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Are the Currency Wars Starting? They already happened – and the Fed won.

Op-Ed by CEME Senior Fellow Paul Schulte (F88)

Paul Schulte Fletcher 88 China Construction Bank CEME Senior Fellow IBGC Speaker Many years ago when the Fed’s quantitative easing (QE) began, Fed Chairman Bernanke gave a health warning.  He said that countries which are linked to the dollar during QE could avoid being run over by the oncoming tsunami of liquidity by doing three things: 1) let the currency appreciate; 2) run budget surpluses and 3) raise interest rates.  What happened instead is that many emerging market countries which already had healthy banking systems and were not caught in the Western Web of potential debt deflation actually did the opposite.  They fought currency appreciation and caused a buildup of liquidity.  Countries like China, India and Brazil are all running fiscal deficits.  And these three countries all lowered interest rates.  Many other emerging markets did the same.   In this way, they have all lost the currency war already and we are now starting to see the destructive influences of this war – inflation.

What is the evidence of this? Look back to 2006 before the QE of the US, UK and ECB started. In 2006, eight of the 15 most expensive cities in the world were Western capitals or major cities.  The only emerging markets city in the top 15 was Moscow.  As usual, Tokyo came at the top along with London, Seoul, Copenhagen and Geneva. Cut to 2013 and we see a shockingly different list.   Of the top 15 most expensive cities in the world, eight are now in the emerging markets.  They refused to listen to the ways in which they could avoid destruction in the currency wars.  Now they are paying the price of becoming uncompetitive.  We need to include Singapore on this list as it is now in 7th place among the most expensive cities. Brazil, China, Australia, Russia, Singapore Hong Kong and Indonesia are in trouble since their cost bases are getting out of control. Consider, for instance, that Jakarta property prices are now higher than those in Kobe, Japan.

Meanwhile, cities like LA, New York, Miami, Milan, Kobe, and Chicago among others now remain dirt cheap, and relative to emerging market property prices are the bargain of the century.  That was the plan of the Fed all along.  The Fed would reflate the world (as it was preventing a debt deflationary mess in the US) and as it did, those reflating countries with dollar-linked currencies would see that real estate in their own cities had no value RELATIVE TO cities in the US, UK and a smattering of cities in Europe.  It worked without firing a shot.  And these same countries in the emerging world which now find their cities unaffordable were planting the seeds for their own self-destruction by buying US government bonds.

This is what is known as REAL appreciation of the currency.  It is stealth warfare, if we can use these terms in economics. Even though nominal currencies have not moved that much in the past few years, the prices of countries relative to the prices of the US have moved enormously. SO, many emerging markets have seen their purchasing power diminished. The very rich have made great gains, but the greater part of the population has a harder time than ever making ends meet.  

As an example, now that Rio de Janeiro and Sao Paolo have among the most expensive real estate in the world, we see smart Brazilians moving their money out of Brazil and buying Miami beachfront apartments at a fraction of the cost of beachfront apartments in Copacabana. Incidentally, in 2007, there was virtually no difference in Miami prices and Rio prices. Cut to 2013, and we see some Rio beachfront prices approaching Hong Kong prices. Similarly, smart Hong Kong Chinese are avoiding their own market and are now buying a three bedroom house in a suburb of LA or Atlanta for about the same price of a car parking space in Central.  This is not a typo. A large house in the suburbs is now about the same price as a car parking space in Hong Kong. In some American cities, you can buy two or three houses for the price of one car parking space in Hong Kong.     

Bernanke has created more wealth in the past five years than just about any man who ever lived. But it has been done so at a price.  Emerging market countries (and Australia) are saddled with ultra-high real estate (with the creation of many billionaires) which is now out of reach to hundreds of millions of people through the developing world.  This has the seeds of social unrest.  Regulators of countries like China, Brazil, Singapore, Hong Kong, Russia and even countries in Africa should now really open the dam and allow capital to flow out and buy assets in the US and other European cities. There is vast wealth to be made and assets are cheap. 

The currency war is not really over. Emerging markets are holding the cards and should deploy the dollars to buy farmland, cheap housing, industrial brands, technology and natural beauty. Ireland, the US, the UK, Germany and Italy are safe and interesting. If emerging markets keep their wealth and capital bottled up in a mercantilist way, their insecurity and selfishness will sink them.  They are smart to actively encourage outbound capital and buy up as much as they can.  Think about it.  Japan did the same thing (but very late in the game) in the 1980s and it is STILL the richest country in the world in terms of net foreign assets despite a long recession at home.  The longer emerging market countries dither and let capital swirl around at home rather than leave the shores and buy cheap assets overseas, the more they risk becoming like Japan.   

Paul Schulte is a Senior Fellow at The Fletcher School of Law and Diplomacy at Tufts University and an Adjunct Associate Professor of Finance at the Hong Kong University of Science and Technology.  He is CEO of SGI Emerging Markets research and can be reached at SGIemergingmarkets@gmail.com

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