Seven Situations to Watch in the Pacific Currency War
It's now one year to the day since the end of our first-ever investment conference at Sydney's Intercontinental Hotel last year. The great economic power struggle that was discussed at the 'After America' conference is raging even more intensely this year.
Big political and economic moves have been made by all the key players - Australia, China, America, Japan, and both Koreas. In this short update, I'll review the five most significant changes investors must reckon with as they're caught in the cross-fire of this Pacific power struggle.
The topics raised and questions debated over those two days last year - China's political power transition, the fate of Australia's commodities boom, and the ultimate fate of the American dollar in the currency war - are still as urgent to investors today as they were a year ago. I went back and viewed some of the presentations recorded on DVD during the week. Here is a quick summary of the key-note presentations and their key ideas:
Knowing What You Don't Know by Dylan Grice: Before he left the Alternative Views team at Societe Generale to join Edelweiss Holdings, our favourite Scotsman delivered a tour of history that puts today's currency war in context. He explored the reasons for the fall of Rome, the cause of the Great Depression, and why Romanian witch doctors have a better record of forecasting than central bankers.
Chinese Grand Strategy and American Hegemony by Dr Paul Monk. 'For most of the past two millennia, China was a world unto itself, turned inward, and in no sense dominant, even in Eurasia, to say nothing of the world at large,' said Dr Monk. The former analyst of the Department of Defence and the Defence Intelligence Organisation added that, 'We should not, therefore, get carried away by what I call the 'middle kingdom mystique'. China's past did not and does not make its ascent in our time natural.'
Following the Money - New Bull Markets for the 21st Century by David Thomas. Thomas, a 30-year veteran of emerging markets and Asia Pacific focused on the opportunities ahead over the long-term. He asked 'Where do we look for growth in the future? After America, what are the clues and the things we should be looking for as an indicator of future booming economies?'
The Great Re-Set by Satyajit Das: The author of Traders, Guns, and Money gave a command performance to close the show. For an hour and a half he showed precisely how Australia's economy is tied to the China story, and how the European debt crisis is a small part of a larger systemic problem requiring a great 'Re-set.' His remarks earned him a standing ovation from the crowd.
And those are just the keynotes!
There are over six discs in the DVD set. Dr Steve Keen dropped in for a cameo presentation on the Australian housing market and the world economy. He said, 'We wouldn't be in this room if it wasn't for the level of private debt in the world right now. Private debt is what's caused the bubble.' He showed in great detail what to expect.
And of course, all of my colleagues at Port Phillip Publishing gave their take on the question. Some of the presentations had immediate investment consequences. But most were longer-term, dealing with the question of how to craft an investment portfolio that takes into account this huge sea-change in economic affairs.
I'm not going to go through each of those presentations. You can watch them all on the DVD. You can also print out and read the transcripts that were made of the entire event's proceedings. If you are just starting to grapple with this issue, it's a perfect way to start your thinking and planning.
Seven Situations Complicate the 'After America' Story
If anything has become clearer in the last year since the conference, it's that Australia is caught in the crossfire of a currency war. The Aussie dollar is making new highs against the Japanese Yen. With the cash-rate at an 'emergency low' of 3%, the Reserve Bank of Australia (RBA) is one of the few central banks in the world NOT engaged in a war to cheapen its currency.
The RBA's strategy has produced mixed results for investors. The strong Australian dollar has induced capital to flow into the country from abroad, driving up bank stocks and other high-yielding blue chips like Telstra. But for manufacturing, tourism, and exports, the high dollar is a bane.
Those are some of the domestic impacts of the currency war. But to put the issue in a larger context, let's briefly look at six big changes to the story since last March. In this long-term battle for economic and political ascendancy, these are the six developments that will determine who wins and who loses. Investors will have to reckon with all of them.
#1: New Chinese political leadership
Xi Jinping officially became China's new President on Thursday, March 14th. His ascension marked the end of an intricate, year-long process marked by a huge internal power struggle within the Communist Part of China (CPC) that resulted in the ousting of Chongqing mayor Bo Xilai. Xi now has the reins of power for the next ten years. His leadership group will decide whether to respond to the global currency war with a new round of 'stimulus' on urban development. This spending, if it comes, is one factor that could contribute to a 'second wind' for the Australian resources market.
#2: Japan and China feud over the Senkaku Islands
The Senkaku Islands are located in the East China Sea, between Japan and China. In September of last year, a long-running territorial dispute over the ownership of the islands reignited after the Japanese government purchased the islands from their private owners. Since then, an escalating game of brinksmanship and political rhetoric has marked this as a flashpoint between Japan-China relations. The US is conspicuous for its absence so far, but may be un-interested (or unable) in managing affairs in the Pacific.
#3: Japan's offensive in the currency war
A key factor in Japan's growing geopolitical tension with China has been the election of the new Prime Minister Shinzo Abe in December of 2012. But Abe's influence over Japanese monetary policy has been just as momentous. He has replaced the governor of the Bank of Japan with a 'dove' who's vowed to fight deflation. This is Japan's offensive in the currency war. The result has been a new-high in the Aussie dollar/Japanese Yen exchange rate. With Japan determined to weaken the Yen, capital flows to Australia have supported a fast start to 2013 for the All Ordinaries (up 8.3% year-to-date).
#4: Renewed tension between South and North Korea
New UN sanctions against the regime of Kim Jong Un have prompted the North Koreans to threaten America and South Korea with nuclear annihilation in recent days. The rhetoric has also ramped up to coincide with annual joint US/South Korean military exercises. China's ability to manage its client state is an open question. Is it using the North Korean regime to destabilise US influence in the region? Or is North Korea a true geopolitical wild card, not answerable to anyone and capable of being the 'Black Swan' of 2013?
#5: Political stale mate in US fiscal policy
Barack Obama surprised the press by cruising to re-election in November of 2012, despite getting fewer total votes than his victory in 2008. But since his official inauguration in January, his administration has been engaged in a series of running fiscal battles with the Republicans in Congress. Deals over the debt ceiling, the sequester, and the budget have become permanent features of the Washington landscape. Despite all this, the Dow Jones Industrials have made a new all-time high and enjoyed their longest rally in 16 years. America's long-term fiscal position of high deficits and a bigger debt continues to worsen.
#6: The 'Code War'
It's clear to most investors that the Pacific Powers - China, the US, and Japan - are engaged in a currency war. The objective of this war is to boost economic growth through exports by making your currency cheaper. But in recent months, another war has hit the front pages. Commonly referred to as 'hacking', I prefer to think of it as the 'code war', wherein governments use computer hackers to attack strategic competitors. When the New York Times published an article on Unit 61398 - a unit of the People's Liberation Army of China that's allegedly in the business of staging cyber-attacks on American groups like the Department of Defence - it was a clear sign that a new era of cyber warfare has begun.
#7: Australia's Federal Election
Australians go to the polls on September 14th to vote for members of Parliament. At stake is the fate of the mining tax, the carbon tax, and the size and scope of future government deficits. Though I'm sceptical that a change in political leadership will mean a big change in fiscal management, Australia's strategic posture relative to China and America IS up for review. How the country navigates between two Pacific powers - one rising economically and the other trying to get back on its feet - is one of the great political challenges of the day.
With stocks rising, investors couldn't be blamed for not taking geopolitical matters too seriously right now. But this is precisely the time to consider them - BEFORE they burst on the scene to affect investment values in the middle of a crisis. That was the whole purpose of the 'After America' conference in 2012. And it's what makes the comments and presentations at the conference valuable today.
Of course a simple review might ask the question: was the premise of the conference even valid? Is China rising? Is America falling? Must Australia choose between the two? Or can it chart a more independent course?
And finally, what are investors to make of all the different forces and factors? Is the commodity boom still a safe bet? Or should recent market highs be taken with a big grain of salt? Could geopolitical factors affect investment markets this year in ways we haven't anticipated? Stay tuned.
Regards,
Dan Denning
for The Daily Reckoning Australia