Wednesday, August 8, 2018

Currencies Continue Trading In A False Paradigm

Currency Wars Constitute Great Risk
With all that is happening in the world, you would think that currencies should be twisting in the wind. A wild and crazy currency market would flow over to stock markets but things appear "magically stable" and the question is why. A previous article on this site titled, "Currencies Are Trading In A False Paradigm" made the case that the major Central Banks being well aware of how devastating currency moves can be have gone out of their way behind the scenes to stabilize an unstable situation which they created with a decade of QE policies. Still, we have witnessed the emergence of Bitcoin and other new cryptocurrencies growing in the fertile soil left full of nutrients from fiat currencies in decay.

The argument that currencies are trading in a false paradigm extends past simple manipulation and is bolstered by their being sheltered from the storm of volatility by existing in a rather closed system. Wealth is somewhat trapped within this system of fiat money by laws and rules that discourage freedom of movement into more tangible stores. It is the coordinated collusion of the major central banks that have allowed this charade to exist. The fact it has not been recognized or acknowledged does not alter nor does it guarantee the system will continue. The failure of any of the world's four major reserve currencies will destroy the myth that major currencies are immune to the same fate that has haunted many currencies throughout history. When the nation granting a currency becomes unable to control their budget they lose credibility and are crushed under the weight of their debt.
Central Bank Balance Sheets Have Exploded

Today the markets are akin to a game of "Whack-A-Mole" where as soon as we take our eyes off one problem another pops up. First, our eyes are on Italy and the EU but before we can hone in on that we shift to China's slowing economy and trade wars, then quickly to surging bond prices in Japan. One thing the global economy doesn't need with all the uncertainty that is currently floating around is unstable currency markets. When you consider just how destabilizing currency swings can be it is easy to see how a strong dollar could obliterate the global economy. It should not be a surprise in our current situation that behind the curtain central bankers could be busy manipulating currencies so they trade in a narrow range that will not rock the boat.

Over the years countries have become very adept at coordinating policy and currency swaps are only one of the tools they use which now extends to even investing in stocks. When the dollar began to soar back in late 2014 the fear index began to rise and concerns were heard about the stress it was causing in countries that owed a great deal of debt that would have to be paid back in dollars rather than their own currency. The world currency market is a complicated place full of pathways that fall away or come back on themselves and many of the tools used to shape it are like a double-edged sword that can cut in either direction. In the case of China, capital is fleeing the country faster than the government can create new ways to bolster the currency and sadly for them much of it is flowing into America strengthening the dollar even more. Adding to China's woes is that as their currency falls they will hear more calls from Trump supporters to place duties and tariffs on their exports to America in an effort to level the playing field and reduce the trade deficit.

As World Reserve Currency The US Dollar Is King
Consider the possibility that currencies are trading in a false paradigm. Part of this paradigm encompasses the myth many people have come to accept that a major currency cannot fail or collapse. Investors should be prepared for a rude awakening when markets are hit by major changes in currency values. A dam has been built around our current system to protect market stability but pressure is building and when it breaks it will wreak major damage. The idea that a major currency cannot fail will be exposed as a myth as concern over the future of both the yen and the euro become more of an issue. Both currencies have major problems going forward. People often point to the fact that behind the dollar America stands with a rapidly growing national debt, however, at this point no other currency is powerful enough to step into the breach and the dollar's problems are nothing compared to the issues the euro and yen face.

Competitiveness and productivity develop at a different pace in different countries. Over time, this leads to large differences in growth and the shifting of wealth through currency valuations. When the "dollar union" of the U.S. threatened to fall apart during the Great Depression due to the different economic conditions and unequal potential apparent between states, the federal government found it necessary to enact federal income transfers from prosperous states to aid ailing ones. The federal budget rapidly increased and this practice of income transfers from one state to another to bind the states together as a union became permanently embedded in our system. Thus far the EU has failed to address this massive problem.

In the United States, a no-bailout policy of crisis-hit states that was enacted decades ago remains intact, however, through federal programs of "inter-system wealth transfers" America achieves that special something that the Euro-zone has been unable to accomplish. Inequality has a way of growing and must be addressed early. After a certain point, it becomes very difficult to implement a system that transfers wealth from the most prosperous to the most needy because too many people will feel cheated or resentful at what is more or less a default on past debts. The bigger a debt problem and inequality is allowed to grow the more people and institutions suffer when they become the victims of a default. Greece has fallen and continues to suffer the consequences of long term wealth drain and Italy now teeters on the brink.

During the last several years the question of how to exit the Euro-zone monetary union and the euro has become a topic of discussion. Uncertainty and fear relating to the costs of breaking away tend to discourage political leaders from taking the risk and decisive steps towards an exit but if one or more sizeable countries should choose to bolt from the shelter of the euro or the Euro-zone the currency could quickly unravel. A major cause of the Euro-zone problem is growing inequality among its members exacerbated by the lack of system-wide bank protection which causes money and wealth to flee the weaker countries and their failing banks. Japan faces an entirely different problem while national debt is an issue for the central banks that issue both currencies. Japan's debt is much larger and the country faces a demographic crisis that leaves it forced to support a population comprised of citizens far too old to work.

The problems described give credence to the possibility the yen and euro will fail or rapidly lose a great deal of their value at some point in this era where wealth leaps across borders at the push of a button and their demise will be fast, and swift. Like many Americans, I have railed against our growing debt and questioned whether it would destroy the dollar, however, when looking at the miserable alternative currencies before us the dollar is without a doubt king. We must not underestimate the advantage the dollar has enjoyed as the world's reserve currency or the size of debt floating across the globe comprised in dollar-based agreements. If the dollar proves victorious in the currency wars and triumphs as the last major currency standing the people of America will reap the benefits of a game well played or just plain luck.

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