Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Ben Bernanke's Fatal Flaw and Our Modern-Day Currency War


When currency becomes more of a foreign policy tool than a monetary policy tool, this is when one can correctly characterize the movements as a currency war.

The key to interpreting what we are seeing in the market is understanding that, as Eric Janszen said, "reserve currencies are political currencies." Because of this, one must look at the global economy from both a market and a political perspective. It is easy to focus too much on one at the expense of the other. Interest rates, exchange rates, and the global balance of trade have been the primary tools of monetary policy employed by central banks to stimulate global economies for decades. While each body acts independently, for the most part their actions are coordinated and taken to achieve the joint objectives of economic growth and stability. Occasionally, usually during times of distress, central banks will deviate from the script and take actions that further their own interests and risk disrupting the stability and growth of their trading partners. It is at these points where currency becomes more of a foreign policy tool than a monetary policy tool, and this is when one can correctly characterize the movements as a currency war. Well, this is one of those times, folks, and this is what a modern-day currency war looks like.

Let me first explain the statement that "reserve currencies are political currencies," as that is the crux of my argument, and then I will elaborate on how I see the US abusing its power and the potential outcomes.

Reserve Currencies

A reserve currency is a currency held by central banks and financial institutions as a means to pay international debts and influence domestic exchange rates (per Investopedia). As Wikipedia recounts, the Bretton Woods agreement in 1944 established the US dollar as the currency to which all of the Allied Nations would tie their currency, so the IMF could bridge temporary imbalances of payments. Thus following WWII, there was a political agreement among nations that they would tie the value of their currency to the US dollar (then still backed by the gold standard). When President Nixon ended the gold standard in 1971, a new political agreement was established whereby all nations would back their currency by holding US dollar reserves. Reserve currencies are established by political treaties, and breaking these agreements, in spirit or deed, can be viewed as an act of aggression.

Ben Bernanke's Flaw

I do not want to pile on the recent name-calling of Federal Reserve Chairman Ben Bernanke. The truth is, the situation he is dealing with is not his own making. I will take issue with what I view as a tragic flaw that may ultimately prevent him from achieving his goal. Ben Bernanke's fatal flaw is hubris. We saw that on display in the 60 Minutes interview when he stated he was 100% certain he could contain inflation. It is easy to see the derivation of this omnipotence; after all, he establishes the world's "risk free" rate of return and can set the price on any asset he chooses, he is backed by the world's largest military and largest economy, and the rest of the world is compelled by numerous treaties and agreements to put its full faith and credit in him. The risk, however, is not in what he can control, but in what he cannot control, namely 1) the weather, and 2) the willingness of the rest of the world to buy US dollars. Just as Dr. Bernanke was wrong when he confidently told Congress that the "subprime crisis is contained" and "the banks are well capitalized," he was wrong about inflation, too. When heat waves and floods destroyed crop yields from major regions, he was helpless to control the price spikes that resulted when demand overwhelmed supply. It wasn't in his script, and he failed to foresee the impact of such an event, which is manifesting in political instability throughout the world.

Currency as a Foreign Policy Tool

Dr. Bernanke and Mr. Geithner have attempted to use this inflation spike to gain an advantage politically, and that is why I would characterize recent actions as a currency war. Monetary policy is now being used as a foreign policy tool to press the political advantage of the US and its domiciled corporations. This is evidenced in Sec. Geithner's letter to the G20 in October, which encouraged a focus on the balance of trade rather than exchange rates. Forget for a moment that QE2 (quantitative easing) began days after he sent a letter to the world encouraging countries to "refrain from exchange rate policies designed to achieve competitive advantage by weakening their currencies." The important part is his statement that "First, G20 countries should commit to undertake policies consistent with reducing external imbalances." This states that the No. 1 policy objective of the US is to bring trade back into balance. He is telling the G20 countries (mostly China) that instead of worrying about exchange rates (which everyone knows can be offset by domestic interest rate actions), they should buy more US exports to correct the trade imbalance. We have seen the Chinese use their dollars to buy natural resources, access new markets, and the final part is likely the purchase of intellectual property. The US and China correcting the trade imbalance is important, and if handled properly could result in prosperity for both nations. Whether or not it happens in the interest of the citizens of those countries, or just the corporate interests, remains to be seen. The goal appears to be making US exports competitive again, but understand that includes narrowing a huge wage gap and improving the technology employed by other nations, making them serious competitors. Nevertheless, the initiation of QE2 days after this letter was issued was a gentle reminder to the world, "if you don't buy more of our goods, we will ramp inflation in your economy until your people take to the streets."
< Previous
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos