector. Brazil’s bilateral trade with the United States went from an approximately $15 billion surplus to a $6 billion deficit over the same two-year period. This collapse in the trade surplus with the United States was what prompted Brazilian finance minister Guido Mantega to declare in late September 2010 that a global currency war had begun.
Because of the yuan-dollar peg maintained by China, a 40 percent revaluation of the real against the dollar also meant a 40 percent revaluation against the yuan. Brazil’s exports suffered not only at the high end against U.S. technology but also at the low end against Chinese assembly and textiles. Brazil fought back with currency intervention by its central bank, increases in reserve requirements on any local banks taking short positions in dollars, and other forms of capital controls.
In late 2010, Lula’s successor as president, Dilma Rousseff, vowed to press the G20 and the IMF for rules that would identify currency manipulators—presumably both China
and
the United States—in order to relieve the upward pressure on the real. Brazil’s efforts to restrain the appreciation of the real met with some short-term success in late 2010 but immediately gave rise to another problem—inflation. Brazil was now importing inflation from the United States as it tried to hold the real steady against the dollar in the face of massive money printing by the Fed.
Brazil was now experiencing the same dilemma as China, having to choose between inflation and revaluation. When the United States is printing dollars and another country is trying to peg its currency to the dollar, that country ends up printing local currency to maintain the peg, which causes local inflation. As a consequence, investors chasing high returns around the world, the so-called hot money, poured into Brazil from the United States. The situation had deteriorated to the point that a Nomura Global Economics research report in early 2011 declared Brazil the biggest loser in the currency wars. This was true up to a point, based on the appreciation of the real. By April 2011, Brazil was “waving the white flag in the currency war,” in the words of a
Wall Street Journal
analysis. Brazil appeared resigned to a higher value for the real after currency controls, taxes on foreign investments and other measures had failed to stop its appreciation.
Lacking the reserves and surpluses of the Chinese, Brazil was unable to maintain a peg against the dollar by simply buying all the dollars that arrived on its doorstep. Brazil was stuck between the rock of currency appreciation and the hard place of inflation. As was the case with the United States and the Europeans, albeit for different reasons, Brazil increasingly looked to the G20 for help in the currency wars.
Brazil is an important case because of its geographic, demographic and economic scale, but it is by no means the only country caught in the cross fire of a currency war among the dollar, euro and yuan. Other countries implementing or considering capital controls to stem inflows of hot money, especially dollars, include India, Indonesia, South Korea, Malaysia, Singapore, South Africa, Taiwan and Thailand. In every case, the fear is that their currencies will become overvalued and their exports will suffer as the result of the Fed’s easy money policies and the resulting flood of dollars sloshing around the world in search of high yields and more rapid growth.
These capital controls took various forms depending on the preferences of the central banks and finance ministries imposing them. In 2010, Indonesia and Taiwan curtailed the issuance of short-term investment paper, which forced hot money investors to invest for longer periods of time. South Korea and Thailand imposed withholding taxes on interest paid on government debt to foreign investors as a way to discourage such investment and to reduce upward pressure on their currencies. The case of Thailand was ironic because Thailand was the country where the 1997–1998 financial panic began. In that panic, investors were trying to get their money out of Thailand and the country was trying to prop up its currency. In 2011 investors were trying to get their money into Thailand and the country was trying to hold down its currency. There could be no clearer example of the shift in financial power between emerging markets such as Thailand and developed markets such as the United States over the past ten years.
None of these peripheral, mostly Asian, countries trying to hold down the value of their currencies is the issuer of a widely accepted reserve currency, and none has the sheer economic scale of the United States, China or the eurozone when it comes to the ability to fight a currency war by direct market intervention. These countries too would need a multilateral forum within which to resolve the stresses caused by Currency War III. While the IMF has traditionally provided such a forum, increasingly all of the large trading economies, whether G20 members or not, are looking to the G20 for guidance or new rules of the game to keep the currency wars from escalating and causing irreparable harm to themselves and the world.
CHAPTER 7
 
The G20 Solution
 
“Let me put it simply . . . there may be a contradiction between the interests of the financial world and the interests of the political world.... We cannot keep constantly explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money from taking those risks.”

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