Its wasn’t a failure of capitalism that led to the financial crisis, but the “monetary socialism” of central bank planning…
Nov 24
Hyperinflation is not simply inflation times 10. In fact, it’s when real prices fall…
SO the FEDERAL RESERVE’s second-round of quantitative easing, announced on November 3rd, was a shoo-in – a fait accompli – already decided when the policy team first sat down the previous day, writes Adrian Ash at BullionVault.
How come? As the minutes released this week show, Brian Sack – manager of the New York Fed’s System Open Market Account (SOMA) – opened the meeting. And asked to judge the matter, he told the 64 other policy-wonks gathered in the Eccles Building that his team "could purchase additional longer-term Treasury securities at a pace of about $75 billion per month while avoiding disruptions in market functioning."
Moreover…
"Implementing a sizable increase in the System’s holdings of Treasury securities most effectively likely would entail a temporary relaxation of the 35% per-issue limit on SOMA holdings under which the Desk had been operating."
Hey presto! The following day, and after apparently intensive debate, a monthly target of $75 billion in Treasury bond purchases – plus a relaxation of the 35% limit on Fed holdings of any particular bond issue – was announced.
Does that make the Fed meeting a sham? No matter. "It’s not as if the Fed is doing anything radical," says Princeton professor Paul Krugman. It’s simply looking "to boost the flow of economy-wide spending by changing the mix of privately-held assets," agrees Berkeley professor Brad DeLong.
"It buys government bonds that pay interest in exchange for cash that does not. That is totally standard."
But totally standard where, exactly?
Sure, buying and selling government debt in the open-market is how central banks control short-term interest rates. That’s why the Fed Funds rate is a target, and the actual outcome in the marketplace is instead known as the Effective Fed Funds. Bidding short-term bills higher (or lower) in price, the New York Fed thus pushes down (or up) the interest rate paid on those bills. But stuffing the market with money, in contrast, is a very different aim. Not least when you do it by buying longer-term bonds. And by only buying, rather than fine-tuning purchases with sales. And by doing it amid the heaviest net issuance of government debt in history. And by doing it so hard that, despite that record issuance, you still need to break your own limit on the proportion of any individual maturity-date you’re allowed to own.
So again, we ask here at BullionVault: Where in the world is such money creation "totally standard"…?
"I think using quantitative easing is a perfectly legitimate thing to do. And for heaven’s sakes, it’s not as if we’re in any danger of inflation any time soon."
– White House advisor and former director of the Congressional Budget Office, Alice Rivlin, speaking to CNBC on 15 November 2010
"We have no ‘dangerous flood of paper’…On the contrary, our paper [money] circulation, though it shows a terrifying array of billions, is really not excessively high…"
– Vossische Zietung newspaper, 16 August 1922
"Several [Fed policy] participants saw a risk that a further increase in the size of the…monetary base could cause an undesirably large increase in inflation. However, it was noted that the Committee had in place tools that would enable it to remove policy accommodation quickly if necessary."
– Federal Reserve minutes from 3 November 2010
"Even if the quantity of money were three times its present size, it would constitute no real obstacle to stabilization…"
– Berliner Börsener newspaper, 18 August 1922
Okay, so pasting a couple of quotes next to each other doesn’t mean the United States is headed straight for wheel-barrows and stormtroopers. Like everyone agrees, 1,000,000% inflation looks a long way off right now. But no central bank ever began a hyper-inflationary policy because it feared inflation. Such disasters always come because of vanished credit and economic depression. And whether in Germany nine decades ago, or in Argentina twenty years back, or in Robert Mugabe’s Zimbabwe around the turn of this century, stuff actually gets cheaper – not more expensive – in real terms during hyperinflation. It’s just that the local currency falls in value faster still, turning the "money illusion" we’re all prey to into a livid nightmare.
Hence the daily flood of French citizens across the border at Strasbourg each day during the early stages of the Weimar madness, emptying the stores with their highly-prized Francs. Hence the real-estate bargains snapped up by wily speculators during Argentina’s last-but-one collapse. Hence the zero-change in inflation – net net – for US Dollar earners during the early phase of Zimbabwe’s hyperinflation, followed by massive a deflation, in US Dollar terms, even as prices in the local currency soared.
On the ground, amidst these crises, it was monetary contraction – not soaring prices – that most worried policy-makers. "The lack of money [now] has a worse effect than the devaluation itself," said one Berlin newspaper in summer 1922, as the Weimar Republic began to run the presses 24/7.
"The government printed notes to satisfy everyone," writes Adam Fergusson in his history of the disaster, When Money Dies, "telling itself that as the granting of credit…had so greatly decreased, the actual currency in circulation had to be so much greater."
But let’s not get perverse. The latest flat-lining in America’s official Consumer Price Index does not mean that hyperinflation is in fact underway. The critical factors to watch out for remain a collapse in tax revenues, plus demands for immediate payment from foreign creditors. It bears repeating nevertheless, however, that – contrary to the worldview presented by academic economists and professional wonks – demand-push inflation is not how hyperinflation begins. Real values in fact fall as a genuine currency crisis takes hold.
And the fact that the Federal Reserve is so dead-set on its "emergency" response that it scarcely needs to meet to agree it, doesn’t mean the Fed actually knows what it’s doing.
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Nov 23
But it might just create a chance to Buy Gold and other hard assets on the cheap…
WELL THIS should be interesting, writes Dan Denning in his Daily Reckoning Australia.
