An excellent article on currency devaluation because its easy to understand - LOL Makes sense to me....
Currency Devaluation 101
One of the major investment themes that's emerged over the past few years is the imminent demise of the U.S. dollar. Critics of the dollar rightly point out that the U.S. is engaged in one of history's boldest experiments in money creation. America has doubled its monetary base over the last ten months, creating nearly a trillion new dollars (mostly of the electronic variety) in an attempt to reflate the economy.
The argument goes that this massive "printing of dollars" should devalue the currency. We should soon see the dollar falling against the euro, the yen, the real and most other currencies around the world. But the experience has been very different. In fact, the dollar has shows considerable strength over the last year against most other currencies.
This is a familiar heartbreak for dollar bears. A chorus of analysts has been forecasting the imminent demise of the dollar now for decades. Yes, we have seen some depreciation, especially after 2000. But it has not nearly been of the scale that the doomsayers were expecting. Something has been keeping the dollar buoyant.
Actually, it appears that something has been weighing down other currencies. Specifically the large-scale printing of money by most governments around the world. The U.K. for example, experienced double-digit growth in its money supply for much of the last few years. Helping the pound devalue in pace with the dollar.
Other countries have been more covert about their money creation. Japan is a prime example. The Japanese have taken a "backdoor" approach to currency devaluation.
For most of the last 30 years, Japan has been a large-scale buyer of U.S. government bonds.
During that period, the Japanese acquired $1 trillion in U.S. debt.
This gave the impression of a fiscally disciplined nation.
The country was putting its hard-earned trade dollars into savings, rather than spending it on government projects or consumer goods (like the U.S. has been doing).
Backed by such a disciplined government, the yen has been seen as one of the world's strong currencies.
But there is good evidence that the Japanese have been quietly "monetizing" their U.S. bond holdings.
How does this work?
In a simplified case, a Japanese corporation might earn US$100 earned by selling electronics to Americans.
The corporation then uses that money to purchase $100 worth of 30-year U.S. government bonds. Looks good so far. But what happens after that?
In some cases, the Japanese government will issue the company $100 worth of yen. This gives Japanese leaders the "best of both worlds".
On the one hand, they give the appearance that the country is fiscally disciplined, spending its excess cash on savings instruments like bonds. But on the other, companies get their dollar investments back in yen, which they can then spend in the domestic economy. Saving and spending all in one.
The net effect is that devaluation of the dollar is matched by devaluation of the yen.
Each dollar that the Japanese lend to the U.S. government in the form of bond purchases allows the U.S. to create a new dollar of government spending.
Under normal circumstances, creating this new dollar of spending would devalue the currency.
But by issuing a corresponding amount of yen in Japan, the Japanese government ensures that the Japanese money supply expands at the same pace as the American money supply. Both currencies devalue in tandem. Meaning that the exchange ratio stays roughly even. In the currency markets, we see little evidence of all the money creation.
This policy has worked extremely well for the Japanese, who wish to keep the yen weak against the dollar and make Japanese goods affordable for Americans.
So well in fact that the Japanese government is expanding the program.
This week, the Bank of Japan announced that as of today it will accept government bonds from France, Germany, the U.K. as well as the U.S. as collateral for yen-denominated loans to Japanese borrowers.
Basically, this means that Japanese organizations can now buy government bonds in four of the world's largest economies and then turn around and monetize these bonds by lending them to the Japanese government in exchange for yen.
This is an extremely important development as it demonstrates Japan's commitment to continue printing yen against its loans to other countries.
Ensuring that the Japanese money supply will expand as quickly as those in the world's largest economies.
And that the yen will devalue at the same rate as the dollar, and now the euro.
This devaluing of the world's currencies in tandem is one way to mask the effects of global money creation.
We won't get any alarms from the foreign exchange markets.
This makes it ever more critical to keep an eye on commodities.
Governments can't print more oil, copper or GOLD.
And these markets will be where rampant money creation shows up, if the money starts making its way into the wider economy."
Dave Forest
dforest@piercepoints.com
Copyright 2009 Resource Publishers Inc.
Note:
The information provided in this newsletter is based on the independent research of Dave Forest and Notela Resource Advisors Ltd.
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