Currency devaluation: Are we repeating the mistakes of the 1930s? How useful are wind farms?

After writing yesterday’s article I sat down and thought of the implications of the recent moves in currency markets. If we review them in the round we have seen the following in recent times.

1. An announcement by China that she will end the peg for the Yuan and allow it to revalue (in effect rise) to help with its trade surpluses. However so far it has only revalued by around 2% against the US dollar from 6.83 to 6.71.

2.Just over a week ago the Bank of Japan began currency intervention to weaken the level of the Yen. It had fallen below 83 Yen to the US dollar and was putting price pressure on Japan’s exporters. However Japan was and still is a country with export surpluses.

3. The United States and her Treasury Secretary Timothy Geithner have been very critical of other countries exchange rate policies. He has been particularly critical of China but much less so of Japan’s recent moves. However if we look at the trade-weighted performance of the US dollar we see this.From 2005 to July 2008 we saw a fall from 92.3 to 72.1 so quite a substantial devaluation followed by some ebbs and flows. But if we look at the last 6 months or so we see the following, a peak on the 8th June 2010 of 88.4 but a current value of 79.9 as I type, making for a devaluation of 9.6% in just over 3 months. The most recent drop has been associated with the statement by the FOMC that I wrote about yesterday.


Plainly these factors do clash. We have already seen friction between China and Japan as China wonders how a country with substantial trade surpluses is allowed to devalue whilst it is under pressure to revalue its currency. Now we are seeing friction between China and the United States as Prime minister Wen responds to Mr.Geithner’s criticisms that the Yuan needs to revalue by at least 20%. According to Bloomberg he said.

“We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside”

So if we look at the currencies quoted earlier we see the following, China has kept a low level of the Yuan since mid-2008 to boost her economy, by one means or another the United States seems to be devaluing her currency and Japan is intervening to reduce hers in spite of her trade surpluses. Some might call this madness as many of these moves are inconsistent but I am more afraid of the echoes of the 1930s when we went through an era of “competitive devaluations”. I hope that it does not lead to more friction as this can have implications for matters such as trade talks.

The Export Fallacy

Why do countries want to devalue their currency? They are hoping to improve their export performance and balance of trade. Individually there may be gains but for the world as a whole this is a zero-sum game and for every winner there is a loser. Of the main currencies it looks like the Euro is currently the loser. It finds itself being intervened against by the Bank of Japan over the last week raising its value from 106 Yen to 113 Yen at the peak so far. But it has also been falling against the US dollar and is now at nearly 1.34 versus it whereas not so long ago in early June we were discussing dips below 1.20. According to the ECB the effective or trade weighted index has risen to 103.84 from its low of 99.86 in early June but remember these numbers are flattered by the fact that until a week again it was falling against the Yen often at a rapid rate.

Looking at the current situation where clashing views on currencies led to disputes not only makes me afraid of a competitive devaluation nightmare it also has another worry, protectionism. Perhaps this is best evidenced by the US Congresses plans to pass a law to get China to revalue the Yuan.

Also I worry about the competence of our leaders. If we stretch our minds back to the summer we can recall European leaders railing against the falls in the Euro with their talk of a “wolf pack”. Yet as the peripheral euro zone members suffer for a lack of economic competitiveness logically the fall in the Euro could be seen as the market operating to help this. So now the leaders have what they want but I can only see this making the situation for the peripheral nations worse. Now exchange rates do not have immediate impacts on an economy and the link is not as automatic as is often assumed but it is plain which is more likely to help over time and yet it is the reverse of what Europe’s politicians wanted. Clueless.

Portugal struggles with its bond issue

Media reports are often misleading on this subject as for example demand was reported to be strong for the two issues made by Portugal. However those more interested in facts rather than spin will have spotted that of a planned issue of 1 billion Euros Portugal in fact only issued some 750 million Euros which sits oddly with the media reports of strong demand.

