Friday, October 1, 2010
- 21st Century Currency Combat
If you ever wondered what Hedge Fund portfolio managers talk about when are trying to solve the world's problems at the bar-rail, it's things like this.
The Federal Reserve Board is run by academics and bureaucrats. But even so they manage to have the markets do a great deal of their 'heavy lifting' for them. But if you had a market's guy like me or one of my friends running the monetary policy of a country, you would see more of this sort of thing not less. With that said though, the outcome of a policy like this isn't necessarily a good thing. Central Bankers leveraging their resources changes the relationship between countries. And if it's done on a large enough scale it can easily upset the whole applecart.
Competitive devaluation is combat of a sort. It's several countries all trying to push their currency to the bottom of the pile at once. If only one country were engaged in devaluation at a time, it would be no big deal in the grand scheme of things. But with everyone doing it at once, it becomes a question of reserves. In the long run, it's the biggest central bank that will win. Obviously, the Mexican Central Bank see's that, and is going to try to use leverage to even the odds.
One thing we have not seen yet is the central bankers exploiting the stratospherically high correlation between assets. For example, if the FRB were just a little less concerned about who the dollar is weaker against, then they could get a lot more mileage out of their devaluation dollar. If the Fed went out and bought 50 Billion dollars worth of gold, a pittance compared to the hundreds of billions being spent on buying treasury bonds, the dollar would drop below EVERYTHING. And since that would cause the price of raw commodities to rise, it would spread around some of the inflation to other countries as well. That would make Europe and Japan very happy but would make countries like China and Brazil very upset, and make people like Hugo Chavez apoplectic. I leave it to you to assess the odds of of them actually doing it.
Of course, the real problem with competitive devaluation is that it's competitive. If something like this were to get heated enough, it's really no great leap to imagine nationalization of foreign assets (think factories and mining not bank accounts). And from there it's one very short step into a military response.
I'm not saying any of that is inevitable, far from it. In fact, Obama is such a girl that a foreign army could seize the Library of Congress along with Pennsylvania avenue from D street to the river, and the only thing he'd do is respond with a strongly worded UN sanction.
I don't see this turning to a shooting war anytime soon. I'm just extrapolating the current data to a worst possible case. And the sophistication of this Mexican trade brings us all one tiny step closer to something horrible like that. Even if it's still a very long way off and way way under 50% odds.