During the cold war between the U.S. and the former Soviet Union, when thousands of nuclear warheads were aimed at each other, the concept of mutually assured destruction was born. The term was used to convey the idea that both sides would be destroyed should a full-scale clash occur. Although those tense times have subsided, we now find ourselves in the midst of another global skirmish — albeit one that's happening on multiple fronts and involves money instead of the military.
Yes, it's the currency cold war, and it has already gotten serious enough to garner reaction from the G-7 earlier this month and from the G-20 last week. While foreign exchange traders would say the hostilities began with the debut of the Fed's unprecedented quantitative easing policy, many observers say the battle took a turn for the worse under the direction of Japan's new Prime Minister Shinzo Abe.
"I think it's a warning shot," says Jeff Saut, chief investment strategist at Raymond James, noting the yen's 20% decline since October. "The warning shot here is the new Japanese Prime Minister's efforts to push his central bank to flood their economy with yen, and the yen has absolutely collapsed over the past six weeks."
To be fair, since bottoming out in 2008 the dollar index (^DXY) has mostly traded in a range of 75 to 80, except for a few periods of risk aversion that stoked dollar demand. But if you go back 10 years or more, the dollar's decline is much more pronounced, having fallen from a range of 90 to 110.
So even though the geopolitical groups have acknowledged the problem and have pledged to pursue growth rather than use exchange rates to achieve their fiscal and monetary goals, it's a statement that is far removed from reality and, in many circles, is downright laughable.
"What I am worried about is if politicians kick the can down the road," Saut explains of the ongoing budget negotiations and the risk that a negative outcome would impact the economy and, in turn, "cause Bernanke to flood the system, and crank up the printing presses again." It's a scenario that he predicts would cause the dollar index to go back down again and likely cause other nations to follow suit to offset the impact of a weaker dollar.
How it all ends is anybody's guess, but if I had to make one, I would say that this race to the bottom will not end well.