Caution Alert, Currencies May Get Wild!

Volatility Is About To Rise

Every now and then a very notable and important event occurs, sometimes it slips by without even being noticed. For months the major world currencies have traded in a narrow range as if held in limbo by some great force. I contend that the central banks were behind much of this in an effort to reinforce feelings of economic stability. This has allowed people to think we were on sound footing as central banks across the world continued to print and pump out money chasing the "ever elusive growth" that always appears to be just around the corner.

Until now because of weak demand for goods and most of this freshly printed money flowing into intangible investments inflation has not been a major problem, but the seeds for its future growth have been planted everywhere. John Maynard Keynes said By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. As the central banks print like crazy to control interest rates on bonds they devalue the currency. While there are not many Bond Vigilantes there are a slew of  Currency Vigilantes and they are ready to make their presence known. Weakness in the value of the Yen, Pound, and Euro must not go unnoticed.

I think most people tend to understand money more than government bonds. In an article way back in early 2013 I raised concern the games central bankers had been playing in manipulating various currencies had reached a dangerous level. This has not only continued but gotten worse. The Currency Vigilantes are acutely aware of when a currency is overvalued or ready to be re-pegged and pounce on the weak currency to tear it apart. In fact history shows no mercy is given when this occurs. Today we live in an age when billions of dollars can be traded in just the blink of an eye, imagine how fast things could go to hell. Even the batch of recently created money will be used against the Central Banks that created it.

The country most vulnerable to a currency collapse is Japan which faces a wall of debt that can only be addressed by printing more money and debasing their currency. This means paying off their debt with worthless yen where possible and in many cases defaulting on promises made. Japan's public debt, which stands at around 230% of its gross domestic product (GDP), is the highest in the industrialized world. When Japan crumbles it will be felt across the world. Often because of its size people forget that little Japan is the worlds third largest economy making it a huge economic power with a big shadow. The recent multi-year lows in the yen are very important. When Japan crumbles it will be felt across the world.

This has been a long time coming and I contend the cross-border flow of money leaving Japan is one reason some stock markets have remained so resilient. With the death of the Yen the myth that advanced Democratic countries are immune to hyperinflation will be destroyed.  Soon after that people will realize that the Euro, Pound, and even the Dollar are not safe from hyperinflation. This means that they will want to get out of bonds in these countries as well.  This will result in a huge monetization in these countries and then hyperinflation. These four currencies make up about 95% of the central bank reserves backing other currencies.  Faith in paper money in general will be shattered, Japan will be the first domino to fall, but not the last. The dollar is not immune, but I predict it will be the last to go.

Back to the idea that we may now have entered "the danger zone". In a silly movie promoted as a political and financial thriller  named "Rollover"  the stars played by Kris Kristofferson and Jane Fonda watch the world collapse and crash. Things have progressed since the film was made back in 1981. In the past currencies were part of a self regulating self adjusting system that was suppose to punish those guilty of economic mis-steps. Today it is questionable how well that mechanism functions, an argument could be made that it is becoming less effective due to manipulation from both central bankers and politicians alike. A word of caution, actions have consequences, and countries can still be punished through their currency.    

More and more often we seen Central Bankers forced to pull rabbits out of their hats. A couple of years ago when Mario Draghi, president of the European Central Bank gave a speech many people say that "he saved Europe."  Intervention and manipulation seems to be the flavor of the day,  making real value an outdated concept. A falling currency is a double edged sword, while it increases exports by making them less expensive it makes everything imported into a country more expensive. Like shown in the dramatic final scene of the silly film Rollover made decades ago, if people lose faith in the major currencies the system will come crashing down around our ears.


Footnote; As always your comments are encouraged. World Central Banks have been on this murky path for a long time, please see the following posts. One deals with how this has detached from reality and other looks at how if a meltdown occurs many people will use it as a reason to adopt a new "world currency"

          http://brucewilds.blogspot.com/2012/06/fantasy-world-of-debt-and-more-liqidity.html
          http://brucewilds.blogspot.com/2014/02/contagion-may-lead-to-new-world-currency.html


Footnote #2 added 1/16/15;  More recent article concerning what is happening in the currency markets are listed below,
http://brucewilds.blogspot.com/2014/11/reserve-currency-status-both-blessing.html
http://brucewilds.blogspot.com/2014/10/fed-concerned-that-stong-dollar.html
http://brucewilds.blogspot.com/2014/10/currencies-are-ious.html