Business Times Singapore Investment
Roundtable
Currency war threat not over yet
Besides liquidity, inflation and protectionism are also stalking global economy; but Asia will emerge on top from rebalancing
William R. Thomson
Dec 1, 2010
PANELLISTS
Masahiro Kawai: Dean of the Asian Development Bank Institute (ADBI), Tokyo and former World Bank
chief economist for East Asia
Mark Mobius: Executive chairman, Templeton Asset Management
Robert Lloyd George: Chairman, Lloyd George Investment Management, Hong Kong
Ernest Kepper: President, Asia Strategic Investment Associates Japan
William Thomson: Chairman of Private Capital, Hong Kong, director of Finavestment, London
MODERATOR
Anthony Rowley: Tokyo correspondent for The Business Times
FOR the moment, Ireland’s sovereign debt crisis
(and other crises looming in the eurozone)
has pushed the threat of currency wars off the
front page. But it has not gone away. What we
have seen so far are only the first skirmishes
in a “phoney war”. As the flushing liquidity
that is prompting these clashes grows to a tidal
wave, inflation and protectionism are other
spectres that are stalking the global economy.
These are the sobering predictions of economic and investment
experts invited by The Business Times to give
their views on 2011. But they are all of a view that Asia
will emerge uppermost from global economic rebalancing.
Meanwhile, investors need to hedge against uncertainty
by going for gold and other tangible assets.
Anthony Rowley: Welcome to this Business Times Investment
Round Table, and a special welcome to our new
guest, Masahiro Kawai, dean of the ADBI. Kawai-san, let
me begin by asking you whether you think currency wars
can be averted and, if not, which currencies are likely to
be most bruised – or unscathed – by the battle.
Masahiro Kawai: They can be avoided provided policy responses
of non-US economies are conventional, such as
currency market interventions and capital inflow controls. The most reasonable response for emerging economies
would be to limit short-term capital inflows, to allow
currency appreciation and to strengthen supervision so
that inflows will not create a build-up of systemic financial
risks like real estate bubbles. In Asia, this would be easier
if economies, including China, Asean countries and
others, allow currency appreciation collectively. But if
such responses are not adopted, countries with flexible
exchange rates and free capital mobility could be hit the
hardest, as their currencies would be forced to appreciate.
Quantitative easing, or so-called “QE2”, by the US Federal
Reserve is generating a lot of concern among emerging
economies that it will induce competitive US dollar depreciation
and hence can have beggar-thy-neighbour impacts
on these economies. Differential speeds of recovery
among advanced and emerging economies such as those
in Asia have been creating capital inflows to the emerging
markets and QE2 is adding pressure.
Mark Mobius: I agree. Currency wars can be averted only
if countries allow more flexibility in their currency regimes.
Unfortunately, that does not seem to be possible
given the stance of a number of them. No currency will escape
being impacted by continuation of the present situation.
There will be both winners and losers and it hard to
predict which in the short term.
William Thomson: As is so often the case, the decision on
whether currency wars can be avoided is mainly in the
hands of Americans. It seems most unlikely (they can be
avoided) since the US has a policy goal of doubling exports
over a five-year period. A cheaper dollar is an essential element
in this process, especially against Asian currencies. A second US objective is to avoid deflation at all costs and
make sure there is some inflation in the system. This
means further quantitative easing on a scale yet to be determined.
The Fed has announced an additional US$600
billion through June 2011. When added to the US$300 billion
refinancing of maturing mortgage bonds, the total QE
so far is US$900 billion – sufficient to finance all the budget
deficit in that time frame. What comes after is uncertain
but if Goldman Sachs is to be believed, the final amount of
QE required could total over US$4 trillion in coming
years.
The worst-hit currencies are likely to be what I call the
three “ugly sisters”: the dollar, the pound and the euro. All
are heavily indebted, with ageing populations and troubled
banking systems. The euro remains a lopsided construct
in a non-optimal currency area. Problems remain
with the “PIGS” countries where the real issues have yet
to be dealt with. The “winners” should be those of commodity-
producing countries and export giants such as
Canada, Australia, China, South-east Asia, Norway and
possibly some Latin American countries such as Chile.
Ernest Kepper: The currency war declared by the US has
massive implications and cannot be averted. The US can
win, since it has all the ammunition it needs – there is no
limit to the dollars the Federal Reserve can create. Understand
that this option is not available to other central
banks as the dollar is the recognised reserve currency, in
lieu of gold. Currency wars are nothing more than price
wars, which could turn into a new bubble somewhere
down the road. Once one or two big countries start a price
war everyone has to join in, either to protect their currency
reserves balance or like Brazil and others to stop their
currencies from going up so fast.
