The currency wars are heating up. The US Senate has passed a bill to penalise countries that manipulate their exchange rates – a move aimed squarely at China. Central banks in the US, UK and Japan have printed record amounts of money, either explicitly to weaken their currencies or with a weaker currency as a welcome side-effect. Even the Swiss franc, normally the closest the world has to a hard currency, has been pegged to the euro, putting Switzerland’s money creation into overdrive.
Yet, for now at least, no one is heading for the hills. Countries may be struggling to gain trade competitiveness in order to ease the post-crisis economic pain but few observers fear large-scale trade wars will result, let alone real bullets-and-tanks wars.
Jim Rickards, an investment banker and military adviser, sets out to change that view in Currency Wars: The Making of the Next Global Crisis. On his analysis, we are well into the third currency war of the past hundred years, and the outcome this time could be far worse than the previous two.
His first currency war was the disastrous 1921-1936 reintroduction and then collapse of the gold standard, which played a part in the Great Depression and by extension the second world war. The second was the end of the postwar Bretton Woods link of the dollar to gold, followed by the economic turmoil and inflation of the 1970s.
Both periods have plenty of lessons for today – not least in the starkly different approaches taken by presidents Barack Obama and Richard Nixon to European crises. Obama has been pushing hard and publicly for the Europeans to get their act together as Italy’s problems threaten the single currency. Nixon, briefed on the problems faced by Italy after sterling’s devaluation in 1972, could not have been less bothered. “I don’t care. Nothing we can do about it,” he said. “I don’t give a shit about the lira.”
Rickards examines the ongoing financial crisis through the same currency lens. On his view, quantitative easing – the Federal Reserve’s creation of money to buy bonds – was a “secret weapon” to weaken the dollar, aimed mainly at China. The Arab spring was collateral damage, as the Fed’s flood of dollars drove food price inflation and so provided the spark for revolution.
All of this is a plausible way to view what is going on, and Rickards tells the tale well. But when he presents his criticism he will lose many readers. The Fed should have allowed more banks to fail in 2008, he argues, as many were insolvent, not merely suffering from liquidity shortages. Even if the Fed was successful in weakening the dollar, currency devaluation does nothing to boost an economy (a claim central to his thesis, but not backed up anywhere). Rickards writes that the Fed is “like a hedge fund” with 50 times leverage; as a former general counsel at Long-Term Capital Management perhaps he should know, although he does not mention his role in the fund’s 1998 implosion.
The aim of the polemic is twofold: first, to warn America of the dangers of hostile states – China, Russia and Iran are named – using financial “warfare” to take down the dollar and weaken the US; and second, to call for a return to a gold standard.
The first point was made to the Pentagon by Rickards when he took part in its first financial war game in 2009. The Russian “player” launched a gold-backed bank and refused to take payment in dollars for its oil and gas exports, forcing buyers to pay in the new bank’s hard currency.
The book contains plenty of examples of countries trying to bypass the dollar. But it relies on too many unsubstantiated claims to persuade the reader that states are deliberately trying to undermine the currency, rather than just find a safer alternative (which, to be fair, is another of his worries).
His gold point is made mostly by warning of the dangers of the current monetary system. The currency war and its antecedents – the failures of Keynesian and monetarist economics and the excesses of central banking – demonstrate the need for an alternative. The International Monetary’s Fund’s Special Drawing Rights are of little use, while multiple reserve currencies, widely expected to include China’s renminbi, are a recipe for further battles. Hence gold.
As an argument this is better than most goldbugs make. But there is no attempt to address the drawbacks of gold. Removing the safety valve of currency devaluation forces economic adjustments to be made via labour costs; as the eurozone periphery is demonstrating, the pain this generates puts enormous pressure on political systems. Even if that were accepted, a relatively slow-growing gold supply all but guarantees persistent deflation.
Still, a move to gold would definitely be better than the apocalyptic final scenario Rickards presents. “In principle, the destruction of wealth, savings, trust and confidence in the wake of a currency war and dollar collapse might be no less catastrophic than a hostile alien invasion,” he writes. “A person’s net worth would consist of those things she can carry on her back.” Let’s hope he’s wrong.
James Mackintosh is the FT’s investment editor
Currency Wars: The Making of the Next Global Crisis, by Jim Rickards, Portfolio, RRP£19.99, 304 pages