Anthony Rayner: Are currency wars a natural progression from trade wars?

In response to recent US announcement on new tariffs, the Chinese authorities allowed the renminbi to weaken above the symbolic 7, versus the US dollar. In turn, this led the US to label the Chinese as currency manipulators. These exchanges might sound like straightforward tit-for-tat but they do appear to raise the ante, which might mean some investors are too complacent.

Cast your mind back to the beginning of 2018, when the dominant narrative was that there would not be a fully-fledged trade war - the conventional wisdom being that the authorities had learnt from past experience that it was not a way to solve economic imbalances, is a zero-sum game and can easily escalate.

Fast forward to today and we are bang in the middle of a trade war. It is not surprising conventional wisdom was wrong - though what is surprising is that the very same arguments are being wheeled out to dispel the idea that the current rhetoric will escalate into currency wars: it is no way to solve economic imbalances, is a zero-sum game and can only too easily escalate.

Nevertheless, currency can become a policy tool - just like tariffs and QE. The context is compelling: global growth continues to slow and, in terms of policy responses, QE looks increasingly tired, while the trade war is escalating. Importantly, QE is increasingly perceived as contributing to slowing global growth - as is the trade war.

It is time to look at other policy responses. We have argued for fiscal expansion for some time: interest rates are low, infrastructure deficits are high and, as opposed to QE, it is a direct way to inject money into the real economy. The main obstacle is the prioritisation of an austerity ideology to reduce debt levels and/or to achieve political objectives, such as a smaller role for the state. That said, the austerity argument is losing steam, even though politicians hate losing face.

That said, there are some signs of a political reset. A story came out of Germany recently around a fiscal U-turn to finance a climate protection programme, while Boris Johnson is sounding more fiscally expansive, with one eye on a general election and the smoothing of a no-deal Brexit. These are no more than stories at this stage and being fiscally expansive does feel like a slower burn, particularly compared with the barriers to currency manipulation.

Currency devaluation

Currency devaluation can be a direct stimulus to economic growth - especially to those economies that are more export-oriented, such as the eurozone. Importantly, for politicians and their austerity ideology, there is little risk of losing face. Plus, the stretch from QE is not so much, in that its financial market manipulation (this time limited to a currency) is trying to stimulate economic growth - and let's not forget QE had a weaker currency dimension to its impacts anyway. Nevertheless, it does encourage tit-for-tat responses.

That is not to say that currency wars will take place - just that markets are probably a little too complacent, as they have been over recent policy developments, such as QE and trade wars. More generally, a key question is the degree to which the US authorities will allow the US dollar to strengthen from here.

The implications for financial assets are tricky to assess at this stage. In general terms, it will add another level of uncertainty for companies and investors. More specifically, we would expect gold to benefit in an increasingly uncertain environment, particularly policy uncertainty, and with currencies being debased.

Looking back, QE might well have been the tool that took the worst out of 2007/08 but then weighed the economy down. Similarly, explicit currency manipulation, if it happens, will likely have short-term positive effects too, with negative consequences in the longer term. More importantly though, while not without risk, it does feel as if we are that bit closer to an inevitable fiscal expansion.

Anthony Rayner is co-manager of Miton's multi-asset fund range

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