Currency Wars or Economic Readjustment?

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Mar 30, 2015 3:07:00 PM

and tagged Commentary

Leave a comment

currency warsAfter writing Friday’s piece on currency wars, it occurred to me that some of the assumptions baked into my argument warranted a closer look. Essentially, instead of a war, I believe we’re seeing an economic readjustment, which is a significantly different way of looking at the situation.

The gap between the currency war viewpoint and the economic readjustment viewpoint largely stems from two differences in underlying assumptions:

  • Whether you view currencies as absolute or relative entities
  • The primary orientation of governments (external or internal)
Currency changes: no longer a zero-sum game

The era of the last major currency wars, between the two World Wars, illustrates quite well what I’m talking about here. I did a review some time ago of a very good book on this era, but for purposes of our discussion today, let’s summarize.

Briefly, the central problem in that era was the gold standard. With exchange rates fixed against gold, countries really were competing directly against each other for that gold. They couldn’t simply change the value of their currency; it was an absolute. Today, we can see this in the struggles of countries in the eurozone—Greece in particular—where the euro is held as an absolute.

The gold standard, in particular, was very good at retaining the value of a currency at an absolute level over time, and this took discretion away from the governments. Since then, of course, the world has gone off of the gold standard to what are called fiat currencies, which have no absolute standard and no fixed value, and depend solely on governmental support. Because of this, comparing currencies with each other is no longer an exercise in absolutes, but a relative comparison.

This is a key issue when considering the idea of currency wars. An absolute relation means that any changes a government makes to its currency are zero-sum—one country’s gain is another’s loss. A relative relationship, on the other hand, can be positive-sum, with both countries gaining. Zero-sum versus positive-sum is the difference between war and adjustment.

Governments increasingly look inward

The second major difference in today’s situation is the orientation of governments—by which I mean the intention of policy changes.

I would argue that in most of the last century, governmental policies were driven largely by international relations. France made policy based on what benefited its international position, rather than what benefited the French population. Again, the gold standard gives us a good example: recessions and depressions caused by adjustments to conform to the gold supply were considered necessary and unavoidable.

Nowadays, we can see the effects of this type of policy in Greece, Spain, and even France—and the populations (and governments) are much less accepting. Countries versus countries is war. Countries trying to improve economic situations for their citizens is adjustment.

Things are just different now

These two points outline why today’s “currency wars” are different from those of the past. First, even as currencies change in value, there is no absolute standard. Second, countries are now making decisions based more on what is best for their populations, rather than international competition.

What does this mean today?

  • It means Japan and Europe aren’t aiming to take down the U.S. in international trade. Rather, they’re desperately trying to spark jobs and growth.
  • It means that the value of the yen and euro may bounce around, relative to the dollar and each other, but those changes are not pure gain or loss.
  • It means that the U.S. can actually benefit—in the form of increased exports, for example—as growth elsewhere increases, driven by lower currency values.

In short, the idea of “currency wars” is based on the underlying ideas of international competition and zero-sum games, neither of which apply to nearly the degree they used to. A currency war simply doesn’t fit the way countries operate today. 

Europe is a great illustration of many of the points I’m making here, and we will take a look at that next.

                        Subscribe to the Independent Market Observer            

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®