The EU/IMF bailout of Ireland is not going off without a hitch. The UK’s Telegraph reports that the Green party, which currently forms the junior half of Ireland’s coalition, might withdraw that support and call for new elections in January. This would call into doubt the ability of the current government not only to execute a deal with the EU and the IMF but also to pursue its four-year austerity program.
What a mess! We’ll get to how Ireland and Australia are similar in a moment. But first, please recall the words of the great philosopher of the New York Yankees, Yogi Berra. He once said, "When you come to a fork in the road, take it."
Today’s fork in the financial road leads down two different paths. One path is continued US Dollar devaluation and a strategic migration to emerging market assets (under the assumption that the BRIICS nations will eventually have to allow for currency appreciation…or face rampant food and fuel inflation). This trade favors Buying Gold, commodities, and tangible assets in general.
But remember what happened in 2008? The Global Financial Crisis actually led to a massive rally in the US Dollar. Emerging markets got hammered. The "risk" trades financed with cheap greenbacks were reversed and commodities took a shellacking as well.
Could that happen again? The boys at Knight Research think it’s going to happen again, but even bigger and badder this time around. In a recent research note, they wrote:
"We believe the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyse a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over."
This is the fork Murray has been preparing for in the Slipstream Trader for our subscribers It would mean falling indexes in Australia, which would of course mean falling components of those indexes. Knight Research elaborates on this fork:
"The game is over. Presently, we believe that the broad-based resurgence of investor confidence in the emerging market and secular bull market in commodities will end badly; proving that the rally which commenced in Q2 2009, was in fact an ‘echo bubble’ facilitated by massive-and unsustainable-stimuli from the Chinese government.
"We believe that the end of the Great Consumer Credit Cycle and the vast structural differences in the terms of trade between the United States, the EU, and China, have finally caught up with the secular bull thesis on emerging market and commodities.
"Quite ironically, the Fed’s aggressive policies will likely prove to be the catalyst which breaks China’s unbridled expansion of credit and non-economic growth, ushering in a wholesale rebalancing of risk assets."
This is not a lukewarm prediction. It would quite obviously be mega bearish for the Aussie Dollar and for commodities. And thus far, there’s not much evidence to support that giant reversal is afoot that is more bearish for emerging markets than it is for the US Dollar. It’s a fork in the road, though. So we have to take it and see where it leads.
There ARE a few factors supporting the "Game Over" theme. One is that Ireland’s woes are not the last o the Eurozone’s problems. There is Greece. There is Spain. And really, Ireland is not even done and dusted yet. To some extent, Euro weakness is dollar bullish and contributes to the "Game Over" theme.
But the bigger factor is Chinese tightening, or just your basic traditional popping massive credit bubble. There are early signs of that. Last week China raised reserve requirements on banks again. And Citigroup agrees with our assessment that rising food prices in China could be bearish for metals.
China’s State Council is talking a big game on controlling inflation. Does it mean China is quickly shifting away from a bias toward export growth toward an inflation fighting bias? That’s the big question. If it does mean that, you can expect lower commodity prices.
For example, three-month copper on the London Metals Exchange fell overnight. The news preceding the drop was that refined copper imports to China fell by a third last month. Comex December copper traded lower too, near $3.75/lb.
We’re going to have Dr. Alex what he thinks about this. But we can guess. He probably loves it. He just got back from another site visit in Africa to a copper project. If you’re a Diggers and Drillers reader don’t worry. You’ve already read about this company. It’s not a new recommendation.
Alex has done his homework on the companies he’s recommended. Weakness in the copper price invariably follows through to the shares. If you’re a secular metals bull, you believe this lowers your average purchase price on the shares most likely to benefit from rising prices.
If you’re a bear on copper, well…you’re a bear. Go dance. Alex, of course, has taken the other fork in the road. This fork is for those who’ve realized the end of the Dollar Standard in the global money system is likely to be bullish for real assets, despite your reflexive US Dollar rallies. Europe’s chronic and structural problems add an element of Dollar support. But the long term story on this fork is to favor "real assets" over paper money.
Which brings us back to Ireland and Australia. Irelands bank’s went all in on the Irish property market. When the bubble burst, the banks were left holding the bag (a huge mortgage book). The bag was so heavy, in fact, it broke their back. So the government had to pick them up. And the bag was too big for the government to pick up too, especially given rising borrowing costs for countries at Europe’s periphery.
Could that ever happen in Australia? Could banks with massive over-exposure to domestic property be caught out by losses and unable to borrow from overseas except at much higher rates? And could the government be forced to step in and cover the bank at the cost of its own good credit?
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Oct 23
Gold Bullion has risen faster against the Euro and Sterling than vs. the Dollar…
TO THE SURPRISE of many investors, the Yankee Dollar has earned only a third-place ribbon for its depreciation against gold over the past 12 months, writes Brad Zigler at Hard Assets Investor.
With all the recent hoopla and headlines about gold making new highs against the greenback, the destruction derby of the world’s reserve currencies is actually won by the Euro, with Sterling close behind, on an annual basis.
Over the past year, the US Dollar lost 29.8% vs. bullion compared with a 39.7% tumble for the European common currency and a 34.5% decline in the British Pound. Bringing up the rear is the Swiss Franc, with a 23.1% loss, and the Japanese Yen, which gave up 16.4% to gold.
Oddly enough, the US Dollar is also the least volatile reserve currency when it comes to Gold Bullion purchasing power, too.
