A popular thesis since the
1930s is that a natural progression exists from currency wars to trade
wars to shooting wars. Both history and analysis support this
Currency wars do not exist all
the time; they arise under certain conditions and persist until there is either
systemic reform or systemic collapse. The
conditions that give rise to currency wars are too much debt and too little
In those circumstances, countries try to steal growth from trading
partners by cheapening their currencies to promote exports and create
The problem with currency wars
is that they are zero-sum or negative-sum games. It
is true that countries can obtain short-term relief by cheapening their
currencies, but sooner than later, their trading partners also cheapen their
currencies to regain the export advantage.
This process of tit-for-tat devaluations feeds on itself with the
pendulum of short-term trade advantage swinging back and forth and no one
getting any further ahead.
After a few years, the futility
of currency wars becomes apparent, and countries resort to trade wars. This
consists of punitive tariffs, export subsidies and nontariff barriers to trade.
The dynamic is the same as in a currency war. The first country to
impose tariffs gets a short-term advantage, but retaliation is not long in
coming and the initial advantage is eliminated as trading partners impose
tariffs in response.
Trade wars produce the same
result as currency wars. Despite the illusion of
short-term advantage, in the long-run everyone is worse off. The original
condition of too much debt and too little growth never goes away.
Finally, tensions rise, rival
blocs are formed and a shooting war begins. The
shooting wars often have a not-so-hidden economic grievance or rationale behind
The sequence in the early 20th
century began with a currency war that started in Weimar Germany with a
hyperinflation (1921–23) and then extended through a French devaluation (1925),
a U.K. devaluation (1931), a U.S. devaluation (1933) and another French/U.K.
Meanwhile, a global trade war
emerged after the Smoot-Hawley tariffs (1930) and comparable tariffs of trading
partners of the U.S.
Finally, a shooting war
progressed with the Japanese invasion of Manchuria (1931), the Japanese
invasion of Beijing and China (1937), the German invasion of Poland (1939) and
the Japanese attack on Pearl Harbor (1941).
Eventually, the world was
engulfed in the flames of World War II, and the international monetary system
came to a complete collapse until the Bretton Woods Conference in 1944.
Is this pattern repeating
Sadly, the answer appears to be
The new currency war began in
January 2010 with efforts of the Obama administration to
promote U.S. growth with a weak dollar. By August 2011, the U.S. dollar reached
an all-time low on the Fed’s broad real index.
Other nations retaliated, and the period of the “cheap dollar” was
followed by the “cheap euro” and “cheap yuan” after 2012.
Once again, currency wars proved to be a dead end.
Now the trade wars have begun. On
Thursday, July 27, the U.S. Congress passed one of the toughest economic
sanctions bills ever and sent it to President Trump for signature. Trump signed
it, although not enthusiastically.
But Trump’s views don’t really matter. The bill was passed by veto-proof
majorities in the House and Senate, so even if Trump vetoed the bill, Congress
would have overrode him and the sanctions would become the law of the land.
This new law provides that U.S. companies may not participate in
Russian efforts to explore for oil and gas in the Arctic. But it goes further
and says that even foreign companies that do business with Russia in Arctic
exploration will be banned from U.S. markets and U.S. contracts.
These new sanctions pose an existential threat to Russia because
depends heavily on oil and gas revenue to propel its economy. Russia tries to
control new discoveries in order to maintain its quasi-monopoly position as the
premier energy provider to Europe. Russia needs Western technology to meet the
challenges of Arctic exploration.
In effect, this law handicaps Russia’s efforts financially and
technologically and weakens its grip on global energy markets.
Russia has already vowed to
Yet Russian retaliation will not consist of reciprocal sanctions
on the U.S. Russia has said it will strike “asymmetrically.” This means Russia
will use the means it is best at, including cyberattacks.
If you wake up one day soon and the power grid is down and banks
and stock exchanges are closed, you can thank President Putin and the U.S.
Congress for starting a financial and cyberwar that neither side could control.
Meanwhile, the long-expected
trade war with China has begun at last. This is a trade
war that President Trump threatened the entire time while he was on the campaign
trail. Yet after Trump was sworn in as president he did nothing about Chinese
trade and currency practices. Trump did not declare China a “currency
manipulator” and did not impose tariffs on Chinese steel and aluminum being
dumped on U.S. and world markets.
The reason Trump did not act swiftly was because he wanted China’s
help facing North Korea’s nuclear weapons and missile programs. If China would
put pressure on North Korea, Trump would go easy on China.
But China did not hold up their end. China has done nothing to
change North Korea’s behavior and will not do so in the future. Now Trump has
no reason to hold back. The White House has already begun to unleash its
formidable arsenal of trade weapons against China.
The Trump administration has made clear its intentions to impose
tariffs on cheap Chinese steel and aluminum and to punish China for theft of
U.S. intellectual property. After that, more action will be taken to punish
Chinese banks that help North Korea finance its weapons programs.
The U.S. can block acquisitions of U.S. firms by Chinese companies
through review by a group called the Committee on Foreign Investment in the
United States, or CFIUS. That committee has already blocked several Chinese
deals and has many more stuck in the review pipeline.
By November, the U.S. will label China a currency manipulator,
which will start another review process, leading to still further sanctions.
Like Russia, China will not take any of this lying down but will retaliate with
its own sanctions, tariffs and bans on U.S. investment in China. Get ready for
an all-out financial war between the U.S. and China.
This trade and currency war
will shake markets and be a major headwind for world growth.
Germany is also in the crosshairs because of its huge trade surplus.
Trump has already torn up the TPP trade agreement and has put Canada, Mexico
and South Korea on notice that their trade deals need to be renegotiated.
None of these trading partners will stand still for this U.S.
assault on bilateral trading relations. Retaliation can be expected. A
full-scale trade war is now upon us.
Next comes the shooting war
with North Korea, which will inevitably draw in Russia, China, South Korea and
Japan. This will be tantamount to World War III.
As Mark Twain reputedly remarked, “History does not repeat, but it
Today looks like a replay of
the 1930s. Let’s hope things do not go as far as they did then. Markets
are not priced for the worst outcomes based on the lessons of history.
As the progression of currency
wars, trade wars and shooting wars plays out, get ready for some major market
moves to the downside as the reality of this sequence begins to sink in.