Yesterday, the fine folks of Tradition Analytics were kind enough to explain (once again) just how it is that the Fed has boxed itself into a corner, where in order to maintain the already outlierish growth rate of monetary supply, the Fed will have no choice but to print (same with the ECB), or else risk a massive economic collapse (thank you Austrian theory).
Today, the same group provides an update on what everyone knows has been the status quo's only way of dealing with the deleveraging tsunami since March 18, 2009: currency warfare. In the note below, they provide a recap of the recent history of FX warfare, as well as an update of where we stand currently. Keep in mind, currency warfare only works to a point. Then it escalates into other, more violent forms, first trade wars, then real ones.
Recent History
From 1999 to 2011, the average growth rate of global foreign exchange reserves is just over 16% annually. At the start of 1999, global foreign exchange reserves stood at $1.6 trillion, before climbing above $5 trillion in 2006, before doubling and breaching the $10 trillion mark for the first time ever in Q2 2011.
Of particular interest is that a breakdown of this growth between developed economies (DMs) and emerging and developing economies (EMs) shows that EMs have debased their currencies at a much faster rate than DMs over the past decade. The average rate of EM reserve growth over the past 12 years is 23%, compared with 10% for DMs. This means that EMs have been creating massive monetary inflation in their domestic economies, and this is confirmed in money supply data, and was also reflected in the accelerating price inflation that these economies experienced from 2005 to 2008.And here is where we are now:
Noting the pie charts included on the following page, see how DMs holdings as a percent of total global reserves have grown since 1999. From 38% in 1999, DMs now hold 68% of global foreign reserves.
As shown on the chart above, EM economies are currently stepping up foreign reserve accumulation, outstripping the pace of forex accumulation of DMs by a substantial margin. This comes at a time when EM economies are slowing substantially, which means EMs are likely to see accelerating price inflation in 2012 as this new money seeps into their respective economies.
The very aggressive forex accumulation by EMs during the boom phase of 2002 to 2008 now has them in a sense trapped; they must continue to create money supply at the same or faster rate as before in order to keep domestic growth supported. These central banks can buy all kinds of assets to achieve this goal, but if they don’t continue to support and buy DM currencies, the major currencies may weaken to such an extent that emerging economies lose their export markets as their currencies strengthen. Also, if they did not buy DM currencies but rather bought domestic assets with newly printed base money, it would result in tremendous asset price inflation as well as consumer price inflation in their domestic economies. As a result, emerging economy governments are forced into buying USD, JPY, GBP and EUR to hold as part of their reserves... Read more>>
