The US dollar was back on the rack this week in expectation of more money-printing – politely known as QE2 or a second round of quantitative easing. But the standout currencies were not the yen nor the euro, let alone the yuan.
No, it was the commodity currencies – the Malaysian ringgit, the Aussie dollar, the Brazilian real, the Russian rouble, the Indonesian rupiah and the Thai baht, which saw the biggest gains as investors sought – they thought – safety in yet-to-be-mined assets. The overall commodity price index was back close to the early 2008 high that preceded the global meltdown even though oil is still only 60 percent of its peak.
All of which sent me 40 years back to an earlier commodity boom when I got taught my first lesson in speculation. I shorted Poseidon, the nickel prospect which was then the brightest of all the many stars of the Australian mining boom. After losing a month’s meager salary in three days I was forced to close my position. Had I been able to hold it I might never have had to continue life as a financial media hack.
God alone knows how long this commodity and associated currency boom can go on. Maybe till Bernanke gets overruled. But commodity cycles remain just that – cycles. So don’t believe anyone who tells you “This time it’s different” because of the China and India booms, because of global warming, desertification or threats from outer space. This is a bubble created by easy money and the long lead times needed for most commodity investments, whether palm oil plantation or iron ore mines. Ask yourself: is China investing in new mines because it thinks the price will go up? Or because it wants the price to go down?
The simple fact is that Chinese money is driving up asset and spot prices in the short term – and will bring them down in the longer term. That’s not rocket science. That’s a bog standard commodity cycle.
The casualties: looking at the above currencies, the Thai and Malaysian ones may be able to sustain their gains when the cycle turns. They are not yet back to their pre-Asian crisis levels and they have been running vast current surpluses for years so even a sharp price fall might have limited impact. Thailand’s commodities are mostly the less volatile agricultural ones and Malaysia has a broad mix of agricultural and energy ones.
But Australia? For the past seven years it has been enjoying perhaps an astonishing gain in its terms of trade, based mainly on mineral exports. The Australian commodity price index has risen from 40 to 120 since 2003! Yet despite this immense rush of wealth Australia has continued to run a huge current account deficit – 5 percent of GDP for the past five years and still pushing 3 percent despite the recent impact of iron ore price rises.
Who says a mature economy can continue to build an external liabilities to GDP ratio already over 60 percent and with more than half of that A$76 billion owed by financial institutions. What happens when those terms of trade turn around as they surely will, probably soon? Goodbye Aussie dollar.
Much the same could be said of Indonesia – though its foreign debt level is much less. As for Brazil the Superman ratings of outgoing President Lula owe a lot to his charm and political skills but at least as much to the commodity boom which has fed domestic demand and the recent surge in the real. Quite what happens to this BRIC when ore and soy prices tumble is not too clear but meanwhile money is gushing in.
But at least some Brazil officials feel uncomfortable and worry publicly about currency wars as China keeps its currency depressed (ditto Korea, Taiwan and Hong Kong) and liquidity flows into open, mid-sized ones. Brazil has little foreign debt – for long for the good reason no one would lend. But all that infrastructure and new mining investment promises to push up volumes by very much less than it drives down prices. Current euphoria promises incoming (probably) President Dilma Rousseff a carnival honeymoon followed by a storm-tossed marriage.
The end of the boom could come even sooner if President Obama goes along with any measures against China which might be passed by an angry if incoherent Congress.
China has certainly been doing enough warrant retaliation. But a better way than discriminatory tariffs might be to subject future Chinese purchases of US Treasury and agency debt to reciprocity. This might push up interest rates but would be sure to drive the dollar lower and force China to open up its own bond market.
But my own view is that drift is the more likely outcome from a US Treasury run by Geithner, who combines being a wimp with being an insider while Obama himself is too interested in being liked to be bold. Which takes me back to 39 years ago when the US was in a roughly similar situation to today – a large deficit, a weak currency and a flood of gold exiting Fort Knox. It then had a Mr Nasty as President – Richard M Nixon, and a Treasury Secretary John Connally, who was a Texas politician who didn’t care what economists, Wall Street or foreigners thought. He cuts the knot, ending dollar the Bretton Woods fixed exchange rate system by stopping convertibility of gold which soon led to the era of floating exchange rates. He also imposed a 10 percent import surcharge which lasted till a new international concord of sorts was cobbled together – the Smithsonian Agreement.
Now knots again need cutting. Who will wield the knife?