The standard deviation of the Gold Price in Dollars stands at just 15.3% for the past year. This may not seem like a testament to the Fed’s steady hand on the nation’s economic tiller, but it’s something. It actually bespeaks the wait-and-see attitude of the central bank after last year’s stimulus and accommodation.
The likelihood of Fed intervention increases when commodity prices – a basic metric of inflation – rise or fall significantly compared with Treasury securities. In the chart below, the red Fed Indicator line dances within a neutral zone – a condition that compels the central bank to watch, but not act. A sustained move in the indicator above the upper band would signal an increased likelihood of accommodation – or lower money rates and a weaker Dollar.
A dip below the lower band flashes a higher probability of tightening, or higher rates and a stronger Dollar…
Keep in mind that this indicator is just that – an indicator. It measures the likelihood of Fed intervention, not its certainty. Political considerations – which can be substantial – are put aside here.
For now, the Fed’s keeping a fairly even keel – even though it’s been economically painful for employees or the unemployed. There’s nascent inflation, reflected in the blue line’s recent trajectory, which complicates the Fed’s handling of the Dollar. What’s economically expedient may not be politically fruitful.
On the other side of The Pond, Sterling’s been the most volatile currency, flopping about with a 17.8% standard deviation in the Gold Bullion market. Largely, this reflects the rising and falling fortunes of the former Labour government. And with all this, one can’t ignore the longer-term trends.
Since the Euro’s introduction in 1999, the Pound’s lost more ground to Gold Bullion than any other reserve currency. Sterling’s average annual loss in gold purchasing power has been 15.3%. The US Dollar follows with an average loss of 14.8% per year. Meantime, the Euro’s given up an average 13.1% each year.
Kinda makes you wonder who’ll take the pennant next year!
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Oct 22
Living standards in the West are certain to fall as Asian wealth grows…
"There are more tears shed over answered prayers than over unanswered prayers…"
– Teresa of Ávila, patron saint of headache sufferers
IT’S NOW five years and $1.7 trillion of Chinese foreign-currency reserves since the People’s Bank ended a decade-long peg to the Dollar, writes Adrian Ash of BullionVault.
Throughout the mid-to-late 1990s’ Asian Crisis, and again as the US currency first began its long decline in the early Noughties, Beijing had defended 8.3 per Dollar. Its rising power – plus grumblings from trade partners – made some level of appreciation inevitable, but only if Beijing kept it strictly controlled. So back then, as today, China refused to even begin making the Yuan freely convertible – and thus accessible to foreign investment – but for very different reasons.
The fear when China carefully recalibrated its Dollar peg in 2005 was of foreign speculators driving the Yuan lower. Whereas in 2010, it’s got the opposite problem. Grabbing export share (and that mountain of foreign-exchange reserves) by suppressing its currency way below any measure of "fair value", Beijing clearly fears a repeat of the Japanese bubble-and-bust that followed 1985′s Dollar-weakening Plaza Accord. Because since first loosening the Yuan’s Dollar peg (if only a little) half-a-decade ago, China has overtaken Japan as the world’s No.2 economy, and become the world’s top importer of copper, biggest user of cement, No.1 consumer of energy, edible oils, soybeans, rice and wheat, and the No.2 destination for physical Gold Bullion.
Yes, China’s currency should reflect this growth, at least according to non-Confucian theories of floating currencies and trade rebalancing. No doubt it will in due course, too. But if US Treasury Secretary Tim Geithner were to get his wish at the G20 meeting this weekend – which he won’t, not yet – and the Chinese Yuan did bear a greater share of the Dollar’s global devaluation, Beijing’s impact purchasing power in the food, energy and mineral markets would only grow greater.
So where Timmy might want to watch out is that the appreciation in China’s purchasing power must come at the expense of today’s freely convertible currencies.
First, Beijing likely holds some $2 trillion or more of the "big four" reserve currencies – Dollars, Euros, Sterling and Yen. Gresham’s Law says it’s more likely to spend those holdings ahead of its own, increasingly valuable money, as it buys ever-more food, energy and mineral resources to meet its surging domestic demand for a better standard of living.
Second, and should the Yuan extend its global usage from this year’s McDonalds’ bond float to central-banking reserves, the relative loss of purchasing power in Dollars, Euros, Sterling and Yen will only accelerate further. Together, the Big Four account for 96% of forex reserves according to the IMF, but that’s the lowest proportion since before the late ’90s Asian Crisis – a crisis which Beijing managed to avoid but remembers all too well.
Third, and most critically amid the global currency war – a war which will not be settled over the conference table for as long as Western central-bank policy remains fixated on currency inflation – flows of "hot money" are rightly expected, not least from US, UK and Japanese wealth fleeing zero-per-cent rates at home.
As it is, China is gently loosening controls on money outflows, but only a little, and actual outflows of Yuan remain blocked. So trying to preserve its global value, retained wealth in the West cannot get direct exposure to the currency (nor the equities at present) which will increasingly put a price on the biggest trend of the 21st century – the Eastward shift of global demand and consumption.
Even if China does liberalize (which it won’t any time soon) retail investors will be last in the queue. So a fair proxy, meantime, remains buying hard assets and natural resources. It also gets to the heart of the problem, because living standards in the West (by way of our global purchasing power) are certain to fall long-term. Asia’s growing use of world resources must come at our expense, in just the same way as the Pound Sterling’s first fall from top-dog currency status – starting some seven decades ago, and running pretty much ever since – made for a relative loss of wealth to the United States.
