Currency Wars September 6, 2015

Andrew Snyder: Hello, and welcome to this week's edition of the Market Wake-Up Call. I'm Andrew Snyder, Editorial Director of The Oxford Club, filling in for Steve McDonald. I'm very excited about our guest this week. Jim Rickards has an incredible background. He's a lawyer, a world-class economist with over 35 years of experience on Wall Street, and a best-selling author. Jim, welcome. Jim Rickards: Thank you, Andrew. Great to be with you. Andrew Snyder: All right, Jim. So, you've been a leading voice about the idea of a currency war. It's a fascinating economic battle that you say started in 2010. What's it all about? Why are we fighting? Jim Rickards: Well, Andrew, this comes out of my first book, Currency Wars, which was released in 2011. Of course, I was working on writing it in 2010. And I make the point that the world is not always in a currency war, but when we are in a currency war, it can last for five, 10, 15 years, or even longer. We're in one of those right now. This new currency war started in 2010. Here we are in 2015, and the currency war is still going on, which comes as no surprise because, as I said, they can easily last five or 10 years, or even longer. I expect, if we chat a year from now, we'll still be in the currency war. Currency wars arise when the world is in a certain state, basically too much debt, not enough growth. Too much debt, not enough growth: That's the condition of the world today. And the temptation for countries is to steal growth from the trading partners by cheapening the currency, promoting some inflation to defend off deflation and promoting their own exports. Well, that can actually work for one country in the short run. The problem is, other countries shoot back. They cheapen their currencies and get into this tit-for-tat currency devaluation, which has no logical conclusion. The only conclusions are either there's a global reform - that is, the major trading powers sit down and reform the international monetary system - or there's a global collapse, or you could have both. You could have a collapse followed by some kind of an emergency Bretton Woods-type conference to reform the system. So, I expect this to continue. Andrew Snyder: So, all right. Let's get specific, and let's dig in a little bit. Investors were thrown for a loop in August when China broke from its trend and devalued the yuan. What happened, and why does it matter? Jim Rickards: Well, it matters a lot. But I would just make the point that that was a big episode in the currency wars. But if you analogize to a real war, it's not continuous fighting all the time. There are quiet periods and then there are major battles. So, go back to World War II, you have the Battle of the Bulge and the Battle of Stalingrad, but there were also times when there was very little fighting going on. Well, the same is true in currency wars. 2011 was the period of the cheap dollar. 2012, 2013 was the cheap yen, Japanese yen. Late 2014, early 2015, we saw the cheap euro. And now China wants to take a turn, so it’s trying to cheapen the yuan. It matters a lot because one of the effects of cutting your exchange rate relative to other currencies is you try to import inflation because if your currency is cheaper you have to pay more for your imports, but you try to export deflation to the other guy. The problem now is that we've seen a weak euro, a weak yen, a weak Chinese yuan and a strong dollar. So, the U.S. has become like a magnet importing all the deflation in the world. In other words, with a strong dollar, when we take foreign vacations, buy French wine, buy Chinese textiles, Korean electronics, whatever it is, it costs us less because the dollar is stronger. Now, think about that in the context of Fed policy. The Federal Reserve wants inflation. This is not a secret. They've told us that. The Federal Reserve wants inflation, but a strong dollar is deflationary. It moves the Fed in the opposite direction, and yet the Fed is talking about raising interest rates. It’s been talking about it all year. Of course, I've said all along that it will not raise interest rates in 2015. I said that last year with regard to 2015 at a time when Wall Street was saying March. Then it said June. Now it’s saying September. I continue to hold the view that it won't raise interest rates in 2015. But here's why. If you raise interest rates, you make the dollar stronger, which, as I said, gives you more deflation. But the Fed says it wants inflation. How does that work? Well, the answer is, it doesn't work. We're stuck in this deflationary trap, and we're going to have to fight it by not raising interest rates. So, it matters a lot because you can actually use something like the Chinese dollar, the Chinese yuan-U.S. dollar cross rate to forecast Federal Reserve policy. Andrew Snyder: All right. Switzerland. I want to dig into a bold statement you made earlier this year. You said the Swiss' move to break from the euro was the currency war’s Pearl Harbor. Was it really that bad? Jim Rickards: Well, it was a shock to Europe, and a couple firms went out of business, and a lot of traders as well as a lot of hedge funds lost a lot of money because it was so unexpected. That's why I used the Pearl Harbor analogy. It was a little bit of a sneak attack. Maybe you could see it coming at some level, but the timing was certainly a surprise. But the reason Switzerland did that is the Swiss economy is very, very dependent on external trade. We think, what is the Swiss economy? Well, it exports chocolates, watches, jewelry and precision equipment, and it has a very large tourism industry, which is a kind of export. You don't ship the Swiss Alps to New England, but people from New England fly to Switzerland and spend money. So, it sort of falls into that same category as exports. So the Swiss economy is very sensitive to exchange rates, and the Swiss National Bank wanted to keep the Swiss franc from getting too strong. It wanted a cheaper Swiss franc so it could sell more watches and