We’re in the throes of Currency War III, and Ben Bernanke has won the first offensive by flooding China with inflation.
If this sounds like a geeky online game, recall how Chinese prices surged after the Federal Reserve unleashed its quantitative easing in 2009 and 2010, one of many moves James Rickards parses in his somber book, “Currency Wars.”
“It was the perfect currency-war weapon and the Fed knew it,” he says, describing how the Fed’s expanding money supply forced China to print more yuan to maintain its peg to the dollar. “China was now importing inflation from the United States through the exchange-rate peg after previously having exported its deflation to the United States.”
Enough was enough, as President Barack Obama has now summed up the U.S. view that the yuan remains undervalued.
Rickards, whose CV includes stints at Citibank Inc. and Long-Term Capital Management LP, has written one of the scariest books I’ve read this year. Though I was tempted at first to dismiss him as alarmist, his intelligent reasoning soon convinced me that we have more to fear than fear itself.
Part history, part primer and analysis, the text covers topics ranging from the “misuse of economics” to complexity theory. The pieces, although disparate, fit together snugly, as in one of those mystery jigsaw puzzles that come with clues in lieu of cover art. The picture that emerges is dark yet comprehensive and satisfying.
Chapter One aptly sets the stage with a behind-the-scenes look at the Pentagon’s first financial war game, which opened on a rainy day in March 2009 at the Warfare Analysis Laboratory halfway between Washington and Baltimore. Rickards describes how he helped design the exercise and recruited two Wall Street pros, Steve Halliwell and Bill O’Donnell, to participate alongside platoons of economists, intelligence officials and military analysts.
Together, the threesome conspired to lob a heat-seeking missile into the battlefield: Without warning, the Russian Central Bank announced it was transporting its gold to Switzerland and issuing a new gold-backed currency through a London bank. Russian oil and gas exports would henceforth be paid for in the new currency, not dollars. By the end of the game, the U.S. was the biggest loser.
Massive National Debts
None of this is, unfortunately, as fanciful as it might appear. Industrial nations inflicted two vicious rounds of currency devaluation on the planet in the 20th century, as Rickards reminds us. The first, in the 1920s and ‘30s, led to military conquests by Nazi Germany and imperial Japan. The second fed a brutal inflationary spiral in the 1970s.
Both episodes, for all their differences, began with vast, unpayable national debts, the same burden that now cripples leading industrial countries from the U.S. to Japan, as Rickards says. Today, as yesterday, countries are attempting to devalue their way out of trouble. Following the strategy of beggar-thy-neighbor, the U.S., Europe, China and Japan all want to weaken their currencies. The flaw in the tactic should be clear. “Not everyone could cheapen at once,” Rickards writes. “The circle still could not be squared.”
What will this war mean for the power and prestige of the dollar, the world’s dominant currency? Rickards runs through four scenarios, which he ominously dubs the Four Horsemen of the Dollar Apocalypse.
Race to the Bottom
The most optimistic prediction, he says, is the one Barry Eichengreen anticipates in his book “Exorbitant Privilege” -- that of a world heading toward a multipolar system in which the dollar competes with the euro and the yuan. The flaw with this model, Rickards argues, is that healthy competition could devolve into an unhealthy race to the bottom by central banks seeking to lock in regional dominance.
The darkest outcome would be chaos: a “catastrophic collapse of investor confidence” into panicked selling of dollars and dollar-denominated securities.
Rickards is less than impressed by suggestions that the dollar can be replaced as the dominant currency with Special Drawing Rights issued by the International Monetary Fund. In the end he holds out the most hope, as you may have guessed, for a return to some form of gold standard.
His arguments for a “flexible” gold standard are too nuanced to summarize here, though he takes pains to distance himself from hard-line gold bloggers and the botched interwar “gold exchange standard” implicated in the Great Depression. All he’s asking, really, is whether central bankers should be allowed to print unlimited amounts of money.
“There is an unwillingness, rooted in ideology, to explore ways to reconcile the demonstrated stability of gold with the necessity for some degrees of freedom in the management of the money supply to respond to crises and correct mistakes,” he writes. “A reconciliation is overdue.”
A fair point, though I found myself distracted a few pages later by a table presenting implied gold prices based on various measurements of money supply. The top value per ounce: $44,552.
Which makes me wonder: Has Rickards been stuffing his mattress with bullion?
“Currency Wars: The Making of the Next Global Crisis” is published by Portfolio/Penguin (288 pages, $26.95). To buy this book in North America, click here.
(James Pressley writes for Muse, the arts and leisure section of Bloomberg News. The opinions expressed are his own.)