Gold & US$
Eric Hommelberg
Note : Gold & US$ is chapter I of the Gold drivers 2005 report of which a preview can be seen here. The article presented here is not the final version, This article has a strong focus on present situation. Besides that I'm still working on a few things (eg 'synthetic dollar-short position) but didn't have the time to finalize. Nevertheless this piece gives enough food for thought so I hope you'll appreciate. END.
The dollar decline seems to be the tune of the day these days. The European Central Bank is getting nervous and describes the rapid rise of the Euro as being 'brutal'. Rumors about massive CB interventions are being heard everywhere. Intervention or no intervention, the bottom line is that you can't manipulate a currency against its primary trend for a long period of time. The fundamentals of the US$ are pointing south and a further decline seems to be unavoidable coming years.
For years now many esteemed Gold gurus (eg James Turk, Jim Sinclair) are pointing towards a declining dollar as a key driver for Gold. Mr. James Sinclair was among the first currency traders who called for a confirmed top in the dollar back in 2002. (The Millennium transition - Gold ……From Commodity to Currency). Ever since then he has warned for the triple deficits - current account, trade and federal budget - to buckle the US$. Only a very few picked up upon it, denial was the tune of the day. Even politicians like Dick Cheney publicly said that deficits don't matter arguing that foreigners would be happy to continue to invest in the US. Sure, as long as foreigners are piling in 2$ billion every single working day, the dollar won't crash. Nowadays approximately 80% of world savings is required in order to finance the US deficits and thus to maintain current dollar levels. You don't have to be a genius in order to see that this can't go above 100% and we're getting close.
It goes far beyond the scope of this article in order to explain what causes the growing deficits and how they interact with the dollar. For the Gold investor it only matters that growing Current Account deficits really do matter and that it eventually leads to lower dollar levels. As said before esteemed Gold gurus like James Turk and Jim Sinclair are saying this for years now and finally their thoughts were being echoed by Sir Alan Greenspan himself on November 19, 2004 :
Greenspan: U.S. Needs to Cut Budget Gap
Fri Nov 19, 2004 08:32 AM ET
WASHINGTON (Reuters) - U.S. Federal Reserve Chairman Alan Greenspan said on Friday the United States should cut its budget gap to foster a more balanced pattern of global trade and avoid painful economic consequences
"It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point," Greenspan said. END.
Let's repeat one sentence here :
given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point. END.
Well, Alan Greenspan acknowledges the fact that foreigners aren't going to finance the US deficits indefinitely. But what about earlier statements made by US politicians that deficits don't matter ? Greenspan doesn't seem to agree :
Alan Greenspan, November 19,2004 :
"Current account deficits, even large ones, have been defused without significant consequences, (but) we cannot become complacent," Greenspan said in remarks prepared for delivery to a European bankers conference in Frankfurt. END.
So by saying "we cannot become complacent" Greenspan admits that huge Current Account deficits really do matter.
But what about CB intervention in order to prevent a dollar decline ? The ECB is getting nervous and describes the recent rapid rise of the Euro as being 'brutal'. So they don't seem to be very pleased with a steady dollar decline. Are they going to intervene ? Will they be successful ?
As said before you can't manipulate a currency against its primary trend for a long period of time. In a question and answer period after his speech, Greenspan said :
Central bank intervention in currency markets to support the dollar -- such as through buying dollars to drive up its exchange rate -- could have only a limited and short-term effect.
Also the US government made it clear that they won't join any kind of intervention effort in order to stop the dollar decline.
You may wonder why only so very few people picked upon it during last couple of years. Well, as said before denial was the tune of the day. When investment gurus like Warren Buffet were betting against the dollar in 2003 analysts were saying that the old man had lost his touch with the markets. Nevertheless, many warnings regarding a future dollar decline did surface over the last couple of years so Greenspan remarks shouldn't really come as an unexpected wake-up call. Just see some remarks below and judge yourself.
Dr. Lawrence Lindsey,
Former White House Economic Advisor
April 30, 2001
"I do think it is important that we all keep this in mind: we have had 20 years of expansion - 18 actually, going on 19. And it has been an extraordinary period. But that does not mean that everything is AOK"
"We are in uncharted territory - - it's unprecedented - - it cannot go on - - something has to give."
"it is unlikely that we could forever borrow 4% of GDP from the rest of the world. Or more precisely if you look at trends, we are borrowing increasing amounts from the rest of the world. Imagine going to your banker and saying "we thank you very much for the $280 (billion) you lent us in 1999, and the $400 (billion) you lent us in 2000, and it looks like this year it is going to come in about $520. We are going to need $650 in additional cash in '02, probably $800 in '03." Getting the picture? This is otherwise known as "evergreen" financing. And it won't work. At some point, it is going to have to be adjusted."END.
