This Season's Hottest Drama: Global Fx Wars

        By Wayne Arnold
        In today's episode of "Game of Thrones: Currency Wars Unit," we turn to the unfolding drama in Ukraine. There, on the eastern border, Russian forces are reportedly massing to protect ethnic-Russian separatists from any attempt by Kiev to reclaim breakaway territories. They're also prepared to defend the Crimean peninsula, which Russia snatched from Ukraine early this year.
        The potential for further aggression by Moscow has caused no shortage of anxiety in Europe, which 25 years after the fall of the Berlin Wall was hoping to welcome the former Soviet satellite into its own political orbit.
        German Chancellor Angela Merkel (not to be confused with Queen Margaery Tyrell from the HBO series of a similar name) let loose a little Sturm und Drang about Russia's behavior at the G20 summit in Brisbane this week, warning of a long confrontation ahead between Europe and Russia. Russian President Vladimir Putin (not to be confused with the Beggar King Viserys Targaryen) ducked out early and flew home.
        But winter is coming. And though Europe and the United States have imposed painful sanctions on Russia, Russia supplies about half Ukraine's natural gas and one third of Europe's. Europe is betting cash-strapped Russia can't afford to forego gas revenues; Russia is pretty sure Europe won't survive the winter without its gas.
        The risk is that a tit-for-tat economic feud erupts that neither Russia nor Europe's economies are in much shape to fight. Any escalation would hurt not only Russia, but also European growth, European stocks and the Euro.
        That would raise the pressure on the European Central Bank to make good on its promise to do "whatever it takes" to restore Europe's inflationary pulse to at least 2%. Earlier this week, ECB President Mario Draghi (not to be confused with Dothraki Khal Drogo) assured the European Parliament he would be willing to start printing Euros to buy government bonds if that's the whatever it takes. If he does, it will push the Euro even lower.
        Wait a minute? Buying government bonds until inflation goes to 2%? Isn't that a plot line from a different series? Yes, it's in "The Walking Dead: Currency Wars Unit," where Bank of Japan Governor Haruhiko Kuroda (not go be confused with "the Governor" from the AMC series "The Walking Dead") last month revved up his own printing presses to weaken the Japanese yen, boost export earnings and revive inflation in Japan's zombie economy to 2%.
        If Draghi expands his Euro barrage over at Game of Thrones, it will counteract Kuroda's explosion of yen over at Walking Dead. The worsening situation in Ukraine and the weakening European economy are thus going to go head-to-head against Japan's own efforts to weaken its currency, revive investment and consumption and export deflation to its trading partners.
        But hold on: that sounds familiar, too. That's the story-line over in China at "House of Cards: Currency Wars Unit." There, China's government (not to be confused with the Chinese government depicted in the Netflix series of a similar name) has for years been keeping its currency from rising along with its growing trade surplus so it could gain export market share and use the earnings to fund industrial development. But the resulting inflationary pressure created over-investment, excess capacity and a credit-led property bubble.
        Now, Beijing is trying to gingerly deflate that bubble by tightening up on investment and lending, steering the economy away from its old model, all while keeping growth fast enough to keep the bubble from bursting and spreading sticky loan defaults all over the financial system. It's spending money on domestic infrastructure, but also needs exports to grow.
        China is more sensitive to European demand than its neighbors -- Europe accounts for 16% of its total exports, compared to 10% of Japan's. And China's exports to Europe have been rebounding, rising almost 12% in the first nine months of this year. A softer European economy and weaker Euro could undo that.
        China's central bank has lately had to inject credit into weaker banks to keep them and smaller borrowers from suffocating. But with growth slowing and housing prices falling, economists predict China will soon have to relax credit conditions more dramatically. With Draghi and Kuroda torpedoing China's exports with bales of currency, Beijing may feel compelled to fire back.
        All this money-printing would mean even more credit to Asia's smaller economies and its weakest borrowers. But to those hopeful this brewing currency war would be good for Asia's economies or real stock-market returns, a word of advice: Curb your enthusiasm.
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        Comments? E-mail us at wayne.arnold@barrons.com
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        Comments? E-mail us at asiaeditors@barrons.com
        (END) Dow Jones Newswires

        November 19, 2014 22:36 ET (03:36 GMT)

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