Monday, May 24, 2010

GLOBAL CURRENCY BUBBLE

The European Central Bank (ECB) is spending a trillion dollars to keep their Euro currency value high at the same time that China is risking a trade war with their primary markets in the West to keep their Yuan currency value low.

If the ECB ends their intervention and allows the Euro to plunge, it would create a positive economic stimulus by making European manufactured goods more affordable and competitive in the global market place and helping to create jobs. A lower Euro would also devalue the huge deficits that European nations have accrued over the last ten years, alleviating the growing social unrest in Europe as ever higher taxes are levied on the people to repay a decade of overspending. Why would the ECB risk bankruptcy by artificially supporting the Euro?


Equally strange is China’s fight to keep their Yuan value low against the US dollar in the face of threats of a trade embargo from Europe and tariffs on imported Chinese products by the US. Unlike the western world, China is having fierce inflation which a higher valued Yuan would help to relieve by making raw materials and energy cheaper in China. It would reduce the cost of manufactured goods by making imported raw materials cheaper and it would increase the prestige of China by having a highly valued currency. Though we have heard arguments that increasing the Yuan’s value would make China’s labor costs less competitive, a 50% increase in the value of the Yuan would still keep their labor costs competitive in the world. Why would China not want a stronger Yuan?


In the US, the Federal government seems set on keeping the US interest rates at historic lows while running the up largest deficit in US history. This should be causing a drop the value of the US dollar. Oddly, the US dollar is holding strong compared to Euro and the Yuan; the only major currency that the dollar has dropped against is the Japanese Yen.

This surreal global currency situation reminds us of 2007 when reality TV programs showed house speculators that flipped houses after a few days of work for a gain of $100,000. When speculators in the overvalued real estate market stopped making their mortgage payments, the real estate bubble popped and the onset of the global economic collapse began. The risk then was being stuck with overvalued real estate or exposed to related debt by owning stocks in banks, mortgage underwriters or construction.


The currency bubble has its own set of risks for those owning stocks of companies dependent on currency exchange rates or currency sensitive investments such as US Treasury Bills and low interest municipal bonds. Manufacturers or retailers whose competitive edge are based on a low Yuan valuation, such as Wal-Mart and any other discount import retailers, will be crushed by a pop in the currency exchange bubble. Their tiny margins created by low cost Yuan manufacturing overhead in China will disappear overnight in a sudden swing in exchange rates. Only high value, high margin manufacturers, service companies and retailers will survive.


Living in Hawaii, changes in currency exchange rates are not abstract. We see the glee of Japanese visitors as their high valued Yen buys them 30% more than their previous visits. When the currency bubble pops, we think it will affect our life even more than the popped housing bubble.

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