The United States risks importing uncontrolled inflation through its deliberate efforts to weaken the dollar. ‘Currency wars’ expert James Rickards says such scenario ultimately threatens the global monetary system.
- US dollar weakening threatens runaway inflation - Rickards (PDF, 184 KB)
James Rickards, author of ‘Currency Wars: The Making of the Next Global Crisis’, told the RBS Macro Conference in London that the world was witnessing the early blows of a battle that could last for years but which no one would win.
He said the US Federal Reserve, Bank of England and Bank of Japan had implicitly agreed to simultaneously weaken their currencies by turning on the printing presses and so gain an advantage over emerging market rivals.
“In the 1930s, countries devalued sequentially, like thirsty soldiers passing around the canteen. Today the US, Japan and the UK are saying ‘let’s all ease together, lets not fight currency wars among ourselves but fight them with the rest of the world’”.
Despite intense focus on the weak yen this year, Rickards said Washington was actually giving Tokyo a “pass to trash its currency” because of its geopolitical importance to Washington and also Tokyo’s willingness to soak up growing supplies of US Treasuries that China was now buying in smaller quantities.
Rickards said the whole aim of the currency wars was not as many believed a competitive devaluation to boost export sales, but a tactic to induce consumer spending by increasing inflation through pricier imports.
If inflation climbs above nominal interest rates then consumers are incentivised to borrow rather than save as real interest rates become negative. The ‘stick’ to encourage spending is then an ‘inflation shock’ of higher-than-expected price rises that create almost a panic buying mentality.
Such a tactic would backfire disastrously, Rickards said.
“The Fed thinks monetary policy is a thermostat to be dialled up or down. That idea is deeply flawed,” he said, likening it instead to a nuclear reactor that was unstable and which could not be reversed if it went into melt down.
The Federal Reserve, he said, was prioritising its unemployment-fighting mandate and would allow inflation to rise upwards of 4 per cent. But its efforts to then rein in rising prices would fail and inflation would start to spin out of control on the back of growing consumer confidence and faster spending patterns.
A similar process over the 1970s ended with US inflation rising to 15 per cent by 1980.
“I don’t think it will take 10 years this time,” said Rickards. “It could take as little as two or three years and end up with inflation around 9 per cent.”
In contrast to the situation 33 years ago however, the sheer complexity of the global monetary system this time meant it would be far more difficult to control the causes of inflation.
The consequences would be dire.
“The risk of a generalised collapse of confidence in paper money around the world is very high. Trade wars, social unrest, shooting wars, they are all possibilities”.
Leveraged to the hilt, the Federal Reserve would then have insufficient firepower to act effectively. The eventual crisis would lead to the end of the dollar standard, Rickards said.
“The next time this happens the Fed will not be able to bail out the world. Their balance sheet will go from USD800 billion to USD3 trillion now and to 5 trillion by the end of next year.
If this crisis hits in a couple of years, what’s the Fed going to do? Take the balance sheet to USD10 trillion? At that point the only clean balance sheet in the world is the IMF’s.
“In an acute financial panic, the IMF will re-liquefy the world with SDRs (special drawing rights) so they will be the world’s central bank and SDRs will be the global currency”.
The statements and opinions expressed in this article are solely the views of James Rickards speaking at an RBS Macro Conference in London on March 14, 2013 and do not necessarily represent the views of the Royal Bank of Scotland.
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