Looking at the figures further Portugal had to pay 6.24 % to borrow €300 million in 10-year bonds, and 4.69 % to borrow €450m in four-year bonds. The yields compared with rates of 5.31 % for the 10-year bonds at the last auction in August and 3.62 % for four-year bonds at the previous offering in July. The yield on the ten-year was the highest for Portugal since the launch of the euro in 1999. In itself the impact is not enormous as compared with the previous issue the ten-year bond will cost Portuguese taxpayers some 2.79 million Euros a year extra and the four-year will cost some 4.8 million Euros extra per year. But over time the cumulative effect of a dripping tap can build up and be severe. So like Ireland we find that Portugal can still issue debt but at a high cost and this cost weakens both of them as we go forwards.

The UK Monetary Policy Committee

Recently the Monetary Policy Committee  has been attempting a re-run of a good-cop bad-cop scenario of a 1970s or 1980s detective series. This makes me think of John Thaw in The Sweeney for the bad cop but please feel free to have whatever image you prefer! Last week we had David Miles as the good cop who apparently is so worried about inflation, then we got Adam Posen who with his talk of possible “heavy-duty credit-easing” was more bad cop on inflation. Yesterday we got another good cop Spencer Dale whose priority is according to his speech.

ask me my three main priorities for monetary policy and I will tell you: inflation, inflation, inflation

followed by a critique of past policy.

The evils of inflation are well known. The high and volatile rates of inflation of the 1970s and 80s stunted our economic performance. Companies and households were unable to budget and plan efficiently. Resources were misallocated. Long-term contracts were avoided. The value of hard-earned savings was eroded.

Unfortunately for  those who think we may be getting someone concerned about the more recent rise in inflation we get.

there are significant risks to both sides of the inflation outlook

Those who are interested on the statistics on Mr.Dale’s tenure of the MPC you get the following.He has attended some 26 meetings and of these some twenty months have been over the target and only 6 below. Also during his tenure in some 16 of the months the rate of inflation has exceeded its target by more than 1% which is the benchmark for the Governor having to write an explanatory letter to the Chancellor.There have been no such downside occurrences. Remember he has been on the MPC at a time of great economic problems and falls in output which one would normally associate with lower rather than higher inflation a point which he made in his speech, I was not there to tell if there was an ironic twist on this.

One could look at this another way. It takes say 18 months or so for changes in interest rates to take effect. So if we ignore the first 18 months of his tenure on the MPC and look at the subsequent months you see the following every single month has been more than 1% over the inflation target. This contrasts substantially with “inflation, inflation, inflation” being a priority. Also echoing Tony Blair may not be entirely wise in itself as it immediately makes many think of an era where many facts were spun.

The MPC Minutes

For a few months now the MPC has been split 8 to 1 where the 8 vote for no change in what is a very expansionary current policy whilst Andrew Sentance votes for a small rise in interest rates. So we have been getting a bit of groundhog day. However the latest minutes showed a small change of nuance.

“For some of those members, the probability that further action would become necessary to stimulate the economy and keep inflation on track to hit the target in the medium term had increased.”

In itself  I see this as a change of nuance but this news came out as our markets were responding as well to the new statement from the FOMC so it is difficult to split what turned out to be an extraordinary move in UK government debt prices into components.

The UK gilt or government bond market surges

This surged yesterday in a move which was very strong and unusual. There is a ten-year gilt and it rallied by 1.3 points or to put it another way the yield fell by 0.15% to 2.97%. If we look to our longest dated gilt which runs to 2060 it rallied by 2.89 to 100.05. So a powerful one-day move which index-linked gilts followed and indeed exceeded as our longest-dated version of this which runs to 2055 rallied by 4.3 to 130.48 or a move of 3.4%.

To my mind this opens up a dichotomy. Conventional gilts were to my mind trying to front-run potential moves by central banks whereas inflation linked bonds were rallying because of the implied implications for inflation too. Now put the impact of inflation on conventional bonds. After the rally our inflation and our prospective inflation is higher than the yield on our ten-year bonds.