The US has depreciated the dollar roughly 13 per cent
against the other major currencies since June. The intent
is clear: The Fed is enacting “easy money” policies to debase
the dollar and reduce the value of foreign debts,
while representing the falling dollar as the outcome of a
policy to boost inflation and spur the economy and increase
employment. Devaluation will be achieved by flooding
currency markets with dollars, providing the kind of
destabilising opportunities that fit perfectly computerised
currency trading, short selling and pure profit-seeking financial
manipulation.
Such speculation is a zero-sum game. Someone must
lose – and the emerging market countries will. So, countries
like Brazil, Thailand and South Korea are taking defensive
measures. In the 1997 Asian crisis, Malaysia
blocked foreign purchases of its currency to prevent
short-sellers from covering their bets by buying the ringgit
at a lower price later, after having emptied out its central
bank reserves. The blocks worked, and other countries
are now reviewing how to impose such controls.
The currencies to own in this situation are Singapore
dollar, Norwegian kroner, Australian and Canadian dollars,
based on their natural resource economies. The renminbi
is his most undervalued currency today. All you
have to do is to forecast the next salvo in the currency
wars, and to position yourself to take advantage of it. We
are going to see extreme volatility going forward.
Robert Lloyd George: I believe that as we approach the
end of 2010, we are moving inexorably towards a world
currency regime, probably with some component of gold,
or gold standard, as was suggested by Robert Zoellick,
president of the World Bank. The US dollar is clearly losing
its credibility as the anchor of the world monetary system
at an even faster rate as Ben Bernanke embarks on
QE2. This global currency may take a form similar to the
euro, with the weaker currencies, such as the US dollar being
co-opted into a harder currency regime, as the deutschmark
dominated the euro when it was established. The yen, euro and renminbi will form the core of this new
world currency. The currencies that are likely to be less
affected by “currency wars” would be of course the Swiss
franc, Norwegian kroner and the commodity currencies
such as the Australian dollar and Canadian dollars, Brazilian
real and perhaps the Russian rouble.
Anthony: So, is there another tidal wave of liquidity on the
way given Ben Bernanke’s commitment to 2 per cent annual
inflation in the US, and how much of this liquidity is
likely to wash up on the shores of Asia? How real is the
threat of future inflation from all this liquidity and what
does it imply for equity, bond and and real estate markets
in Asia and elsewhere?
Mark: There is a continuing wave of liquidity but there is
evidence that the rate of increase is declining. Looking at
the success of IPOs (initial public offerings) in Asia with almost
half of emerging market IPOs and secondary issues
taking place here it is clear that a lot of the liquidity – perhaps
as much as a half – is finding its way to Asia.
Masahiro: Liquidity creation by the US at this point, when
many emerging economies are growing in a robust way,
can be the source of future inflation and asset price bubbles
in emerging economies. Commodity price increases
as in the case of gold, metals, minerals, energy and food –
would create inflationary pressure globally and particularly
in emerging economies.
William: A tidal wave of liquidity has been clearly flagged
by the Fed’s actions. Only the ultimate size is in question.
If, as seems likely, there is policy paralysis in the US after
the mid-term elections, monetary policy will be the only
game in town over the next two years. Do not believe the
talk about a 2 per cent inflation goal. The true goal is
much higher since they hope to diminish the real value of
debt and support asset prices, especially housing. But the
policy of inflation requires deception to be effective. Inflation
is on the way as commodity prices and devaluation
work their way through the system. In fact it is here already
but official statistics do not properly capture this
fact.
Asian nations have a choice: either let their currencies
appreciate, or suffer a property and equity bubble, or put
in place currency and lending controls. I expect we will
get a combination of all three over the next two years.
More generally, as long as interest rates are negative in
real terms we will get equity bubbles elsewhere too. Property
is more problematic since banks are being restrictive
with their mortgage lending and unemployment remains
high.
Ernest: By promoting a weaker dollar, the US is creating
dangerous inflationary pressures that will have negative
repercussions globally. As a consequence of QE2 – central
bankers will be forced to intervene in currency markets,
institute ad hoc controls and resort to protectionist policies
to protect their exporters. This can only mean a more
drawn-out and difficult global recovery.
Arbitrageurs and speculators are swamping Asian and
other emerging market currency markets with low-priced
dollar credit to make predatory trading profits at the expense
of Asian central banks which are trying to stabilise
their exchange rates and keep asset prices from rising by
selling their currency for dollar-denominated securities.