chocolate bars and ski vacations. And the way it was doing that was by selling its own currency, printing the currency and buying euros. So, it had the effect of pegging to the euro. Whenever the euro was getting a little bit weaker, it would go out and print some more Swiss francs and buy euros, and that would tend to cheapen the currency and make the euro a little bit stronger. So, it was maintaining a peg with the euro. There was only one problem with that strategy. Look at what was going in in Europe. Greece was falling apart. Go back to 2011, 2012, throughout 2013, what was everybody talking about? Well, they were talking about the “Grexit” and Europe breaking up, and Greece getting kicked out, and Spain quitting, and Spain going back to the peseta and devaluing the currency to lower the unit labor costs, and maybe Italy would quit too. The whole thing was supposedly falling apart. Of course, I said at the time, and I continue to say, that that's all nonsense. Europe is not actually falling apart. No one's been kicked out of the euro. No one quit the euro. In fact, they've added members. But that aside, certainly the sentiment was very negative toward the euro. So, here's the Swiss National Bank trying to maintain a peg to the euro at a time when everybody hated euros. So, what was it doing? It was buying every euro in the world. You had to just sit there, keep the printing presses going, keep printing Swiss francs and keep buying euros to maintain the peg when everyone was dumping euros. So, the Swiss National Bank was getting to the point where the quantitative easing in Europe wasn't coming from the European Central Bank, it was coming from the Swiss National Bank. Of course, that was completely nonsustainable. You get to a point where you own every euro-denominated instrument in the entire world practically. That wasn't going to happen. So, when something is nonsustainable, it won't be sustained. So, it broke the peg. It let the Swiss franc go up. Today, the Swiss franc is one of the strongest currencies in the world. In fact, it's so strong that it has negative interest rates. If you buy Swiss francs and deposit them in a Swiss bank and come back a year later, they'll actually take money out of your account. They're not paying you interest; they're collecting interest. That's what negative interest rates are. So, the problem with all these pegs and the reason I emphasized Switzerland recently is because you can compare it to the efforts of China to peg the Chinese yuan close to the U.S. dollar. Whenever you're pegging your currency to somebody else, you have two problems. No. 1, you give up your monetary policy to the other guy. If China had it pegged to the dollar, and the U.S. tightened, China had to tighten even though it wanted to be easing. So your monetary policy is in the hands of the other central bank. The other problem is, by definition, if you're pegging, you're fighting the market because, after all, if the market wanted to put your currency about where the peg is, you wouldn't need a peg. It would just go where you want. If you have a peg policy, a policy pegged to another currency, as I say, you are fighting the market, and you can win in the short run, but you almost always lose in the long run. So, whenever you see these pegs, you can start to think about when they might break. The biggest peg right now that may break is the GCC. These are the gulf countries, Persian Gulf countries. So, Saudi Arabia, Kuwait, Qatar, United Arab Emirates, Bahrain and a few others, they're all pegged to the dollar. And again, with a strong dollar and low oil prices, that's really hurting their economy. So, they may break the peg as well. So, it's just an interesting dynamic and way to think about exchange rates. Andrew Snyder: All right. You gave us a lot there, and there's one final question I know our Members want me to ask. It's simple. What's it all mean for investors? Do we buy foreign currencies? What's the opportunity here? Jim Rickards: Well, you can buy foreign currency. If you want to make a bed you can buy foreign currency futures or forwards from the bank, but the way I think about it, we've had a very, very strong dollar for the last two years. You go back to 2011 - that was the age of the weak dollar. Right now, 2014/2015 is the age of the strong dollar. The problem is, the Fed allowed the dollar to strengthen by talking about interest rates, so that the European currency, the euro, could go down, Japan could go down, now China's gone down. All that depreciation in those countries is designed to help their economies. The Fed did this in the mistaken belief that the U.S. economy was strong enough to bear it. The Fed operates on a forecast. It actually has the worst forecasting record of any major institution. It’s been wrong by a huge magnitude six years in a row. So, it thought the U.S. economy was getting stronger. It thought we could afford, or bear, a strong dollar. It turns out, as usual, its forecast was mistaken and it has a strong dollar in a weak economy. This strong dollar is killing the U.S. economy. We're looking at third quarter GDP estimated, as of now, at about 1.4%, which is incredibly weak. So my expectation is that not only will the Fed not raise interest rates - we discussed that - but that they're also going to have to let the dollar weaken. So, I would look for a strong euro. So, what that means in part is that you might want to buy some good European companies because you have two ways to win. One is the stock could go up, but the other one is the currency could go up. So, Europe is a very interesting market to me right now. Andrew Snyder: All right, Jim. I can't say how much I appreciate you taking the time to join us today. Your insight is quite unique and highly regarded. Thank you. Jim Rickards: Thank you, Andrew. Andrew Snyder: If you'd like to know more about Jim Rickards and the currency wars, he says they're about to shake up the markets. Click on the link below. That's all for this week. Thanks for watching. [End of Audio]