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John Law found that he lived under a despotic government, but he was not yet aware of the pernicious influence that such a government could exercise upon so delicate a framework as that of credit...

…Charles McKay on the Mississippi Bubble;
Extraordinary Popular Delusions and the Madness of Crowds

Imagine yourself in Larry Summers' shoes. After building an empire, Rubin finally hands the reigns over to you, his nearest protégé…er…patsy. Sounds pretty exciting, don't you think? The economy is growing swiftly, there is no sign of this core CPI inflation stuff, your CEO claims that the budget is now balanced, the Dollar is used and accepted everywhere in the world, and virtually everybody is working. American capitalism has won the world over, and lest we forget the most important legacy of all; over 120 million Americans think that they have, or will, become richer. What a glamorous job it must be to be the Treasury Secretary at such a triumphant moment in history. He had better enjoy it, because in all likelihood, a moment is all that it will be. Mr. Rubin took his golden parachute and jumped, in what might amount to the best trade of his life. As for Mr. Summers, well, he hasn't even seen the 'empty' cockpit yet. He may soon find out that you can't fool all of the people all of the time.

In this discourse, I will first update you on recent gold market related developments, where the tape is beginning to feel much more unyielding, to the bears. Then I will attempt to demonstrate how the Achilles' heel in the dollar's fundamentals can, and probably will, shift the global balance of political power away from the United States.

Section I:   Gold Market Update…what an enormous bottom
Section II:   What is wrong with the Bank Stocks?
Section III:   The American Consumer is the Achilles' heel
Section IV:   The Increasing Politics of the Dollar

Could This Be A Two-Year Bottom?

Weekly $GOLD; August 1997 to Present

If so, I can't wait to see what the rally will look like. Anyhow, the $270 handle appears pretty firm, and the $250 level seems like a long shot, at the moment, for hopeful bidders at the next UK auction. The dollar rally in May pushed at $270 gold, but when that snapped, gold fought its way back towards $300. Even with the perpetually selling bullion banks and the Swiss National Bank pounding away at the market in between the UK auctions, rising global interest rates, and a soggier looking US economy, prices were firm. This market wants higher. And there is plenty of reason for it to go higher, but first the ambush, then the laundry, and finally, the bull market. Of course, the technical picture cannot veto an equal likelihood that the next 120-point move might just as well be down, but that would shut down an enormously unrealistic amount of production. The most important observation that the investor can make, as this pattern develops, is whether Gold starts to act like a hard asset once again.

The FOMC's decision to leave the Fed Funds rate unchanged in June clearly reflects a desire to assess the impact of previous tightenings as well as to re-liquefy the market's current liquidity dearth. However, whether deliberate or not, Mr. Greenspan will actually be subjecting the productivity hypothesis to a test, by virtue of allowing for the higher long term growth rate assumption into his policy deliberations.

In the meantime, the conveniently bullish progression of recent events begs an explanation other than, well, unrelated coincidence. Hopefully, there exists some kind of strategy between the Fed, the Treasury, and the President. After all, they are a team, whose most recent motif is, above all, that the glorious investment merit of dollar denominated securities is simply unable to coexist with an oil crisis.

"If the price does not decrease, Saudi Arabia, in conjunction with other producers, will increase production by 500,000 bpd, within the next few days. WE HAVE SOUGHT, and will continue in any way we can, to bring the prices down from their current level to the target levels of $25 per barrel of OPEC basket of crude's," Ali al-Naimi, July 3rd, 2000

That news came out of the blue on Monday, without warning, and just shortly after Saudi Arabia's ex-oil minister denounced the future utility of oil. The current Saudi Oil Minister, Ali al-Naimi, who told the Saudi Press Agency just before it hit North American wires, delivered the quote. Pretty serious about face over there, don't you think?

What do you think motivated strong words like this? American pressure is hastily thought to be behind this. Like what? "Hey, If you guyz over there don't get on side, you'll be sorry…Bush Jr. will actually win." Here's a brilliant one..."You know, we'll just have to start selling our last two months worth of Strategic Oil Reserves into the market." How do you think Saddam would like that? Whatever the case may be it is clear that the Saudis are prepared to act independent of OPEC objections.