Robert: If the Fed prints another US$600billion plus of liquidity,
I would expect that 75 per cent of this will go offshore,
and the large part to emerging markets, notably in
Asia. There is a real danger of inflation reaching 10 per
cent in countries as diverse at India, China, Indonesia,
Philippines, Brazil, Argentina and other fast-growing resource
producers. Our investment strategy is to run an inflation-
hedging approach in buying oil and gas producers,
mining houses, gold, silver, agriculture and real estate, especially
in the Asian hemisphere.
Anthony: There is a great debate about global economic restructuring
in which emerging-market economies supposedly
will put more emphasis on domestic demand and less
on exports and vice versa in advanced economies. How do
you see this working out, and in what kind of time frame?
Masahiro: There is a view that export-led growth is bad. I
don’t agree. Exports should be encouraged by all countries,
and so should imports. All countries cannot produce
net export surpluses, but they can enjoy export-led
growth as long as imports rise everywhere. If each country
shifts productive resources (capital, labour, knowledge,
etc) to sectors where the country has comparative
advantage, then the global economy will become more efficient
in resource use. Also such export expansion creates
more investment and jobs. Free trade should be protected.
Mark: Restructuring is happening right now and this is evident
not only in China but in other emerging markets like
Brazil. Unfortunately, the evidence will be difficult to detect
since stronger emerging market currencies mean that
these economies can import more with fewer dollars.
William: China has clearly signalled in its next five-year
plan 2012-17 that it intends to increase the level of consumption
in the economy from an incredibly low 35 per
cent to around 45 per cent. A higher exchange rate is an
important element in that transition but it must be done at
a rate that does not ruin export industries. Social stability
is the primary goal of Chinese authorities. It will require
reforms in housing, education and the development of social
safety nets. None of these can be accomplished overnight
but I would expect clear progress to be made.
The US and the UK both recognise that their economies
need rebalancing with more emphasis on manufacturing
and less on financial services. That is hard to accomplish
since they are simply not competitive at today’s
exchange rates in most industries. I fear the US will become
increasingly protectionist, especially after 2012 if
the economy remains mired in stagnation. If things are
not going their way, populist anger is likely to make them
rip up the rule book as they did in 1933 and 1971. The
end of empire is never pretty.
Robert: I believe it will take several years to achieve the
restructuring of global imbalances, to make China save
less and spend more and make Americans spend less and
save more. But recession and unemployment in the USA
have had a fairly rapid effect and with the falling dollar imports
will slow down and exports hopefully will increase. In a completely free-floating currency regime, the self-correcting
mechanism should have worked to correct the imbalances.
But as we saw with the yen after the Plaza Accord
in 1985, it does take up to five years.
Ernest: The ongoing shift of global output from developed
economies to emerging economies, particular Asia, will
bring a lot of volatility. Growth may be evident in the
emerging markets but the volume is in the developed countries.
It is unlikely that growth in emerging markets can
make up for the lack of growth in the developed countries. The biggest challenge is that emerging markets achieve
growth from productivity gains rather than from manipulation
of their exchange rates.
Anthony: As wealth becomes more balanced globally under
this process, how will it affect the relative importance
of financial markets around the world. Where will the
pools of capital be located in the future, and where and
how are these likely to be deployed by portfolio investors?
Mark: More capital will be diversified globally instead of
being concentrated in home markets. More will be in equities
although fixed income will still be larger than equities.
Masahiro: Emerging Asia will be wealthier and a larger
pool of savings will be created in Asia. The challenge is to
make financial intermediation more efficient at the national
and regional levels. Japan’s and China’s savings should
be mobilised to finance productive investment in Asia.
William: The Asian financial markets can only grow in relative
and absolute importance since that is where capital is
increasingly generated and the tax and regulatory regimes
are more attractive. London, New York and Switzerland
will not disappear but Singapore, Hong Kong, Shanghai
and possibly Mumbai will grow in importance on a regional
and international level. Middle East regional markets
are likely to become more important in their locality
as their sovereign wealth funds become investors of last
resort.
Robert: I expect that China will be 25 per cent of the world
capital market within the near future. India follows close
behind. The “Frontier Markets” in Africa, for example,
will go from being less than 2 per cent to perhaps 10-15
per cent of world markets. Some 90 per cent of IPOs in the
world are now taking place in emerging markets rather
than in Europe or the US. Before 1800 China and India
were the wealthiest nations in the world and by 2020 it
will be true again.
Ernest: The global financial system has taken on a life of
its own separate from meaningful trade and investment
as dollar outflows do not create assets or provide tangible
investment in plant and equipment, buildings, research
and development. It is more the creation of debt, and its
multiplication by mirroring, credit insurance, default
swaps and an array of computerised forward trades.
Financial conquest is seeking today what military conquest
did in times past. Countries on the receiving end of
this US financial conquest are seeking ways to protect
themselves. Ultimately, the only way to do this is to erect a
wall of capital controls to block foreign speculators from
destabilising currency and financial markets.
