The irresistible attraction of the perfect currency storm

After more than twenty years of stagnation and increase in its public debt, Japan appears ready to break this vicious circle. Unfortunately, the solution proposed by the new Government led by Shinzo Abe looks more like sailing full steam ahead towards a monetary and economic Pearl Harbor.

As a result of government pressure, the Bank of Japan announced that it set a target for inflation of 2% and will launch a program of quantitative easing without an expiration date, starting in January 2014, as part of which it will begin purchasing 13 trillion yen (152 billion dollars) of government bonds monthly.

Prime Minister Abe has welcomed the decision of the Bank of Japan and described it as historic. Markets were disappointed that the show is slow to start and bought the yen, strengthening it.

What does it feel like to Bernanke, whose latest unlimited money printing program is "just" 85 billion dollars a month? Will he want to exceed the new standard of monetary insanity and end his term at the helm of the Federal Reserve in an ocean of confetti?

Before any reaction from the Fed, major industrial groups in the United States were already complaining. A recent article from Bloomberg said that "auto manufacturers in the US are asking President Obama to punish Japan for its weakening of the yen." The urge came from the Automotive Policy Council, a group which comprises Ford Motor, General Motors and Chrysler. US car manufacturers are convinced that the depreciation of the yen leads to disrupting trade relations between the two countries, and this policy is unacceptable", Bloomberg further writes.

It remains to be seen whether President Obama will be able to satisfy the wishes of each of its domestic lobby groups, especially since the viability of the auto industry is viewed with skepticism in the White House. "A White House insider told me that the bailout of the auto industry was aimed at paying the pensions of the union members, but the industry does not have long-term viability", James Rickards, executive director at Tangent Capital Partners and author of the book "Currency Wars", recently wrote on Twitter.

The currency war, known as "competitive depreciation" is a term that refers to the package of monetary and exchange rate policies implemented with a view of depreciating a nation's currency. The Finance Minister of Brazil used this term in September 2010 in a criticism of a quantitative easing program launched by the Federal Reserve.

James Rickards views the year 2010 as the starting point for the new global currency war. The quantitative relaxation programs of the main central banks have now reached the stage where the negative effects on trading partners, in particular those of the emerging economies, can no longer be denied.

Entirely disregarding the implications of starting the printing presses of the Federal Reserve at full speed, the studies of US economic institutes are blaming others for the loss of US and lay the theoretic foundations for an out of control global currency war.

According to a December 2012 study, of the Peterson Institute for International Economics, US trading partners are responsible, through the depreciation of their national currencies, for the loss of 5 million jobs in the United States. The main culprits would be China, Denmark, Hong Kong, Korea, Malaysia, Singapore, Switzerland and Taiwan.

Starting this year, Japan has quickly gained a spot on the list of the Peterson Institute, probably going straight to the top position.

The main argument of Fred Bergsten and Joseph Gagnon, the authors of the report, is the accelerated increase of the foreign exchange reserves. But what Bergsten and Gagnon are forgetting is the main reason behind the accumulation of these reserves: the successive quantitative easing programs of the relaxation Federal Reserve.

Countries from the list of the Peterson Institute did nothing else but desperately cling to maintaining a strong foreign competitiveness, which, with very few exceptions, was threatened by domestic lending bubbles.

Emerging economies are caught in the crossfire of the wars between the major economic powers. "The wave of cash from major central banks causes new boats to rise: the countries of emerging Europe," Reuters writes.

Anna Suszynska, director in the Polish Ministry of Finance, said that the "unorthodox policy of the Fed and the ECB are a threat to the entire region", also according to Reuters. All emerging economies in Central and Eastern Europe have been faced with massive inflows of speculative capital lately, amid attractive margins. At first glance, the effects are beneficial: the borrowing costs of the governments drop and national currencies strengthen.

But the miracle may not last long. "If this unorthodox policy will be stopped, that means bond yields will grow very quickly," Anna Suszynska said, at a conference organized by Euromoney magazine.

Will central banks listen to the stream of warnings, launched by the emerging economies? Almost certainly not, because the major economic powers are nowhere near ready to take measures of fiscal prudence which they ceaselessly advise others to take.

The Prime Deputy Governor of the Bank of Russia said that "the world is close to a new currency war", given that "Japan is weakening its yen, and other countries could follow suit." Similar statements have come from China, Brazil and South Korea. The Governor of the Central Bank of South Korea said that a steep decline of the yen "could cause an active response to minimize the impact on exports and investor confidence", according to a piece of news by Reuters.

Before handing over the reins as head of the Eurogroup, Jean-Claude Juncker has warned of the danger represented by an overly strong Euro. Chris Turner, at ING Groep in London views Juncker's statement as "the first shot of the European authorities in the currency war of 2013".

According to the opinions on James Rickards' Twitter account, Russia is well prepared for this confrontation, because its gold reserves, relative to GDP, are larger than China's and are nearing those of the United States.

China is also arming itself with gold to handle the regional currency wars, which are very close to turning into a global perfect storm. Nor is it any wonder, given that the major currencies have depreciated rapidly towards this monetary standard (see chart), despite the efforts of the central banks of the neutralization of its historical role.

"Since the Fed has launched QE2, in august 2010, we have been in a currency war," Alessio Longis, portfolio manager of the Oppenheimer Currency Opportunities Fund, who expects an acceleration of competitive currency depreciation, given that the US is the "leader" of the entire process.

Michael Meister, a member of the Government coalition in Germany, told Bloomberg that Japan's actions could trigger countermeasures at a European level, and Germany could submit this issue for debate in the context of the of the near meeting of the G20 members.

Convinced that the economic stagnation of Japan has structural causes, Meister correctly assesses the danger of a spiral of downward depreciations. "What could be the options of Japan's competitors? Either we are all intelligent and we do nothing, or we follow their example and we will create a spiral which will affect us all", the German MP said.

A spokesman at the Ministry of Finance in Berlin sought to assuage the foreign exchange markets, saying there is no evidence that Japan was engaged in competitive depreciation of the yen and that there is no reason for concern regarding the relationship between the euro and the yen.

Does anybody still appreciate this kind of dark humor after so many years of crisis? Of course, that the official statements of the governments and central banks have no value. The gradual expansion of the regional currency wars on a global level is happening in spite of an agreement signed in 2009 by the G20 Finance Ministers, by which they promised that "they would refrain from competitive devaluation of currencies".

The escalation of the global currency conflict will continue unabated, due to increasingly difficult economic problems, which will be covered by foreign "adventures" similar to those of the United States and France. Let's hope that Michael Meister's advice will be followed by Germany at least, and the Government in Berlin will be able to convince European partners of the importance of non-combat on the currency wars front.

Just like in Japan, the economic problems of Europe have structural causes, being generated by the fiscal oppression, excessive bureaucracy and an irresponsible monetary policy.

It is worth waiting for signs of intelligence on the part of the European authorities? Unfortunately, this is an extremely risky bet and instead of waiting for Godot, maybe it would be better to prepare our individual defensive systems.

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Note: The article represents the author's point of view, it does not reflect or imply the opinions of the institution that employs him and it does not represent an investment recommendation.