Most clearly amid the currency turmoil only just getting started, China’s ever-growing demand for Physical Gold and silver highlight that big, fat 21st century trend in action. By the time (if ever) that Yuan deposits become widely available through retail banking in the US, Eurozone, UK or Japan, this morning’s $1319 price-tag on gold might look a great bargain.
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Oct 14
How differing rates of "money growth" are weakening the US Dollar…
AT THE END of September the price of the Euro in US Dollar terms closed at 1.357 – an increase of 7% from the end of August, writes Dr.Frank Shostak, chief economist at MF Global in Australia and a regular contributor to the Austrian-school Mises.org, for the Cobden Centre.
The yearly rate of growth of the price of Euro stood at minus 7.3% in September against minus 11.5% in the month before.
The currency rate of exchange seems to be moving in response to so
many factors that it makes it almost impossible to ascertain where the
rate of exchange is likely to be headed. We suggest that rather than
paying attention to the multitude of apparent variables, it is more
sensible to focus on the essential variable. As far as currency rate of
exchange determination is concerned we suggest that this variable is the
relative changes in the purchasing power of various monies. In short,
it is the relative purchasing power of various monies that set the
underlying rate of exchange.
A price of a basket of goods is the amount of money paid for the
basket. We can also say that the amount of money paid for a basket of
goods is the purchasing power of money with respect to the basket of
goods. If in the US the price of a basket of goods is $1 and in Europe an identical basket of goods is sold for 2 euros then the rate of exchange between the US$ and the euro must be two euros per one dollar.
An important factor in setting the purchasing power of money is the
supply of money. If over time the rate of growth in the US money supply
exceeds the rate of growth of European money supply, all other things
being equal, this will put pressure on the US$. Since a price of a good
is the amount of money asked for the good, this now means that the
prices of goods in dollar terms will increase faster than prices in euro
terms, all other things being equal.
As a result an identical basket of goods is priced now, let us say at $2, as against 2.5 euro. This would imply that the exchange rate between the US$ and the euro will be now 1.25
euros per one dollar. Note the fact that changes in a money supply
affect its general purchasing power with a time lag means that changes
in relative money supply affect the currency rate of exchange also with a
time lag. (When money is injected into the economy it starts with a
particular market before it goes to other markets – this is the reason
for the lag. When it enters a particular market it pushes the price of a
good in this market higher – more money is spent on given goods than
before). This in turn means that past and present information about
money supply can be employed in ascertaining likely future moves in the
currency rate of exchange.
Another important factor in driving the purchasing power of money and
the currency rate of exchange is the demand for money. For instance,
with an increase in the production of goods the demand for money will
follow suit. The demand for the services of the medium of exchange will
increase since more goods must now be exchanged. As a result, for a
given supply of money, the purchasing power of money will increase.
Less money will be chasing more goods now. Various factors, such as the
interest rate differential, can cause a deviation of the currency rate
of exchange from the level dictated by relative purchasing power. Such
deviation, however, will set corrective forces in motion.
Let us say that the Fed raises its policy interest rate while the
European central bank keeps its policy rate unchanged. We have seen that
if the price of a basket of goods in the US is one dollar and in Europe
two euros, then according to the purchasing power framework the
currency rate of exchange should be one dollar for two euros. As a
result of a widening in the interest rate differential between the US
and the Euro-zone an increase in the demand for dollars pushes the
exchange rate in the market toward one dollar for three euros. This
means that the dollar is now overvalued as depicted by the relative
purchasing power of the dollar versus the euro.
In this situation it will pay to sell the basket of goods for dollars
then exchange dollars for euros and then buy the basket of goods with
euros – thus making a clear arbitrage gain. For example individuals will
sell a basket of goods for one dollar, exchange the one dollar for
three euros, and then exchange three euros for 1.5 basket, gaining 0.5
a basket of goods. The fact that the holder of dollars will increase
his/her demand for euros in order to profit from the arbitrage will make
euros more expensive in terms of dollars – pushing the exchange rate in
the direction of one dollar for two euros. (We suggest that the
arbitrage will always be set in motion if the rate of exchange deviates,
for whatever reasons, from the underlying rate of exchange).
Since November 2009 the money growth differential between the US and
the Euro-zone has been in a visible increase. After closing at minus 24% in November 2009 the differential jumped to minus 4.2%
in August this year. We suggest that the strengthening in the
differential is the key reason for the underlying strengthening in the
Euro against the US$. Given the relatively more conservative Euro-zone
central bank versus the US central bank it is quite likely that the
money growth differential will continue to strengthen further – thus
providing further support to the Euro.
After closing at minus 3.7% in April the growth differential between
US and Euro-zone industrial production climbed to 0.11% in August. We
envisage that in the months ahead the differential is likely to
stabilize at the August figure. So from this perspective the slight
increase in the differential is likely to provide only marginal support
to the US$ versus the Euro. The differential between the federal funds
rate and the European central bank policy interest rate is likely to
stand at minus 0.75% in the months ahead. (The fed funds rate is
forecast at 0.25% while the ECB rate at 1%). So from this perspective it
is going to have neutral effect on the price of Euro in US dollar
terms.
Again we maintain that the strong support for the Euro versus the US$
is on account of a strengthening in the money growth differential since
November 2009. (Note again that the effect from changes in money supply
and the differential works on the currency rate of exchange
determination with a time lag). This means that the US$ is likely to
remain under pressure. An increase in the industrial production
differential is likely to mitigate the strengthening of the Euro against
the US$. On a short-term basis the price of the euro in US dollar terms
appears to be just about “right” as far as the valuation versus its
12-month moving average is concerned. The price to its 12-month moving
average ratio stood at 1.0 in September versus 0.9 in August. Note that in September last year the ratio stood at 1.08.
