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CURRENCY WARS: Belligerent Bullies
The Currency War being heralded by the media is not what it appears. Remember:
"Strategy is something that happens TO YOU while YOU ARE LOOKING the other way!"
As in the game of chess, which taught warriors of yesteryear about strategy and how the elements of cunning and positioning delivered 'check mate', this game is about understanding the strategy being slyly carried out. Currency Wars may be an old game, but it is a very different battlefield today, utilizing quite a deceptive strategy in this modern era of FIAT Currencies.
This is also a war being fought out of necessity. Rather than be destroyed by over indebtedness, it requires weakening sovereigns combatants to strike first before it is too late and their debt quickly erodes existing strategic advantage. It involves taking full advantage of the malinvestment and mispricing, which presently shrouds the difference between price and value. As Warren Buffett is fond of saying: "Price is what you Pay, Value is what you Get". Never has this been more true than in today's Bond and Currency Markets.
AN OLD GAME - NEW BATTLEFIELD
Currency Wars are an element of the Beggar-Thy-Neighbor game, but they are only one side of the game. Currency Wars are the export component of what is part of historically a Trade War. The other side is the import element which is more easily identifiable as part of a Trade War because it typically involves easily recognizable trade barriers and protectionism. Today the later elements are highly restricted by the regulations of the recently established World Trade Organization (WTO).
The latest barrage in Currency interventions was perfectly predictable, as was the inevitability of what would be labeled "Currency Wars".
Prior to the dot.com bubble this eventuality was identified and laid out by some luminaries such as the Comstock Fund. A chart that they published then, and have steadfastly defended to this day, is show to the right. It is a chart that has hung on my office wall for well over a decade.
The area circled in red identifies the natural process that the cycle of deflation has lead to: Competitive Devaluation which we are experiencing today, then to Protectionism and Tariffs, then to full scale Beggar-Thy-Neighbor.
In our 2010 Thesis paper "Beggar-Thy-Neighbor" (available at gordontlong.com) we used this idealized cycle as a framework to consider the major new developments associated with the rapid advancement of Globalization, Structural Trade Imbalances, Currency Swaps and the US dollar's growing exposure as the world's Reserve Currency.
It then led us to outline that the Financial Crisis would evolve quickly into a Global Economic Crisis and then a Political Crisis, as monetary malpractice associated with unsound money practices would lead to moral hazard and unintended consequences and then to malinvestment, mispricing and dysfunctional markets. This is exactly where it has led us.
By consequence we knew this would lead to dramatic expansion of monetary bases and central bank balance sheets. Throughout 2011 we ended almost every Global Insights audio broadcast with "Don't worry, They'll print the money!". It was perfectly predictable, as is the road map for the next stage which now lays in front of us.
To understand the Currency War currently in play, we need to appreciate how the situational landscape will be different in this latest reincarnation of a Currency War. Then we can discuss who the combatants will be and what will be steering strategy.
NEW BATTLEFIED - This Time It Really is Different
After WWI the French went to great length and expense to construct the magnificent and impregnable Maginot Line between Germany and themselves. It was never tested. Hitler reinvented warfare with the Blitzkrieg and highly mobile armor. He quickly flanked the Maginot Line and was in Paris before the French could get their 'strategically positioned' troops off the Maginot Line. Warfare is fought that way. It is always about startling new changes in the "rules", usually due to revolutionary technology advancements and an unexpected new strategy that capitalizes on them.
This war is no different. It is about TECHNOLOGY and STRATEGY once again.
It is critical to recognize that never has a Currency War been fought within the context of the following situational conditions:
As I mentioned earlier, this Currency War is being fought out of necessity. Rather than be destroyed by over indebtedness, it requires weakening sovereigns combatants to strike first before it is too late, or their debt will quickly erode their existing tenuous strategic advantage. They must be the aggressor even against their former allies if they are to survive. They must do what they have preached against others doing before they are destroyed by those who are also being forced into the same compromising position. Political leaders only understand the necessity of survival, not a loyalty that would outlasts their brief elected tenures.
HOW THE BELLIGERENTS TIP THEIR HAND
FINANCIAL REPRESSION: Belligerents will force Negative Real Interest Rates
The mortar and missiles being launched from the belligerents are one of 'hot money', money that overwhelms the smaller recipient countries and is incredibly disruptive financially, economically and politically.
The hot money typically forces the recipient to counter in ways which produces destabilizing domestic inflation.
It normally forces controls such as: capital controls, trade controls, price controls and often wage controls to be implemented.
Bushfire battles are igniting everywhere around the globe. The underlying problem of liquidity pumping by the developed economies is increasingly causing widening distortions in the following hotspots:
THE ARGENTINEAN ROAD MAP
Currency Wars Lead to Capital Controls which lead to Export Controls, which lead to Price Controls, which lead to Media Controls, which lead to.... more AUTHORITARIAN CENTRAL STATE CONTROLS.
TECHNOLOGY & STRATEGY
Let's now consider the new disruptive technology and strategy that can, and is being used.
Obviously, sovereign Cyberwar technologies are top secret and classified. We therefore don't know the details, so we can only speculate. We do know however many things, such as years ago, James Rickards was involved in Currency War Games with the US Military which front ended his acclaimed book on Currency Wars. Clearly its strategic importance within the context of financial technologies has been well understood for some time.
CYBER DISRUPTION - CYBERTHREAT - CYBERWAR (DISRUPTIVE AGENTS)
To understand the strategy we only need to return to the Cycle of Deflation chart we started out with. For the cycle to finish and turn upward, the malinvestment and mispricing must be cleared. We require a market clearing event that resets prices and allows pricing power and investment to return to the markets.
The BELLIGERENTS UNDERSTAND AND & KNOW THIS IS THE ONLY WAY OUT - IT IS INEVITABLE!
When the capitalist system is working in an unrestricted fashion, this is normally and naturally achieved through:
When this is understood (and none are presently considered an option because of the degree of leverage and rehypothecation exposure), then you are left with only have a limited number of options:
The Central Bankers have tried #1,#2 and #3 over the last five years and they have failed to gain sufficient traction.
Rapid debasement of the Currency is now the required strategy.
DON'T BE FOOLED
"Strategy is Something That Happens TO YOU while you are LOOKING THE OTHER WAY"
Growth is shrinking globally and the Belligerents know it. Fighting over a piece of a shrinking economic pie is a zero sum game and the Currency Cartel is also keenly aware of this.
THIS CURRENCY WAR IS ONLY SECONDARILY A TRADE WAR.
The central bankers are loading the Helicopters with only one purpose: to quickly bomb the value out of their debt through coordinated debasement of their currency.
Deceptive acronyms like OMF (Overt Monetary Funding) will soon join the lexicon to replace QE∞ and ZIRP.
The casualties will be the holders of the paper that the Currency Cartel will print ad infinitum.
Those holders, are pensioners and elderly who are dependent on the government for sound money policies. The government considers them easy prey.
Those holders such as foreigners who have accepted Cartel Currency in 'trade for kind', will also be raped. The government now considers them casualties versus valued trading partners.
All are signs of desperation of a trapped animal with no obvious way out.
The regimes currently running sovereign policy are likely to go down in history as some of the worst the world has ever seen.
The strategy is deceptive but illusionary.
This strategy, like the ones that preceded it, will fail miserably.
Part I: The Belligerents - 20 Minutes, 25 Slides
Part II: Bushfire Battles Blazing - 22 Minutes, 32 Slides
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Gordon T Long
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments.
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