This Is Not A Currency War, It Just Looks Like One

Includes: GLD, SPY
by: Evan Schnidman

Chairman Bernanke's press conference and the minutes of the September FOMC meeting indicated that one of the main drivers behind QE3 was international economic pressures. The past week has highlighted those pressures more than ever. In particular, Bernanke's speech at the IMF meeting over the weekend left many observers wondering if he was starting an all-out currency war with China. As I noted in earlier commentary about the international implications of Fed policy, this is not how I view the Fed's recent actions. However, my previous assessment that this is "coordinated" monetary stimulus might have been a bit generous.

To be precise, many countries around the world are using monetary policy (and in some cases also fiscal policy) to stimulate their economies. These actions are not independent of one another, but it is also inaccurate to say they are coordinated; they are calculatedly coincident. That is to say that central bankers around the world pay very close attention to what other central banks are doing and their policy choices reflect not only the needs of their domestic economies in the short term, but also longer term responses to global macroeconomic pressures. So, the fact that China, Japan, England, Europe etc. are all providing some form of monetary stimulus definitely factored into the Fed's decision to pursue a third round of asset purchases, but that doesn't mean the Fed is engaging in any sort of currency war.

Bernanke's Words

The best way to demonstrate that this is not a currency war is with Bernanke's own words from his speech over the weekend. He began by explaining that monetary "accommodation" in the developed economies (the U.S. and Europe) has both costs and benefits for developing economies (primarily China). He then went on to say "the linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted." So, he is basically saying that the global economy is complicated and that monetary policy is not the only driver moving capital. With specific regard to investment, Bernanke said "swings in investor sentiment between "risk-on" and "risk-off," often in response to developments in Europe, have led to corresponding swings in capital flows." So, he basically pawns off investment flows in and out of developing countries on other macroeconomic happenings, outside of his control. This may seem like a cop-out, but he is not wrong to point to European turmoil as the driving force in global economics right now.

Bernanke then used all his practice blaming Congress for fiscal failing in the U.S. to once again flip the script and scold developing economy policymakers for a long history of poor monetary policy choices:

The effects of capital inflows, whatever their cause, on emerging market economies are not predetermined, but instead depend greatly on the choices made by policymakers in those economies. In some emerging markets, policymakers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth. However, the perceived benefits of currency management inevitably come with costs, including reduced monetary independence and the consequent susceptibility to imported inflation. In other words, the perceived advantages of undervaluation and the problem of unwanted capital inflows must be understood as a package--you can't have one without the other.

This section was entirely devoted to scolding China for currency manipulation and explaining how they made their own bed by not allowing their currency to float. Bernanke even got in a nice little cheap shot (economic cheap shots are pretty tame) when he said "Under a flexible exchange-rate regime, a fully independent monetary policy, together with fiscal policy as needed, would be available to help counteract any adverse effects of currency appreciation on growth." Essentially, Bernanke was telling the People's Bank of China that had they floated their currency years ago, monetary policy would be much more effective in combating their current economic slowdown.

Ultimately, Bernanke closed by saying that the U.S. was not deliberating devaluing the dollar and even if we were it might be good for developing economies. To be precise, Bernanke said "monetary easing that supports the recovery in the advanced economies should stimulate trade and boost growth in emerging market economies as well." In other words, we aren't manipulating our currency, but if we were, you should thank us for it.

How Is This Not A Currency War?

Bernanke's language at the IMF meeting was unusually strong, but they were not fighting words. He was firmly justifying continued to QE to a global audience. Given the venue, he had to draw on international concerns since domestic unemployment under 8% would not be sufficient rationale for continued easing to a global audience. It is particularly worth note that these were not fighting words because Bernanke never named China and he never directly accused anyone of being a currency manipulator.

Bernanke's tame words differ greatly from those of the Romney campaign. Governor Romney's tough rhetoric has led a few commentators to note that these words coupled with a change in Fed leadership could have adverse economic effects, if he wins the election. All of this is not to say that Romney would harm the economy, but simply to point out that just how tame Bernanke's rhetoric was in comparison to the political speech we hear every day. Bernanke could have been bold and named China specifically, but he did not. This indicates that he is frustrated with his global critics, not that the Fed is initiating any sort of currency war.

At this point, it is safe to assume that global monetary policy will continue to be calculatedly coincident and as long as the economic indicators continue to look weak. This means easing will continue for the foreseeable future. Continued global easing will likely bolster safe-havens like gold in the near term, but if inflation fails to meet expectations, gold prices will likely decline. Currencies are a more complex investment in the current environment because virtually every major central bank is easing simultaneously, so it is a question of who is going to do it best. To this question, it is obvious that the People's Bank of China is struggling to hold down the value of the yuan in relation to the U.S. dollar, and if the dollar declines, that is typically correlated with a rally in U.S. equities.

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. I have no business relationship with any company whose stock is mentioned in this article.