Prospects for the Yen against the US dollar
At the end of September the price of the US$ in Yen terms closed at 83.9 – a fall of 0.3% from the end of August. Year-on-year the price of the US$ in Yen terms fell by 6.5% in September after declining by 9.5%
in the month before. Observe that the Yen has been strengthening
against the US$ since July 2007. The price of the dollar to its 12-month
moving average stood at 0.94 in September the same figure as in August. Note that in September last year the ratio stood at 0.946.
Since November 2009 the money growth spread between the US and Japan has been trending up. The differential stood at 2.8% in August against 2.1% in July and minus 13% in November last year. Now after falling to minus 29.1% in February the industrial production growth spread between the US and Japan climbed to minus 9.2%
in August. In the months ahead we expect the growth spread to stabilize
at around the August figure. The interest rate spread doesn’t have much
importance at present given the policy rates in US and Japan are close
to nil. We suggest that in the months ahead the money growth
differential is likely to dominate the currency rate of exchange scene.
This implies that the price of the US$ in yen terms is likely to remain
under pressure.
Money growth differential continues to support Aussie dollar against the US dollar
At the end of September the price of the A$ in terms of US$ closed at 0.967 – an increase of 8.5%
from the end of August. The growth momentum of the price of the A$ has
also strengthened visibly. The yearly rate of growth jumped to 9.4% from 5.4% in August. The ratio of the A$/US$ to its 12-month moving average climbed to 1.076 in September from 0.999
in the month before – this could be interpreted that relatively to its
12- month moving average the price of the A$ in US$ terms is
over-stretched.
A major factor behind the strengthening in the A$ against the US$ is a
visible strengthening in the money growth differential between the US
and Australia. After falling to minus 15% in November last year the differential shot up to 9.1% in June before settling at 7.6%
in August. From the demand for Aussie dollars perspective a strong
increase in the price of gold provides important support for the
Australian currency versus the US dollar. From these two key factors we
suggest that for the time being the Aussie dollar is going to be well
supported in the months ahead, all other things being equal.
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Oct 05
The world’s top four currencies are the stand-out losers vs. gold…
The UPSHOT from last week’s London Bullion Market Association conference in Berlin, writes Adrian Ash of BullionVault, was that there’s more sound and fury about bullion in the financial pages than in the dealing rooms right now.
Several dealers I spoke to said business was quiet, if not boring. Gold’s current rally, said one speaker, "punches above its weight in terms of significance." Another noted that at the start of September, when Dollar-gold surpassed its June high, volatility was at a 5-year low. (It still is. Silver Price volatility has fallen to a 3-year low as it broke three-decade highs.)
You can see this lack of frenzy in prices alone, in fact – but only if you don’t focus on the Dollar alone…
BullionVault‘s Global Gold Index shows the price of gold against the world’s top 10 currencies, weighted by GDP.
Latest forecasts for economic growth from the IMF are applied for 2010, putting the US Dollar top, with the Euro next…then the Chinese Yuan…Japanese Yen…British Pound….Russian Rouble…Brazilian Real…Canadian Dollar…Indian Rupee…and Mexican Peso.
Reviewing our index of gold vs. the official currencies of more than half the world’s population – and more than two-thirds of its annual economic output – three points stand out from the last 3 months’ action:
- Gold’s bull-market pattern against all the world’s money continued in Q3 (July’s low was higher than the previous bottom in March);
- Q3 marked the 33rd positive quarter of the 43 since Jan. 2000, but only just. The GGI rose to 422 from 421 (New Year 2000 = 100);
- Most notably, gold’s 5% gain vs. the Dollar was its strongest rise against any currency.
That third point is only to be expected, perhaps. Because the Dollar’s decline made headlines across the summer/start of fall. But crunching the numbers further again, two truly remarkable points jump out from there…
#1. July-Sept this year was only the third quarter since the start of 2000 when the Dollar was the weakest major currency against gold. (The currency most commonly bottom-of-the-heap has been the Brazilian Real, but it’s not been worst-in-show since 2005.) The USD was previously in the dog-house during Q4 2004 and Q3 2007 – periods when, just as over the last 3 months, US central-bank policy stood out as deliberately weakening the Dollar compared with its paper alternatives;
#2. Over the last four quarters (starting Oct. 2009), the stand-out losers against gold have been the world’s top four reserve currencies:
- Q4 2009 – gold rose 13.5% versus the Yen (which accounts for 3.3% of central-bank reserves, by Dollar value, worldwide);
- Q1 2010 – gold rose 9.3% against the British Pound (4.2% of world reserves);
- Q2 2010 – gold rose more than 23% in terms of the Euro (26.5%);
- Q3 2010 – as we just saw, gold rose fastest against the US Dollar (62.1%).
Yes, the world’s most reservable currencies have topped the bottom of the league-table against gold for the last four quarters running – and in reverse order of reservability, too!
Again, this countdown shouldn’t surprise us, perhaps. Because while the US, Eurozone, UK and Japan now account for 97.9% of officially reported FX reserves worldwide, they’ve seen little reason not to abuse that demand, slashing interest rates further than any lesser currency-issuer could dare (0%, 1.0%, 0.5% and 0% respectively). And oddly enough, emerging-market central banks have been reducing the Big Four’s weighting in their reported reserves right alongside, actually nudging it below the "advanced economies" weighting of USD, EUR, GBP and JPY since the start of last year.