Consider, however, that since it is a Saudi initiative rather than an OPEC initiative, could it be that the up and coming Saudi Arabian Monetary Agency wants to make a play for the big leagues here, and that Mr. al-Naimi is simply making a gesture to the big boys? I am in no way an expert, or anything close, on Middle Eastern Affairs, but with the little knowledge that I have about international finance, it seems too logical. Indeed, the SAMA must have already gained from the generally higher activity in oil markets, and there is no question that an economy, which is currently 70% dependent on oil revenues, needs to diversify away from its oil dependence. This could very well be an opportunity for the bank to gain some political leverage in the world of finance, even while there is no guarantee that oil prices will stay down. The Fed, for example, has been threatening the stock market for years, to no avail. In fact, oil prices will probably stay generally sticky around the $25 to $35 range, and could go higher, unless the Fed itself can get itself out of its current monetary predicament. Let me explain.

Jude Wanniski, one of the original supply side economists in the Reagan camp, convincingly demonstrated how the oil crisis is a function of poor monetary policy in the first place. I will try to show you how many potential crises loom over us now, if that is indeed the case. Higher US interest rates are not going to matter much to oil demand if there is any kind of notable financial destabilization that explicitly undermines the Dollar. I have a hunch that the SAMA well understands the US predicament; hence, the Saudi's don't have much to lose and everything to gain from this kind of position, including much bigger export market shares. It is a fact, ceteris paribus, that a major oil price spike from these already lofty levels would be counterproductive, as it would kill off demand. However, if this is a monetary problem, a hoarding mentality could evolve that would put the SAMA right smack in the middle of global finance…ceteris paribus need not apply.

As you will see later, it is my contention that, due to the irreversible nature of foreign claims on US assets, US foreign policies may have to become increasingly accommodative. Even Mr. Greenspan, while he may be able to drive interest rates to the moon, must know that he no longer has control over the dollar.

The Ambush

Allow me to devise a hypothetical political "strategy," that is not only entirely plausible, but also profitable under the circumstances:

Mr. Greenspan, perceiving that another hike in interest rates might undermine the dollar at the moment, chooses this to be a good time to give Larry Summers another chance to demonstrate his capabilities with respect to the strong dollar directive. Assuming that Mr. Greenspan is not political then, his main concern must lie with the acute fragility of the financial system. Larry has his instructions. He wastes no time in getting on the horn to the current Saudi oil minister, Ali al-Naimi, who of course will look back to Mr. Greenspan for the nod. Mr. Greenspan, in return, takes the Saudi Arabian Monetary Agency more seriously, while the Saudi's return the favor by at least appearing to be putting a lid on the oil market, and hence, capping a monumental psychological concern for US credit market players. Concurrent with the benefit to bond markets, banking titans Wachovia and Union Bank triple expensed their reserve accounts, possibly to demonstrate leadership, and to facilitate the coming changes in capital adequacy rules, which all involved, hope can only be taken by dollar investors, as a long term positive.

Wow, what all just happened there? The Saudi's gained a political favor. Larry Summers got to play with the big boys again. US Banks got their interest rate relief. Wall Street got easier credit and lower oil prices. Clinton hopes that the public will get cheaper gasoline prices so that he's not forced into more decisive action. The Fed, meanwhile, thinks it may have gotten what it wants – a stable financial background for the transition to better capital adequacy standards across the board. Of course, this might manifest itself as an ambush in gold prices if it turns into a boon to US financial markets and particularly the dollar exchange rate.

The Laundry

An organized cartel, however, might be wise to take advantage of such an ambush in gold prices to wash all of their bad short positions out of the market, if there were any, while firming up their long positions. Such a cartel might then have less reason to pressure gold prices going forward, knowing that in the end, they will have to let it go anyway.

Ed Bugos
http://www.safehaven.ca/Politics.htm

9 July 2000