Energy Policy and wind farms

I am often asked about the topic of energy supply with particular variants being peak oil and will we run out? Having seen the news that the world’s largest wind farm has opened off Kent I would like to open a discussion on this. I know that there are amongst my readers some with expert knowledge in this area and I would like their thoughts on this. I understand that wind farms are expensive so the implications of this on energy prices might be one strand. But my conceptual problem with wind farms is what do we do if the wind does not blow? For example the cold snap in February of this year was a period of still air as well as I understand it.


21 thoughts on “Currency devaluation: Are we repeating the mistakes of the 1930s? How useful are wind farms?

  1. Notayesman, you have identified a clear dissonance between the MPC’s open market operations (designed to keep inflation up) and its open mouth operations, (designed to deny that this is what they are doing). The overall strategy is clear: inflation, inflation, inflation! Just like the man said.

  2. As you say wind power is unpredictable therefore you always need on hand sufficient traditional generation sets. In other words wind can supplement NOT replace the use of coal,oil,gas and nuclear. What surprises me is how little attention we give to tidal energy schemes.We have plenty of coast,plenty of inlet and some spectacular tidal ranges. Tide times are completely predictable and we can be confident how and when that energy source will be available.

    The missing link in Alternative Energy is storage.Much much more work needs to be done in battery technology.

    • I remember coming across an article recently about a scheme to store wind energy as compressed air in underground caverns, which can later be used to drive a turbine when there is demand for electricity. I’m sure the article was about a project where the mechanical energy of the turbine was directly used to drive a compressor, but I also find articles describing a system that uses electricity to run the compressor, e.g.

      I agree though, that tidal power seems a more logical way of reliably generating electricity. The critical consideration is cost (or EROEI, which tends to dictate cost), but I find it hard to trust the numbers given by e.g. the nuclear industry, where many of the costs are typically dumped on the taxpayer. Sadly though, due to the political cowardice of the last administration we simply don’t have time to debate and develop a sensible energy policy now.

  3. Thanks for the article …. I agree with what you say, and even more emphatically so.

    Competitive currency deflation has recommenced as the Bank of Japan and Kan have declared war on the currency traders to stop the rise of the Yen …. “Japan and the currency traders have scorched the investment skies” … “Welcome to the investment desert of the real” … “We have a new investment matrix” … It was Kan’s selling of Yen on September 15, 2010, has started global competitive currency devaluation.

    The debt deflationary bear market that started April 26, 2010, has recommenced, as is seen in the ratio of the small cap pure value shares, RZV, to small cap pure growth shares, RZG, falling lower. The Banks, KBE, European Financials, EUFN, Nasdaq Banks, QABA, Semiconductors, XSD, and software manufacturers, SWH, are the loss leaders, in what I believe will be the mother of all bear markets where fiat wealth of currencies, stocks and bonds is wiped out.

    Bonds, BND, rose with the longer out Zeroes, ZROZ, rising more than the long duration US Government Bonds, TLT. This being reflected in a steepening of the 30:10 yield curve, $TYX:$TNX, to close at 1.469. But the trend since August 10, 2010, has been for a flattening yield curve. The yield curve will once again soon flatten again, with the effect of diminishing the longer maturity bond wealth the fastest.

  4. Regarding your discussion on renewables. As I sit here in Scotland, watching a torrential downpour, during a severe weather warning, I can’t but help wonder why hydro electric power doesn’t figure more in our renewable energy supply stategy. It even resolves the problem of energy storage.

  5. Well, it’s lovely and sunny here in Quebec, where hydroelectric power means that the price of energy here is one of the cheapest in the world. The big reason for this is the masive number of lakes and the small population density.
    Wind energy suffers from a common problem in power generation and that is intermittency, which makes matching supply with demand very difficult. For a slightly techy but interesting read, try The site has some interesting articles on peak oil and alternatives.