Gold Bullion, of course, pays nothing you in interest. But that zero-yield is no longer a handicap against the world’s most heavily-owned paper money. As BullionVault never tires of saying, the "opportunity cost" of holding gold’s rare indestructibility in your portfolio has evaporated. Little wonder it’s getting a strong bid in the market – and little wonder the strongest bid is coming against the world’s most heavily-owned paper.
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Oct 04
The inflation/deflation debate rages on. But why…?
The INFLATION/DEFLATION debate is now the ‘topic du jour’ and although we have discussed this issue in the past, we want to throw more light on this very important subject, writes Puru Saxena of PuruSaxena Wealth Management in Hong Kong, China, for the Daily Reckoning.
Today, many prominent economists (Nouriel Roubini, David Rosenberg and Paul Krugman) and fund managers (Bill Gross and Jeremy Grantham) are forecasting deflation and according to these folks, a deflationary contraction is now ‘baked in the cake’. In fact, these deflationists are extremely worried about the ongoing private-sector debt-deleveraging in the developed world and they are also concerned about the lack of aggregate demand in the industrialized nations. Bearing in mind these two factors, these prominent people believe that deflation is now almost guaranteed and inflation is out of the question.
On the other end of the spectrum, and in stark contrast to the deflationist camp, many prominent market participants (Paul Tudor Jones, John Paulson, Jim Rogers, Marc Faber and Peter Schiff) are now warning about high inflation or even hyperinflation. According to these people, the large fiscal deficits and massive debt overhang almost guarantee runaway inflation.
It goes without saying that such conflicting views are extremely strange when you consider that all these highly experienced and successful people are reviewing the same economic data! Well, everyone is entitled to their opinion, but as far as we are concerned, deflation is an urban myth and the global economy will have to contend with very high inflation.
It is our conjecture that inflation is always a monetary phenomenon and willing policymakers have the ability to create inflation. Now, before we delve any further, we want to make it clear that inflation is an increase in the supply of money and debt. Conversely, deflation is a decrease in the supply of money and debt.
Furthermore, it is critical to understand that an increase in the general price level is a consequence of inflation and a decrease in the general price level is a consequence of deflation. Most importantly, despite what you may hear elsewhere, you should keep in mind that a booming economy (operating at maximum capacity) is not a pre-requisite for inflation.
Now, if you reside in the deflation camp and believe that inflation cannot occur in a weak economic environment, you need to visit Zimbabwe and meet Mr. Mugabe who will explain how you can create hyper-inflation at a time when a nation is facing an economic depression! Whether you like it or not, Zimbabwe’s hyper-inflationary saga clearly shows that despite a huge output gap, surging unemployment and a bankrupt economy, reckless policymakers can succeed in creating massive inflation.
Look – we do acknowledge the fact that the economies of the developed world are struggling and they will probably remain weak for several years. We also accept the fact that the aggregate demand in these troubled economies will stay well below the available capacity (output gap). However, contrary to the deflation camp, we totally respect the money-creation abilities of the central banks. Accordingly, we firmly believe that in order to avoid sovereign defaults in the near-term, the Federal Reserve and the European Central Bank will create unprecedented inflation.
Already, short-term interest-rates in the US and in Europe are at extremely low levels and real short-term interest-rates are negative. If such a loose monetary policy fails to create inflation, you can bet your bottom Dollar that these central-banks will unleash even more rounds of ‘Quantitative Easing’. Needless to say, such reckless monetary-inflation will dilute the existing money-stock even further and reduce the purchasing power of money. Okay, enough about the inflationary bias of the public-sector, let us now move on to the private-sector.
As far as the private-sector is concerned, you may recall that after the credit-bubble burst two years ago, commercial-bank credit in the US started to contract. After all, this debt repayment by the private-sector was a logical response to the crisis and for 17 months, commercial-bank credit declined by roughly US$700 billion. In fact, it was this private-sector debt contraction, which prompted many economists and investor to enter the deflation camp.
Whilst it is true that the private-sector in the US did experience deflation (contraction in debt) for a brief period of time, it is notable that this ‘austerity’ did not last very long! Figure 1 shows that US commercial-bank credit bottomed out earlier this year and since then, it has risen by roughly US$400 billion. So, it should be clear to all observers that the private-sector in the US is no longer de-leveraging and this is inflationary.
Furthermore, we would like to point out that even though commercial-bank credit in the US contracted between October 2008 and March 2010, during that period, America’s federal debt went through the roof!
Ironically, during the time-frame when American households and corporations were tightening their belts, the US-Treasury borrowed almost US$2 trillion; thereby stopping deflation in its track. The truth is that at no point during the recession did total debt (private-sector plus federal) in the US contract, so deflation did not occur. Now, it is conceivable that the private-sector in the US may abruptly start repaying its debt again. However, if such a debt-contraction occurs, Mr. Bernanke will create money like there is no tomorrow.
Today, America’s total liabilities (including social security, Medicare and Medicaid) are around 800% of GDP and federal debt has climbed above 90% of GDP (Figure 2). Given the fact that deflation will increase the real value of this debt, you do not have to be a brain surgeon to figure out that before the US government declares bankruptcy, it will desperately try and inflate its way out of trouble. By unleashing another ‘stimulus’, Mr. Obama’s administration will try and maintain nominal GDP growth, so that nominal incomes and tax receipts are sufficient to service the outstanding debt.
