The currency wars are back! Actually, they never went away…

The currency wars are back! Actually, they never went away…

Trump has had it!

Trump is declaring a currency war on the rest of the world.

Trump resents China and Europe cheapening the yuan and the euro against the US dollar in order to help their exports and hurt America’s.

AP News wrote last week:

President Donald Trump on Wednesday accused China and Europe of playing a “big currency manipulation game.” He said the United Stated should match that effort, a move that directly contradicts official U.S. policy not to manipulate the [US] dollar’s value to gain trading advantages.

In a tweet, the president said if America doesn’t act, the country will continue “being the dummies who sit back and politely watch as other countries continue to play their games – as they have for so many years.[1]

He’s had enough and says it’s time for the US to cheapen the US dollar also.

Trump has a point.

If you put a 25% tariff on many Chinese exports to the US (as Trump has done), or a 25% tariff on German cars exported to the US (as Trump has threatened to do), it can be a powerful way to reduce the US trade deficit and generate revenue for the US Treasury.

Same old strategy

A trading partner can undo the effect of the tariff just by cheapening its own currency.

Let’s say a Chinese-made mobile phone costs US$500 in the US.

If you slap a 25% tariff on the imported phone, the immediate effect is to raise the price by $125.

(By the way, the consumer does not usually pay the ‘extra’ $125. It could be borne by the importer through lower margins, by the exporter through a lower export price, or the manufacturer could simply shift the supply chain to another source country so the tariff does not apply.)

Regardless of cost shifting or supply changes, a simple solution to tariffs is to devalue your currency by 20% against the US dollar.

Local currency costs do not change, but the mobile phone now costs $400 when the local currency price is converted to US dollars.

A 25% tariff on $400 results in a total cost of $500 — exactly the same as before the tariffs were imposed.

Tariff costs have been converted into lower production costs through currency manipulation.

There’s only one problem with Trump’s currency war plan.

There’s nothing new about it.

The currency wars started in 2010, as described in my 2011 book Currency Wars

As soon as one country devalues, its trading partners devalue in retaliation and nothing is gained.

Currency wars produce no winners, — just continual devaluation until they are followed by trade wars.

That’s exactly what has happened in the global economy over the past 10 years.

Let’s hope the currency wars and trade wars don’t turn into shooting wars as they did in the 1930s.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia