Wednesday, September 15, 2010

Competitive Devaluation and gold

On Sep 15th., shortly after a new government was installed, Japan began buying yen massively, to protect its exporters against the unremitting strengthening of the yen. This was the first time in 6 years that the BOJ has intervened. From media accounts, it would appear that the intervention was unilateral.

“The bottom line is that it was very silly thing for Japan to do. It almost gives everyone else the right to intervene unilaterally and trigger a competitive devaluation process,” said Noriko Hama, of Japan’s Doshisha University (quoted in FT of 16th Sep.)

When I began buying gold in September of 2007, exactly 3 years ago, it was in anticipation of just such a development. There were two stages to this thought:

1. That there would be a severe financial crisis in the US, the inevitable result of too much credit, too cheap, and for far too long.

2. In trying to effect a recovery, national economic administrations would try to:

i. Create even more liquidity.

ii Export their way out of trouble. In order to this, we would see competitive devaluation of currencies.

Step 1, of course, happened a long time ago. Step 2.i, has been under way for two years now, and has restored the pre-crash situation in financial markets - high correlation between all asset classes: since June this year, equities, commodities and US Treasuries have been buoyant. Not to mention real estate in India.

Step 2.ii has been building up for a while, with the US trying to shout China into allowing the yuan to appreciate. While making the occasional token gesture on this front, China has gradually stopped using its export surplus to buy Treasury bonds - which could have driven the dollar up further. Instead, it began buying Japanese bonds. Of course, this drove the yen up, to a level which made Japanese exporters a worried lot.

But this week, dollar buying by Japan has put a whole new spin on export competitiveness. Wilful currency depreciation has begun. In itself, it is both dangerous and unpredictable, as national politics can lead to strange dynamics.

Large investors (call them speculators if you wish), can react by taking bets on government moves, which will amplify such moves. The other likely development is that many will decide that such unpredictability makes currency investments hazardous, and precious metals a lot less hazardous. This is a development which could put a strong trend line under gold and silver.

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