Currency Wars, which up to now have received only scant news coverage, have become a hotly reported on topic these days. This theme has been table chatter for professional investors since quantitative easing (money printing) got under way in 2009. Since the topic is becoming more widely covered by the media, I thought it would be useful to lay out the Currency War basics for you.

The first element needed for a currency war is for a central bank make a concerted effort at artificially devaluing its currency. The intent of such devaluation is to make domestically produced goods more “competitive”. Another words, as a foreign buyer’s currency increases in value versus the devalued currency, foreign manufactured good become cheaper for the holder of the non-devalued currency to buy. Theoretically the nation with the devalued currency should receive a domestic manufacturing boost. The opposite would then hold true for the country who is not devaluing their currency. Their domestic manufacturing should slow as their goods become more expensive to buy. I believe this logic is short sided (see this article) and dangerous however that is a discussion for another day. During periods of slow global economic the risk a retaliatory devaluation grows. Often multiple countries end up pursuing currency weakening strategies at the same time. Such escalations lead to a “Currency War”.

Mr Rickards argues that are Currency War has already begun:

“We are already in a currency war. It began in 2010 when President Obama declared a goal of doubling U.S. exports in five years as part of his January 2010 State of the Union Address. Since then, the U.S. Federal Reserve Bank has used quantitative easing to cheapen the exchange value of the dollar both to promote exports and to import inflation as part of the Federal Reserve’s efforts to target nominal GDP.” (Source: The Voice of Russia Feb. 2013).

Here are a couple of recent Currency War related news stories:

Reuters: “G7 fires warning shot over currencies, markets confused  U.S. and European officials have been concerned about comments from Japanese officials that suggested Tokyo was targeting a specific level for the yen, which would run counter to the G7’s official stance.”

Bloomberg: “Russia Flips Petrodollar On Its Head By Exporting Crude, Buying Record Gold “The more gold a country has, the more sovereignty it will have if there’s a cataclysm with the dollar, the euro, the pound or any other reserve currency,” Evgeny Fedorov, a lawmaker for Putin’s United Russia party.”

Theoretically, no country should be irrational enough to really want a full out Currency War. A recent bloomberg.com article pointed out that, “International Monetary Fund spokesman Gerry Rice said that talk of international currency wars is “overblown.”  What the G7 is currently addressing in the press is a “devaluation tit for tat”. So far, an all-out war has been avoided because Clausewitz noted, “War must total and all-encompassing in order be won.” In Currency War terms, an all-out war would require accepting the possibility of chaos in the global currency market. Central bankers and economists know that such chaos could lead to a break down global trade. If that were to happen depression of epic proportions would ensue.

As a Currency War escalates, markets try to anticipate future devaluations with understanding that every action could “have an equal or greater retaliatory reaction”. Rapid devaluations by multiple parties can make assessing what a true “price” is nearly impossible. Because of this, investor need beware that during all-out Currency Wars; markets will likely look quite confusing and be quite volatile.

My goal was to give you the basics of what a “Currency War” is and if you want more information I suggests you read “Currency Wars: The Making of the Next Global Crisis” by James Rickards. If you want to discuss the implications of Currency Wars on your investments you should consult your financial professional. Be aware that a serious professional should have read a book are two regarding the historical implications of Currency Wars, or at the very least, have given the implications some thought. Understanding what Currency Wars are provides you with enough information to ask the right questions to find out just how well versed in market dynamics your advisor really is.

One last thing, view the likely hood of an all-out Currency War like you view the prospect of Nuclear War. Adjust to the threats if necessary, but don’t embark on “bomb shelter building” escapade. The odds are that cooler heads will prevail!