Watch Out for Currency Wars

Focus: MARKETS

Axel Merk Image Axel Merk President and Chief Investment Officer, Merk Investments, LLC

Axel Merk, president and chief investment officer of Merk Mutual Funds, and co-portfolio manager Kieran Osborne warn that competitive currency devaluations are a real danger.

Competitive currency devaluation appears to be the name of the game for many Treasury departments and central banks alike. It may also be a key driver of the recent strength in gold.

For many countries, the motivation to devalue the currency is to spur export growth. Devaluing a country’s currency is akin to providing a subsidy to the export sector, as it makes that country’s exports relatively cheaper.

The flip side is that for a high-growth developing economy, the combination of an undervalued currency and increased production and labor costs can cause substantial domestic inflationary pressures, as evidenced in China.

Moreover, devaluing a currency may lead to escalating international political strains, global criticism, and intensification of protectionist pressures, [such as] the US criticism leveled at China, culminating in the passing of legislation aimed at pushing up the value of the yuan.

We have long argued that China should allow its currency, the yuan or renminbi, to appreciate, as it may help alleviate much of China’s domestic inflationary pressure.

The Chinese are unlikely to allow the currency to float freely overnight, as even small moves to the currency affect many businesses throughout the Chinese economy; the process is likely to play out over many years. This hasn’t stopped US politicians from taking a swipe.

But it is unlikely that [many] of the jobs that already left as part of the outsourcing bubble that occurred throughout the last decade will return to the US.