It is interesting to observe that in order to fund its spending binge, so far the US administration has succeeded in borrowing huge amounts of money at low interest-rates.
It is notable that up until now, demand for US Treasuries has been strong and the US administration has not had much trouble raising money. Perversely, in today’s volatile economic environment, US government debt is still viewed as a safe haven. However, every good thing comes to an end and investors’ perception could change at short-notice. When that happens and the bond market starts to focus on America’s ballooning deficits, demand for government-debt will dive. At that point, the Federal Reserve will have no option but to create new money so that it can lend it to the US Treasury. In fact, the Federal Reserve has already announced that it will use the proceeds from the sale of its mortgage-backed securities to buy US Treasuries. In our view, this is only the beginning and outright asset-monetisation will intensify over the following years.
Throughout history, periods of massive money-creation have always been inflationary and this time should be no different. Over the following months, if the economies of the developed world take a turn for the worse, you can be sure that the respective policymakers will respond by creating copious amounts of paper money.
If you still believe that deflation will prevail, perhaps you should review the table below, which highlights the inflation rates in various countries. It is noteworthy that the inflation rate depicted here for each nation is in fact the Consumer Price Index (CPI), which significantly understates the price increases within an economy. Let there be no doubt that the majority of government agencies make seasonal and hedonistic adjustments to bring down the level of the CPI. Regardless, you can see that despite such ‘feel good’ adjustments to bring down the reported ‘inflation’ rate, every nation (except Japan) is currently experiencing ‘inflation.’
Bearing in mind this compelling data, we are left wondering how anybody can get hoodwinked by the deflation hype!? Perhaps, the deflationists know something the rest of us do not, but at this point, hard data does not support the deflation thesis.
Given the inflationary environment we find ourselves in, we do not like cash or fixed-income securities. In our view, both cash and bonds will lose considerable real value over the following years and the ongoing strength in the government bond-market may turn out to be an exceptional selling opportunity. Conversely, we maintain our view that precious metals, energy and the stock markets of the fast growing developing markets in Asia will provide stellar returns in this inflationary environment.
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Oct 02
Forget mining and
central banks. Here’s the single most important gold supply issue today…
SO IT WAS TOUGH yet
again to meet any gold "bears" at the London Bullion Market
Association’s annual conference last week, this year hosted in Berlin’s Hotel
Adlon.
The bullish arguments you know already no doubt. Low-to-zero
Western interest rates…plus a growing clamor to buy gold amongst Chinese
households (the Middle Kingdom’s demographics are more bullish still, as
Mitsubishi’s Matthew
Turner showed)…make a compelling case for rising gold investment demand,
even without the risk of government-bond defaults, rising inflation or
continued losses on "mainstream" financial assets.
The Berlin conference had plenty more to say on those
stories too, as we’ll see below (and as you can see on the slides now freely published
on the LBMA’s
website). But first, what of supply?
Well, all the gold ever produced in history came from a
mine, as Paul Burton of GFMS World Analyst
reminded the conference. But in the last decade, gold mining has failed so spectacularly
to meet the surge in demand, he could only question its "relevance" to
the market’s net outlook. Dollar gold prices quadrupled from
2000 to 2009, another speaker noted, yet annual mine output rose just 1%. And allowing
for the intervening slide in output, said Burton, gold mining output is now so
price inelastic, it took eight years of rising prices to produce any meaningful
blip in output (2009′s year-on-year increase of 7%).
Further output gains look unlikely, Burton went on, thanks
to the gold mining
sector’s "production lag" – both because of an "exploration
lag" (new investment only turned higher in 2003) and because new
discoveries of 1-million ounce deposits have collapsed regardless. The five
years to 2009 saw record-high levels of exploration spending, perhaps totaling
the previous 12 years added together (at least on BullionVault‘s skew-eyed reading of
Burton’s chart from the conference floor. See what you make of it on page 9 here). Yet
all told, GFMS’s best forecast is now for annual gold mining production to
decline by 13% between 2012 and 2019.
That other constant drip-drip of gold supply – the
"official sector" of central banks and outfits like the International
Monetary Fund (IMF) – also looks irrelevant for now, as Burton’s GFMS colleague
Philip Klapwijk
showed in his speech. European states are now holding, not selling their
reserves, but emerging markets (for now) remain mere ankle-biters compared to
the weight of private investment or jewelry demand each year. So net-net, said
the GFMS chairman, central bank activity looks "neutral", despite the
bullish picture for emerging-market demand he also laid out. More notably, and
"something we haven’t seen before", private-sector investment
holdings now outweigh central-bank gold reserves overall. Making investor
sentiment a key plank of any longer-term forecast.
Even without the end of central-bank sales, however, or the
failure of mine output to rise, "The single most important gold supply
issue is scrap," as John Reade of Paulson Europe said in his conference
summary. Re-selling unwanted jewelry "has gone mainstream" noted Jeffrey Rhodes,
CEO of INTL Commodities DMCC, becoming "socially acceptable" in a way
that using pawnbrokers to raise cash never was. Throw in gold coins, dental
bridges, bonding wire from microchips and any other supply "not from a
primary [ie mining] source", and scrap gold matched more than one fifth of
global gold mine output last year, up from just 7% a decade ago. Turkey has
overtaken India as the No.1 source of scrap gold supplies (217 tonnes in 2009,
equal to almost a tenth of world mining supply), but the most dramatic change
has come in the developed West, where "sophisticated electronic assay
equipment has seen the captain’s ball at your local golf club replaced with
gold buying parties," as Rhodes said.
