Tuesday, September 6, 2011

Race to the bottom

You may have heard or read about conditions being right for another step in the degradation of fiat currency. It has been a tale that has been told many times before. That is the tale of hyperinflation. Hyperinflation is something which has happened too many times in the past. You may have heard about Germany during the Weimar republic, or the phrase "not worth a continental" which was a bit closer to my home.

It would not be surprising to me if the fate of the US dollar will be the same as so many other currencies of the past. I have thought this for a while, but was still surprised to hear about the "race to the bottom" idea. This idea is that many countries will try to keep the exchange rate of their currency low so that exports appear cheaper and imports more expensive. I must say that I originally thought that this idea would not come to fruition. Now, I'm not so sure.

Today, after study, we are faced with the fact that there is evidence for this race to the bottom hypothesis. Over the past few months the bank of Japan has intervened to weaken its currency. Switzerland has also lowered interest rates. Today, we read about the Swiss central bank announcing that they will effectively devalue their currency and peg it to the Euro. A result of this intervention is a 7% drop in the value of the Swiss Franc verses gold, and a 9% drop verses the US dollar. I view this as evidence of the ongoing race to the bottom.

The results of this move will be good for the Euro in the short term. The value of the Euro will be supported by this new demand from Switzerland. Long term, the issue is much different. Over time, as the Euro experiences new trouble, so will the Swiss Franc. This move will make it so the Franc and the Euro act as if they were the same currency, and as such, a collapse of one will lead to a collapse of the other. The European Central Bank will depend on the support from Switzerland, and not address the structural difficulties it faces.

The Swiss Franc has been a pillar of stability for quite some time. Today, that has changed. Perhaps the Chinese Yuan may step up to the plate, in effect become the new Swiss franc. Alas, this will not happen as long as the Yuan is pegged to the dollar. It seems that people who wish to preserve their purchasing power are left with only one option, commodities.

1 comment:

Anonymous said...

very good article, you've demonstrated a deeper understanding of the dynamics of the situation than 99% of the mass media