Currency Wars Expand Their Battlefield

Wall St. Cheat Sheet

The price of gold has been in decline over the past few weeks. Despite the Federal Reserve launching a fourth round of quantitative easing, the precious metal can not seem to stem the heavy selling pressure. However, long-term investors are not likely to be deterred by the short-term price action as central banks around the world continue to engage in currency wars.

In a recent speech at the Economic Club of New York, Bank of England Governor Mervyn King predicted a continuation of currency wars next year. He explains, “I do think 2013 could be a challenging year in which we will, in fact, see a number of countries trying to push down their exchange rates. That does lead to concerns. Will other countries react in kind? What will happen? The policies pursued by countries for domestic purposes are leading to tension collectively.” He also adds, “There are limits to how far monetary policy can be effective in the very long run shifting spending for the future to today.”

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At this point in the war, central banks are still trying to find their limits. Over the past six years, the maestros of the printing presses have injected the financial system with roughly $11 trillion and show no signs of slowing down. At its two-day policy board meeting, the Bank of Japan decided to increase its asset purchase program for the third time in only four months. The central bank effectively launched QE10 by expanding the monetary easing weapon by 10 trillion yen to 101 trillion yen. Including the latest move, the BOJ has expanded its quantitative easing program five times this year. “Japan’s economy is weakening further and is expected to remain weak for the time being,” explained the central bank, according to Reuters.

The bond buying expansion was widely expected as Shinzo Abe, the country’s new prime minister from the Liberal Democratic Party, recently won his election in a landslide. He has promised to stimulate the economy with a large spending package and is a strong advocate of monetary easing by the BOJ. In addition to QE10, the central bank pledged to review its “medium to long-term price stability” at its next meeting in January. The BOJ currently has a 1 percent inflation target, but is expected to implement a 2 percent target, as demanded by Abe.

The Federal Reserve already has a 2 percent inflation objective and recently explained in its latest Federal Open Market Committee statement that it will tolerate higher inflation as long as longer-term inflation expectations continue to be well anchored. While the BOJ does not technically have an unlimited bond purchasing program officially in place like the Federal Reserve and European Central Bank, there appears to be little limit in how much the BOJ can ease, so far.

When central bankers intervene and manipulate financial markets it distorts investment decisions and creates capital misallocations. The full effects of monetary easing will likely not be known for years, but some investors are taking caution ahead of time. As the WSJ reported earlier this week, a small number of pension funds in Japan are starting to invest in gold in order to “mitigate the damage from possible market shocks.” Gold is currently trading near multi-month lows, but corrections like this are not uncommon and precious metals still remain as a viable way to diversify a portfolio against currency wars.

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Disclosure: Long EXK, AG, HL, PHYS