With Japan’s recent aggressive devaluation of the Yen, the financial news has again taken up the phrase “currency war” to describe any lack of coordination in the steady devaluation of fiat currencies across the globe.
In a recent piece over at the Financial Times, Niall Ferguson identifies the Bank of England as the current winner in the stealth currency war that is currently being waged. While the Bank of England may be the winner, the losers are not other nations, as the term war would suggest, but rather the savings of those who are unfortunate to count bank accounts or debt instruments denominated in national currencies among their assets.
Who, then, are the winners in of the currency wars? In a simplified sense, those who hold the Dow Jones Industrial stock index and those who own gold.
In an attempt to illustrate this point, we have created the following graph, which plots a normalization of the M1 and M2 monetary measures against both the Dow Jones Industrial Average and gold prices, all averaged on a monthly basis since April of 1968. Finally, the graph includes the Federal funds rate so that its effects on these measures may be observed.
Those with a keen eye will notice that the only data point that has been on a downward trend since the US Dollar was officially released from the shackles of the gold standard on August 15, 1971 has been the Federal funds rate, which in theory should have an inverse relationship with all of the other data points.
This graphic exercise serves to illustrate the following relationships:
1. The most volatile of the two asset data sets has been that of the Dow Jones Industrial Average. Despite its volatility, its overall trend tends to follow that of the M2, or expanded, money supply measure.
2. The more stable of the two asset data sets has been gold, which has generally lagged growth in the M1, or base money supply to which it was tied to up until 1971. Beginning in the year 2000, gold again began to follow the M1 trend.
3. The light blue line, which tracks the Federal Funds Rate, has been on a downtrend. The upticks in the Federal Funds Rate, in theory, should have lead to downward ticks in the M1 and M2 As you can see from the graph, this is not the case.
The conclusion of this brief analysis is the following: Holding stock indices such as the Dow Jones should give some measure of protection against inflation over the long term, perhaps even superior to gold. However, since 2000, gold has held steady as an inflation hedge and generally will have less liquidity risk than stocks.
Finally, and perhaps most importantly, is that upwards changes in the Federal Funds rate, even those as dramatic as were experienced during the Volcker years, have little or no effect on the near term trajectory of the M1 and M2 monetary measures and have never caused these monetary measures to trend downwards, ever. At most, these movements may serve to temporarily arrest the upwards slope of the growth of the M1 and M2 monetary measures.