  6. On wind farms, it is quite fair to say that when the wind does not blow alternative dispatchable energy sources must be made available – typically coal or gas. Even when wind farms are distributed off-shore around the coast of the UK there are still many occurrences when distributed wind farms will experience the same weather pattern and therefore produce little output. Nevertheless when the wind does blow our consumption on imported fossil fuels will reduce (as will CO2) which would appear to bring longer term societal – but at a cost.

    It should not be forgottenthat reserve capacity is already required today in order to back up conventional power stations. Indeed the short term reserve capacity is dominated by the requirement to fulfill a shortfall of the largest generator going offline (SizewellB at 1.2GW) so wind is not the only culprit from an intermittency perspective (Sizewell generated at its rated capacity for 92% of the time). Our aging coal generation plants have more regular outages arising from planned and unplanned events.

    So from a short term reserve requirement wind is preferable as there is a very low probablity that many units go offline in a short time period and it has little impact on the existing reserve requirement.

    When the wind stops blowing this can be predicted on a rolling 30min basis enabling backup generation to come on line as required.

    Going forwards wind still remains as the most scalable source of renewable energy. Hydro has a role to play but the remaining resources are difficult to exploit due to environmental impacts (there is currently 1.4GW of natural flow hydro versus a UK electricity demand of around 40-60GW depending on time of day and season).

  7. I saw something on the net that this has reminded me about. It was hydro electric generation but using wave action to pump sea water on to land that would then fall down a gradient back to the sea and generate electricity through a turbine. The thing looked just like a buoy.

    What about electricity generation from sea currents rather than waves.

    If only we were Iceland with all those hot water springs.

    • There are plenty of ways to generate small amounts of renewable energy, but doing anything in scale and economically is the challenge. In all likelihood we will need to tap just about everything that there is going as fossil fuels and uranium eventually become depleted.

      The Prof David Mckay (now online scientific advisor for DECC) online book at is excellent to get a feel for energy resource of wave and tidal.

  8. UK bond market surges : this is the danger of the QE-world where the fundamentals go out the window. George Osborne shouts hurrah when his gilts boom and bubble and long term rates lower. Is it just me or do others see this as a fools’ paradise, awaiting the ‘burst’.

    • I agree entirely Shireblogger. We are heading for collective “burst” if they blindly continue to pursue these policies, against all the fundamentals.

      • One clear issue is that the concept of investment diversification has become virtually pointless at this time. If we just take the rise in gold it has logical contradictions with the rise in conventional government bonds and yet there they are. Then add in the recovery of equities over the past year and take the rise in bonds you have markets which are again logically inconsistent at this time.

        So if you are left with asset prices being driven higher by something and you look around you see all the money that has been created and pumped into the system by the worlds central banks.In some ways this may turn out to be the worst moral hazard of all and kind of leads into Andy’s comment today. In a world where ignoring moral hazards has become policy then many will ask why not take advantage of it? I still believe that you should not partly because I believe that central banks ability to control events is more limited than the central bankers believe….

  9. On the subject of energy, has anyone ever come across the term ‘thermoeconomics’? I’ve just been reading the wikipedia page about it – several interesting quotes such as “Neoclassical economics is inconsistent with the laws of thermodynamics” and “If you go from using a 20-to-1 energy return fuel down to a 3-to-1 fuel, economic collapse is guaranteed” (presumably because the level of debt in the economy rises till a certain rate of growth is required to maintain it). I certainly think energy supply/cost is a much over-looked but essential factor in the functioning of the economy. In other words, a stable financial system and medium of exchange is a necessary, but not a sufficient, condition for economic health.

  10. Wind is a valuable resource, it is an energy FLOW. Same as solar (including thermal), wave, tidal, hydro, hence constantly renewable. Current power grid management is up to managing a rapidly changing supply and demand and does so well by using gas turbine and some pumped storage (Dinorwic) and should be OK up to 30% I believe. Coal, gas etc are STORES that deplete, the strange thing is that there are still vast stores of fossil fuel to go but the reference to thermo-economics is apt, the term is EROEI, “Energy Return ON Energy Invested” in winning the resource, that figure is looking increasingly sick for oil, which is why it is at $75 and why we are only finding 1 new barrel for every 4 we use right now. Oil is the first fossil fuel to hit the production wall, only demand destruction by economic contraction is staving off the supply squeeze that seems inevitable in the coming years.

