The Currency Crisis of 2010-2011

Michael Sankowski, Editor, Currency Profits Trader, TaiPanPublishingGroup.com

Financial markets in the last two years have been absolutely nuts. Huge moves in currencies, bonds, stocks, commodities – every market went crazy as the world nearly fell into a dark age. Yes, it was very close to “guns, ammo and water” time, much closer than any of the CNBC pundits would let on.

The financial markets seem a bit calmer over the past few months. Even with people flooding into U.S. government bonds because of safety concerns, the markets aren’t making the huge moves they made in 2008 and 2009. Yes, investors are avoiding the stock market, but it isn’t like there is panic in the streets, like there was until May of this year. The markets have calmed a bit.

Now for some bad news: These calm times aren’t going to last. Soon, people are going to be talking about the currency crisis of 2010-2011 – as we live through it, blow by blow.

But the biggest part of it will be due to the titanic clash of wrongheaded economics clashing with real-world facts.

When the financial markets realize this, there is going to be huge, unprecedented moves that rock all markets – and the calm times will be over.

We need a way to understand what might happen in the next year and profit from it.

Competitive Devaluations of Currencies

The currency crisis of 2010-2011 will be about two big ideas: recognizing losses from the housing market and a double-dip recession. But profiting from the currency crisis will be about one huge idea: competitive devaluation of currencies. During 2010 and 2011, the biggest topic will be how countries are competing to make their currencies less valuable, not more valuable.

The reason for this is simple – according to standard economic theory, the only way for an economy to grow is to make stuff for rich people and sell it to them. Nearly every economy in the world is export-driven except the United States. A weak currency is great for exports.

So during the next year, as the world economy falls off a cliff, countries will be fighting for the crumbs from an ever-smaller pie. There is really only one choice here – the way to economic growth in this situation is to be the cheapest supplier of goods.

In these lean times, companies are already running with the minimum staff possible. An easy way to make your goods cheaper is to make your currency less valuable than it was.

We’ve seen this already – countries are bickering about weakening their currencies. China is holding its currency artificially weak against the U.S. dollar and has for years. Japan just had a meeting on how they are going to intervene and make their currency weaker. But Germany is in the best situation of all.

You’ve heard about the problems with the euro – the euro currency is down nearly 25% from its highs because people are worried that some countries in the eurozone could default on their debt. But for German exporters, this low euro is great news. It is like a 25%-off sale, but they magically get the same number of euros to pay their workers. And they don’t have to spend a euro to make their currency weaker.

Germany recorded 2.1% growth in one quarter – that’s nearly 9% growth over a year – largely because the euro is so undervalued right now. The only problem is that this growth is coming at the expense of another country’s growth.

It’s actually a long list of other countries that want this growth. You can bet that Japan, China, Australia, the U.K, and the rest of the world took notice of that smoking-hot quarter. I bet they are all wishing they had a currency crisis too right now – 9% growth transforms a weak currency into a strong domestic economy.

But one country’s growth is another country’s lost growth. The competition to weaken currencies will be fierce, and governments will spend hundreds of billions to support their domestic economies.

The next few years are going to be defined by currency interventions and plots to manipulate the currency market. Most of these interventions will be unsuccessful, but some will succeed. China has been extremely successful in pegging its currency for several years, so a country with enough money can make it happen. But in any case, when countries intervene, Forex markets get hot.

Recovery for the Global Economy?

The global economy never recovered from the shadow banking crisis of 2008. While today people are talking about government spending, the reason the world blew up in 2008-2009 didn’t have anything to do with governments. The crisis was due to investment banks blowing up – because they lost hundreds of billions of dollars. People forget this, but it was excessive speculation that started the crisis.

Then governments around the world made a huge, huge mistake. The U.S. government decided to save the banking system, thinking that it was lending that drove the real world economy. Really, it’s the other way around – our real world economy is what drives real economic growth and the creation of wealth.

Of course, our government spent several trillion dollars on this stupid idea of supporting banks – at the expense of throwing real people and businesses off the bridge. You can see the shoddy results: 9.5% unemployment, trillions of dollars of new debt, horrible consumer sentiment, low economic growth – a grand slam of bad outcomes. And it has all been caused by a failure of an economic paradigm that doesn’t recognize how money is actually created.

Now we are stuck with a situation where governments have absorbed much of the private sector losses in the crisis through a variety of programs. But the problem is that although those losses might have changed hands, they didn’t go away.

Now, there are really only two ways for losses of this magnitude to go away. One, they can be written off and recognized by the banks, companies, and people who made the bad business decisions. That isn’t happening at all – these banks have done everything possible to push the losses off on U.S. citizens, or pretend they don’t exist. Two, they can be inflated away. That isn’t happening either. Inflation is the lowest it has been in my lifetime. And inflation expectations over the next 10 years are very, very low.

(By the way, regular Taipan Daily editors Adam Lass and Justice Litle will be back this week. Sign up to receive their investment commentary.)

Moves in the Global Currency Market

So what is going to happen? We’re not recognizing the losses, and we’re not inflating the losses away. We’re facing persistent low inflation in the U.S., Japan, and the eurozone, which is about 60% of the world’s economy. And competitive devaluations have already started – that’s a fact.

Well, there are five possibilities:

1. Banks are forced to recognize additional losses because of more real estate losses, causing a second banking crisis.
2. The euro loses another 20% due to the sovereign debt crisis but the eurozone economy is white hot.
3. One country decides to end its own crisis by inflating away the losses, and also benefits through resulting currency devaluation. Other countries follow suit and inflation once again takes hold.
4. Countries decide to attempt to stimulate their way out of the second recession with additional government spending and are unsuccessful.
5. Countries decide to stimulate their way out of the second recession with middle-class tax cuts and are successful.

These are the most-likely scenarios for the next year – and every single one involves large moves in the currency markets.

That’s why I expect huge market moves in 2010 through 2011 across the globe, most likely resulting in massive currency moves.

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About the Author

Michael Sankowski is the Editor of Taipan Publishing Group’s Currency Profits Trader. He has worked as a financial trader and analyst for the past 13 years in over 60 financial markets, beginning as runner on the floor of the Chicago Board of Trade in 1994 and working his way up to become a trader. Michael has traded for a $250 million hedge fund, which required him to trade all over the world, including the United States, Europe and Asia. He has also worked as a product designer for U.S. Futures Exchange, where he focused on trading in Forex, futures, options and fixed-income cash markets.

Michael holds the prestigious CFA Charterholder and Chartered Alternative Investment Analyst (CAIA) designations. The CFA charter is a certification for finance and investment professionals, particularly in the fields of investment management and financial analysis of stocks. The CAIA designation establishes a standard for those who specialize in the area of alternative investments, such as hedge funds, venture capital, private equity and real estate investment. Michael’s solid background and certifications in financial trading make him the best man to share his expertise and Forex recommendations with the readers of Taipan Publishing Group’s Currency Profits Trader.