Anthony: Commodity-producing and exporting countries
have been on a roll with their terms of trade improving
dramatically. Can this last, and what is the outlook for industrial
and agricultural commodities?
Mark: Yes it can last, given the growing global demand
from the most populous emerging markets. There, of
course, will be great volatility which sometimes will look
like a bear market but it will be merely a correction in an
on-going long-term bull market.
Masahiro: Emerging Asia’s growth will continue to raise
commodity and energy prices. The US easy monetary policy
will help these price rises further.
William: Commodity cycles typically run from 15 to 25
years and we are only 10 years into the present one. If we
are talking about energy, oil demand continues to increase
and new discoveries are inadequate. The emerging
markets have a huge demand for commodities used in infrastructure
and their food demands are growing. Prices
are likely to be quite volatile reflecting cyclical and seasonal
patterns but underlying growth is likely to remains
strong as long as the global economy remains open and
vital. But the West, especially the US, could lose faith in
globalisation. I believe this is a valid fear. I see some unfortunate
straws in the wind.
Robert: The commodity bull cycle will last until 2014, with
agricultural commodities being particularly strong in the
next three to four years, as they catch up in real terms
with oil, gold and mineral prices.
Ernest: There are three broad and major areas of opportunity
that will be generated from the Fed’s move to depreciate
the dollar – currencies, precious metals and stocks
and bonds in emerging markets. Precious metals and
grains will continue their price growth until 2012 or so.
Anthony: Talking of precious metals, will gold go to
US$2,000 an ounce or even beyond in the foreseeable future
and what are the implications of central banks’ decisions
to stop selling gold? What about other precious metals?
Mark: Gold at US$2,000 an ounce is certainly possible and
the same bullish scenarios can be given for such metals
palladium and platinum as well as other metals.
William: US$2,000 an ounce is certainly possible in the
next two to four years. Gold has appreciated about 20 percent
per annum since the lows in the year 2000. Much will
depend on the rate that the US devalues the dollar by printing
more money. If some of the figures I mentioned earlier
for QE happen then US$2,000 would seem to be a lead
pipe cinch. Indeed, we could have a 3 or 4 in front of the
price before the end of the cycle.
But, I do not believe trying to forecast the price is particularly
useful. Gold is part of an insurance policy in a portfolio
rather than a profit centre. I do believe that whilst
bullion will still go up that quality gold mine shares will appreciate
more. I also believe that silver will appreciate
more than gold from here. Platinum will probably trade
like gold but maintain a premium to it since it is rarer.
I found Robert Zoellick’s recent comments about defects
in today’s international infrastructure and the need
to consider some role for gold as a reference for the appropriateness
of current policy interesting. This is the first
time an establishment figure has indicated dissatisfaction
with the post-1971 settlement. I suspect it is the opening
salvo of a new and overdue debate.
More Shine? Gold is seen
topping
US$2,000 an
ounce within the
next six to 12
months, and get
to US$5,000 per
ounce by 2014.
Investors are
told to hedge
against currency
uncertainty by
going for gold
and other
tangible assets.
Robert: I expect gold to top US$2,000 an ounce within the
next six to 12 months, and get to US$5,000 per ounce by
2014. Central banks will be buying rather than selling and
it is completely misleading to suggest that we are in a gold
bubble because it has barely started and the real value is
at least 4 times higher than its current price. The real value,
adjusted for monetary inflation is at least US$5,000. Silver will probably outpace gold, in other words, it will
probably exceed its US$50 an ounce high of 1980. Platinum,
palladium and other precious metals will match or
outpace gold.
Ernest: Gold should reach US$1,500 by year-end, surpass
US$2,000 in 12 months or so, and will reach US$2,500 in
around 18 months. The reasons why gold will go much
higher are that central banks will continue to buy large
quantities as the debt crisis goes global and Europe’s debt
problems are getting deeper. Motivated by either fear or
greed, investors are jumping into gold as they shift away
from the US dollar.
Unless a new currency structure provides that each currency
is backed up by something tangible – the same
game is just being perpetuated. Honest money must be redeemable
by something tangible or real – not just a warehouse
receipt of some sort. That’s why investments in
gold (oil is another tangible investment) are so important
at this time for your portfolio.
Anthony: Thank you all for a stimulating discussion and allow
me to wish you a prosperous New Year in 2011.
###
Nov 29, 2010
William R. Thomson
email: wrthomson@private-capital.com.hk
William Thomson is Chairman of Private Capital Ltd. in Hong Kong and an adviser to Axiom Funds and Finavestment Ltd. in London.
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