Has The United States Started A Currency War?

Includes: FXE, UDN, UUP
by: John M. Mason

Has America started a currency war?

Brazilian finance minister Guido Mantega has once again raised this possibility. He stated that the Fed's QE3 program will "only have a marginal benefit (in the U.S.) as there is already no lack of liquidity … and that liquidity is not going into production."

Mantega argued that QE3 "was instead depressing the dollar and aimed at boosting U.S. exports." Read about this at "Brazil Finance Chief Attacks U.S. Over QE3."

That is, if the Federal Reserve cannot directly pump up the United States economy then the Fed can only weaken the U.S. dollar and thereby stimulate exports. By increasing exports, the U.S. will indirectly increase U.S. output and lower U.S. unemployment.

Early on I commented on the potential effect of the new round of Federal Reserve easing. The recent action by the Fed has raised growing concern about future inflation. This concern is being reflected in the financial markets. For information on this see "Bearish Treasury Bets Hit a Record Amid Inflation Concern."

And, how has the foreign exchange markets been grading the Federal Reserve leading up to the latest meeting of the Federal Open Market Committee? Well, it too seems to be picturing more U.S. inflation in the future thereby leading to a decline in the value of the dollar.

At the end of August, just before the speech Mr. Bernanke gave at Jackson Hole, Wyoming, a euro could purchase about 1.26 dollars. Recently, the exchange rate has been around 1.31 dollars per euro. This represents a decline of about 3.8 percent in the value of the dollar against the euro.

The Wall Street Journal dollar exchange Index has declined by about 3.0 percent over the same period of time. The Federal Reserve's index of the dollar versus other major currencies in the world, during the same period of time, has fallen by about 2.8 percent. And, what about Brazil? To date the value of the dollar versus the Brazilian Real has declined by a little less than 2.0 percent.

The problem is that if the value of the dollar declines sufficiently against the euro and other major currencies, the European Union and other areas of the world may react to this attempt by the United States to spur their own exports with actions to counter what the Federal Reserve is doing. Europe, for all intents and purposes, is in a recession now. China's economy is suffering. The Brazil economy is going through a downturn. India also faces recession. And, Japan is not growing.

Who is the United States going to sell to? And, don't these other areas want to increase their exports as well? Might not they attempt to introduce "protective" measures to counteract the actions of the United States? The ECB is already into its own efforts to achieve quantitative easing. The Japanese central bank has just introduced efforts at quantitative easing.

This seems to be what the Brazilian finance minister is getting at. Brazil, as well as these other nations, is not going to just idly sit by and let the United States devalue the dollar to stimulate exports without a response. Hence, the possibility of a currency war!

And, need we not forget, this was part of the world's condition in the 1930s as economic depression around the world resulted in greater and greater amounts of protective trade actions by the nations to protect themselves from what other nations were attempting to achieve. As I stated in my earlier post, cited above, I believe that the "endless" effort of quantitative easing on the part of the Fed will continue to erode the value of the dollar against the euro and other major currencies.

I believe that this is part of what the Federal Reserve is attempting to achieve. And, I believe that other countries around the world will react to this. If this is true there should be some real opportunities to make money. This is what the hedge funds have taught U.S. over the past 20 years or so.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.