21/10/2010 - 00:00

No winners in currency ‘race to the bottom’

21/10/2010 - 00:00


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Artificial market manipulation most often leads to blowback, thanks to the immutable laws of supply and demand.

NO-ONE wins a war. All sides suffer, something the world seems determined to re-discover as the current currency skirmish threatens to break out into a full-scale trade war.

Described as a ‘race to the bottom’, the currency war is all about countries trying to depress the value of their currencies to protect export industries.

Brazil, Japan and Thailand have been among the lead players in the currency game, which is actually more about trying to avoid being squashed by the falling US dollar – arguably one of the biggest economic events of the past 50 years.

Australia is on the sidelines in the currency phase of what’s happening, which is a good thing because even though farmers and miners are crying foul as the value of their exports decline (because most exports are sold in US dollars), there is nothing a small country can do at times like this; just let the currency float.

The best example of how helpless we are in a currency war can be found in the price of gold. During the past five months, gold in US dollar terms has risen from around $US1,200 an ounce to $US1,376/ounce. In Australian dollar terms it has fallen from $A1,470/ounce to $A1,376/ounce.

Gold illustrates the real story behind commodity prices. They’re not actually rising; the US dollar is falling.

The purpose of repeating the well-known gold example is to highlight the fact that sometimes the winner in a war is actually the loser. But before getting too deep into philosophical matters, let’s go back to the question of what happens should a currency war become a trade war – and why they are to be avoided.

Back in the 1970s, the Organisation of Petroleum Exporting Countries (OPEC) used oil as a weapon as part of the never-ending Middle East conflict. For a few years it seemed that OPEC was the winner and the Western world threatened being choked by sharply reduced oil supplies.

What a surprise to look back now and discover that OPEC was really the loser, and is continuing to lose. In 1973, the Arab-led cartel controlled roughly 51 per cent of the world’s oil supply. Today its hold is 40 per cent, and falling as alternative energy sources are developed and science finds ways to extract natural gas from hard rocks such as shale.

Another way of looking at how OPEC declared a trade war and thought it had won can be found in living standards and income levels in OPEC members. A few are very rich, but most OPEC members who put all their faith in a single commodity remain poor, badly governed and destined for the scrap heap of failed states.

Russia’s gas war with Europe two years ago has backfired badly as the Europeans scramble to substitute gas from Siberia with LNG shipped in from Africa. The result is that Russia’s share of the European gas market has fallen from 28 per cent to less than 25 per cent.

Looking ahead, it’s a fair bet that China’s attempt to squeeze the global rare earths market by limiting exports will produce the same result as countries that use rare earths scramble to start new mines – with the promise of rising production certain to prove the point that rare earths really aren’t that rare, it’s just that so little is used no-one has bothered to open new mines, until now.

For investors, consider those examples when thinking about opportunities that rely on artificial market manipulation; and remain alert for the inevitable price correction as supply rises to meet demand.

No-growth zone

MUCH is being written today about the lack of growth in the world economy, a point that escapes many Australians because we have emerged relatively unscathed from the global downturn.

But, to understand the depth of the problem confronting the ‘old-world’ economies of Europe and the US, you only have to think about what a 30 per cent unemployment rate means for adults and 60 per cent for young people.

Those numbers are not make-believe, they are the latest measures of hopelessness on the Italian island of Sardinia – once a major mining centre (lead and zinc) but which today has been put out of business by bigger and cheaper mines elsewhere.

Sardinia is a case study of what happens when the mining industry behaves badly (spoiling the environment) and then governments behave badly by not appreciating that mining techniques have improved infinitely, and even have a role in the clean up.

In the US, the unemployment rate is stuck at around 10 per cent; growth is flat and looks like staying that way for many years as the country (and home owners) repair ruined balance sheets.

One critical measure of the pace at which the US is going backwards is the fall in the average income of working families from $US61,000 in the year 2000 to $55,800 today.

Another measure is the fact that household debt stands at 123 per cent of annual household disposable income, a number that means a decade of saving to pay back unwise loans taken out in the boom.

Those income and debt numbers mean the US will be a no-growth area for a decade, and that means the global economy is running on six cylinders instead of eight, which is why growth in the non-Asian part of the world is non-existent.

New sparkle

SPEAKING of wars and a changing world, it was utterly astonishing to see last week an advertisement from the diamond giant, De Beers, promoting brown and yellow diamonds.

On display where two superb pendants – one containing uncut diamonds, the other cut stones.

But what was so interesting is that there is every chance that those diamonds came from Rio Tinto’s Argyle mine, primary source of brown diamonds which it calls cognac but which the media unkindly dubbed ‘beer-bottle brown’.

Back in the 1980s, De Beers and Rio Tinto fell out badly over how to market the brown diamonds and it wasn’t until someone discovered how good the colour looks on non-white skin that sales picked up.

Today, De Beers is eating humble pie and promoting beer bottle browns as if nothing happened all those years ago – another wonderful example of how war of any kind (words in this case) is a wasted effort.


“The best way to keep one’s word is to not give it .”

Napoleon Bonaparte



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