    So I am relieved to see the government going large on Wind, and on micro-generation (FIT Tarrifs) and Ground Source heat pumps and energy efficiency drives. We became a net fossil fuel importer in 2006 and currently run an import deficit of around £40M a day that goes straight on the deficit, so something HAS to be done before that becomes £120M/day (We use around 3.6M barrels a day, with a 1M import gap from production in the North Sea).

    Be clear though, we do not have the technology to be energy independent, nowhere near but it would be criminal negligence to do nothing and so wind HAS to be part of the solution. The fact that it doesn’t blow all the time is a minor inconvenience.

    Note: all sorts of energy stores are being explored to smooth flow generation, even proposals to fix carbon and hydrogen and produce….gas or oil, these are being looked at seriously

    For extended debates on these subjects, take a look at there are a lot of informed people debating these issues in depth.

  11. Yes. My foolish question about energy is nuclear energy. Do the raw materials that go in to the process eventually run out? Or can nuclear power be self-perpetuating using by-products of the generating process?

    If these resources are finite how much is there out there.

    This is aside from the political stability of the countries where the the uranium can be found.

    Oildrum website bookmarked.

    • Hi Sean
      I think part of the answer is the difference between nuclear fission which uses scarce elements such as uranium and nuclear fusion which uses a lot more common elements or to be more specific elements with low atomic numbers. These sort of elements are much more common and indeed power the sun. According to the atomic achive “Unlike nuclear fission, there is no limit on the amount of the fusion that can occur.”
      However so far my understanding is that we have only been able to create fusion for one hundredth of a second so much remains to be done. I am happy to be corrected by those who know more!

  12. Nuclear has its own problems. Two types Fusion and Fission. We use fission now which relies on radioactive ore, Uranium that is mined from fault lines in a few key places in the world. Again, it is the case that there is more Uranium in the world than we could probabaly ever use but it is the cost of extraction that is the issue. We used to be able to pick lumps of the stuff up off the ground, now we are mining around 10 tons of rock to get 1 ton of ore, which is rapidly heading to 1000 tons and as the easy stuff to get runs out the economics of winning it fall apart, EROEI tends towards one and then there is no point to further excavation. Some estimates suggest this point may be around 2020. I hope the people deciding to build a UK reactor programme have worked this one through……. especially since every other country is currentlt targeting nuclear…..demand for ore is going to go through the roof in the next few years.

    FUSION is the scientific dream that is consuming billions of dollars in fundamental research. Progress has been made but a commercial reactor is always 30 years away. Latest estimates indicate 2050. Fact is that it is a bet but if it comes off and we can get self fuelling reactors then we enter a new age of energy independence. Keep your fingers crossed, projects such as JET and TOKAMAK are the big hopes.

  13. P.S, Economists tend to sit in the “cornucopians” camp. They are usually right when they say we have massive supplies of raw commodities and elements in the earth. They assume science will mobilise new projects to win these resources or create substitutes in a way that means the laws of economics will still hold good. Nature doesn’t always agree to be helpful to the engineers though, hence the rare earth debate between Japan and China at the moment. No rare earths, no Japanes electronics, hybrid cars etc. Who has all the rare earths…China… only supplier of Hafnium in the world at present. No substitute yet found.

  14. Isn’t the whole point about ‘green technology’ is that it can produce R&D and manufacturing jobs at a time of economic stagnation? Also any improvement in our ability to be more self-sustaining in terms of power generation should be encouraged. It may be high cost but there is a chargeable return as well as national benefit to consider so for once not just artificial economic stimulation.
    As I live in an area of quite high unemployment, and that will soon be even worse once the public sector guys join the statistics, but one which has a viable stake in this technology even to the point of earmarking manufacturing base then only one thing to say……bring it on ASAP!

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