Since 2005 alone, US scrap supply has more than doubled
according to data from GFMS Gold Survey, taking United States’ re-sales from fifth
to second position worldwide in 2009 with 124 tonnes. Italy’s re-sale market
moved from seventh to sixth with a tripling to 78 tonnes of scrap, and the UK
& Ireland have leapt 1505% from virtually nothing a decade ago to nearly 60
tonnes in 2009, bagging the world No.6 slot in the first-half of this year.
Throw in Germany and France, and four European nations make the top 10 scrap
supply nations by growth since 2000. In the first six months of this year,
scrap supplies from each of the US, Italy and UK & Ireland had all outpaced
India (the former No.1, remember), enabling scrap to become the "only
credible counter to investment buying." But should these massive supplies
of scrap in fact be overwhelming investment pressure on prices?
Since "investment buyers and scrap sellers are driven
by the same motivation of price expectations" as Rhodes reminded the LBMA
conference, this price-elastic source of supply could threaten "a perfect
storm of selling once sentiment changes," he believes. But first, that
would require higher prices again, because (for now) even scrap-gold merchants
have turned bullish, he reported, capping flows to refineries in anticipation
of stronger gains ahead. And second (and more critically given the source of
the last few years’ real jump in scrap supplies), "Is the drawer
empty?" as Paulson Europe’s John Reade
wondered in his quick-fire recap before the conference adjourned.
Cash-strapped households, remember, can only sell their
unwanted gold bracelets once. How high would prices need to go before more
cherished pieces could be sent to the smelters? Apply the same question to
private gold investments in fact (ETF holdings have proven notably
"sticky", if not yet as "long-term means forever" as gold
coins), and you get to the nub of the "bubble or boom?" debate.
Because at some point, according to pretty much every speaker, the circumstances
now boosting global investment demand will recede – and with them, therefore,
the gold price will fall back as well. As we’ve already seen (in Part I),
the bubblicious frenzy needed to mark the top of spike remains plainly absent.
Leaving only the circumstances behind this current boom to consider.
"The current bull market has much deeper roots than the
credit crisis," the LBMA was reminded by former Blackrock head of natural
resources Graham
Birch (now a farmer). Pointing to gold’s nadir of 1999, "continuous
disinvestment" was needed to keep prices down, and when Europe’s big
central banks agreed to cap their sales that September, it marked the start of
this rise. Roll on 11 years and 350%, however, and "Just because gold’s a
safe haven doesn’t mean it’s a cheap safe haven," Birch warned Berlin.
Which raises the question of cost and utility for new buyers today.
"I think people long gold should not be concerned
reading this slide," said John Reade in his summary, pointing to slide 14
of William White’s opening
keynote speech. Chairman of the OECD’s Economic & Development Review
Committee, White had prefaced his 20 minutes of gloom-and-doom (salted with
uncertainty, fear and doubt) by saying that the OECD itself would certainly
disagree with everything he was about to say. Reade reminded the delegates that
White’s copyrighted sales-line should be "Scaring investors since
2003," as he accurately picked the shape of the bubble well ahead of
schedule, and hasn’t been proven wrong yet.
"Investors should be positioning for ‘tail
events’," White concluded. "But which ones?" Somewhere between
deflation, slow growth, de-coupling of Asia from the West, or a lurch into
rapid hyperinflation or a new series of bubbles fed by ultra-loose monetary
policy, "Is there room for gold in a world like this?" asked the former
Bank for International Settlements forecaster.
"The answer has got to be yes. But quite what
role…well, that’s for you to decide!"
A handful of private investors have begun to make that
decision, as Wolfgang
Wrzesniok-Rossbach of the Heraeus refinery showed in detail. But the real
weight of money – the institutional mandates caring for your insurance and
pension savings – has scarcely bothered to buy gold ’til now, a point made at
length by both Shayne McGuire and Graham Birch on Monday morning. Across in
Asia, "People don’t need convincing on gold," said David Gornall of
Natixis, noting that 81% of global "bar hoarding" demand comes from
Asia, with buying amongst the "traditional buy-side countries" such
as India and Thailand – as well as the fast-growing world No.2 for gold demand,
China – continuing to grow despite record-high gold prices.
Even there, "the emergence of retail physical gold investors has resulted
in structural changes in distribution, product and buying behavior," as
Sunil Kashyap, managing director of Bank of Nova Scotia-ScotiaMocatta
explained. Yet all told (and absent the "bubble" idea which the
conference demolished time and again), what looks like a new paradigm might in
fact mean more a return to old patterns – globally – of gold buying and
hoarding…with a little "mobilization" thrown in by the scrap market
when times get tough.
India and Turkey, after all, have long been both top buyers
and scrap suppliers to the international gold market. Rising investment demand
here in the "rich West" (which, to repeat, remains well off a
"bubble" today) represents a simpler, unleveraged way of retaining
your savings than most Western households have grown used to. But gold was a
core chunk of private wealth holdings not so long ago, back before the
debt-fuelled boom we’ve enjoyed since WWII began – a boom which must now end
with "rebalancing" between the world’s debtors and creditors, as George Magnus of
UBS made plain Monday morning. The kind of dislocation required won’t be much
fun for either, which again looks good for gold demand, if not necessarily
prices.
All told today – and seeing the world’s fastest-growing
economies continue to buy and hold ever more gold as their wealth increases –
maybe US and European savers are only just getting back to the future. Either
way, that "bubble in gold" doesn’t exist. Not by a long way just yet.
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