Currency Wars: yuan and pound take lead in race to bottom

Markets

DRAINAGE

The goal in the global deflationary battle is for each country to export its deflation as quickly as possible. This is especially important to emerging (submerging) markets where so much of their GDP is tied to exporting goods. Brazil, China, India etc cannot reflate their economies if their currency remains strong relative to the countries they wish to sell their goods to. Everyone's solution is to weaken their currency in an orderly fashion. But like water circling a drain, controlled descent cannot be maintained after a certain point.- Soren K.

Terminal Velocity: the constant speed that a freely falling object eventually reaches when the resistance of the medium through which it is falling prevents further acceleration.

China

China's problem is unique in that is has chosen to peg its currency to the USD for several reasons. However, that has not stopped them from widening the tether of the peg itself. It had a plan to slowly devalue the Yuan vs. its USD peg over time. But the Brexit vote forced that process to accelerate for political reasons. Bloomberg comments on that below the fold.

The UK's Brexit vote merely forced its own hand from a stimulus standpoint faster as well. If the UK were to remain in the EU, it would at some point force the GBP to weaken and converge with the EU. The vote to leave, accelerated the GBP fall for a different reason. That reason in part being a refection of their ability to go it alone with diminished EU trade status. Ironically, the cure for the GBP plunge was.... monetary easing and fiscal stimulus! So a weaker GBP is good for trade, but a weaker GBP too fast was a sign of non-confidence. The key for the UK and all these countries is controlled descent.

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Japan

The Japanese are the front runners in the battle to end deflation for a decade with no success. They will embrace (publicly admitting) a fiscal stimulus solution first and most aggressively. Ben Bernanke has been lobbying them since the Brexit event for more of this.

Needs fiscal stimulus according to the game plan. And itwill happen without a doubt. We feel it will be triggered (publicly) when the EU banking issues are unbearable. Buying negative yielding bonds for sanitizing newly printed money is not doable. Corporate bonds and equities are next to be bought. You can already see this in the EURO zone corporate bond action as players position themselves for the next obvious asset to be bought if the ECB is not doing it already.

USA

Will be the last to debase and export its deflation, as it has been most adept at keeping its markets afloat with a strong currency so far. Let's face it, Being the world's reserve currency and having your Central bank run by the best market "managers" in the world has its advantages.

Unintended Consequence Potential

The Goal is to end deflation. The risk is to ignite inflation or worse. The USA has skillfully applied the do as we say, not as we do concept into keeping other world bankers from just hitting the gas pedal even harder. Meanwhile the US enjoys natural demand for its reserve currency even while hitting CTRL-P as much as it wants. We just do not see how the pendulum of monetary policy can swing so far one way without the eventual reversal having so much momentum that efforts to stave off unintended consequences like inflation are useless. The market will destroy someone, but it will not be the oligarch class that has benefited from asset inflation. it will be the working class that will be taxed both directly and through a higher cost of living.

Terminal Velocity and you:

Going back to the imagery of FIAT circling the drain. As water drops towards the bottom, its centripetal force increases in smaller and smaller circles. So to, we think the last legs of global currency debasement will be a juggernaut of unstoppable speed as the bottom of that drain is approached. This will approach terminal velocity and cannot be stopped accept by a true bottom. In this case, the bottom is a complete loss of confidence in that currency as a mechanism of exchange.

-Soren K.

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U.K. data

The day after the Bank of England began purchases under its enlarged quantitative easing program, more data showed the economy there softened somewhat in June. Industrial production for the month rose 0.1 percent, with manufacturing output dropping 0.3 percent. The trade deficit unexpectedly widened to 12.5 billion pounds in the second quarter. There was some good news for the post-Brexit economy, however, as the British Retail Consortium reported a 1.1 percent same-store increase in sales in July. The pound was trading at $1.2976 as of 6:09 a.m. ET.

Yuan, one year on

One year since China roiled markets by devaluing its currency there is little sign of the yuan's decline ending. The main difference between the steady drop that has occurred since March of this year and the sudden shock of a year ago is the lack of apparent investor concern at the weakness. While the yuan is within 1 percent of a five-year low against the U.S. dollar, the global effect seems limited, with the S&P 500 Index climbing to an all-time high. There is still at least one investor, however, who is convinced that the currency is going to crash.