Stephen Roach (Morgan Stanley, New York)
August 2003
There comes a point in every current account deterioration when enough is enough -- when foreign investors demand a premium to keep funding a saving-short economy. History tells us that such a breaking point usually occurs when the current account deficit hits 5% of GDP. END
Warren Buffet
The Capital Times November 3, 2003
Buffett says he is losing faith in the soundness of U.S. currency as an investment vehicle because the United States is running a huge trade deficit -- close to $500 billion, and rising rapidly -- that is causing income to flow out of the country at such a rapid rate that it will soon become unsustainable. In the November edition of Fortune magazine, Buffett warns that the rapidly mounting U.S. trade deficit could lead to a dramatic plunge in the value of the dollar and a host of additional economic consequences that could add up to disaster for American families. END.
This year warnings regarding a further dollar decline increases dramatically.
Buffett increases bet against dollar to $19 bln
NEW YORK, Aug 9 (Reuters) - Warren Buffett increased Berkshire Hathaway Inc.'s bet against the U.S. dollar to $19 billion at the end of the first half of 2004, his holding company disclosed in a regulatory filing.
Buffett previously disclosed making investments in five foreign currencies in a belief the dollar will decline in the long run as a result of the United States' ballooning trade deficit. END.
Stephen Roach (Morgan Stanley)
June's enormous US trade deficit should be a wake-up call to America and the rest of the world. It is a direct manifestation of a lopsided global economy that remains biased toward unprecedented external imbalances. As long as the US continues to live well beyond its means and as long as the rest of the world fails to live up to its means, this seemingly chronic condition will only get worse. The imperatives of global rebalancing are reaching a flashpoint. END
Also the mainstream press seems to be waking up, Reuters reported on August 13
CHICAGO -- The dollar fell sharply on Friday following news that the U.S. trade deficit widened much more than expected in June, calling into question the health of the U.S. export market and the broader economy.
"It's absolutely stunning the number is that high. We've imported a ton of stuff," said Greg Anderson, currency strategist at ABN Amro in Chicago. "It makes it much more difficult to have any argument other than weaker dollar going forward." END.
France's Sarkozy-U.S. deficits reason for concern
BIRMINGHAM, England, Nov 9 (Reuters) - French Finance Minister Nicolas Sarkozy said on Tuesday that U.S. deficits which are forcing the dollar down were more a reason for concern than the rise of the euro.
"Asked by reporters whether he was concerned by the dollar's fall against the euro, Sarkozy said:"It is not a question of anxiety, it is like I said In Italy yesterday, it's a problem with American deficits."
"The markets are worried by the strong U.S. current account deficit."END.
Rubin: Dollar Decline Could Accelerate
By CHUCK HAWKINS, AP Business Writer
NEW YORK - Former U.S. Treasury Secretary Robert Rubin warned Monday night that the dollar's recent decline could accelerate and interest rates could rise if politicians in Washington don't act quickly to narrow the federal budget deficit. END.
The growing Current Account deficit is getting more and more media attention :
The New York Times
By Edmund L. Andrews
Tuesday, November 16, 2004
"The United States is spending nearly $600 billion more a year than it produces, almost 6 percent of its annual gross domestic product. Much of that spending has been financed by Asian governments, which bought more than $1 trillion in Treasury securities and other dollar assets in the last two years to help keep the dollar strong against Asian currencies.
Many analysts expect the financing gap to widen and the dollar to decline further." END.
So what do we see :
We see a growing Current Account deficit exceeding 5% of GDP (this year Current Account deficit is projected at 6% of GDP) which in turn could trigger the classic current account adjustment process characterized by a weaker currency (see Caroline L. Freund, "Current Account Adjustment in Industrialized Countries," Board of Governors of the Federal Reserve System International Finance Discussion paper #692, December 2000). This thesis is supported by the fact that at present 70 - 80% off all world's savings is required (inflow of 2$ billion dollar every working day) in order to sustain current dollar levels. Needless to say this can't continue for much longer. So when will this end ? When are foreigners going to stop acquiring ever increasing quantities of US dollars ? Isn't the FED afraid that foreigners are just going to do that ? Well it seems they are :
Reuters reported on October 28 :
NY Fed-Slower Cenbank Buying Would Hit Dlr, Rates
Thu Oct 28, 2004 03:26 PM ET By Victoria Thieberger
NEW YORK (Reuters) - U.S. interest rates would rise and the dollar would fall if Asian central banks slowed their recent heavy purchases of U.S. assets, the New York Federal Reserve warned in a report on Thursday.
Central banks, especially those of China and Japan, have built up their holdings of foreign currency assets in recent years and have been massive buyers of U.S. Treasuries and other assets.
The increasing importance of foreign official holdings of U.S. assets has made some in financial markets worry about the consequences if Asian central banks were to slow their buying.
The New York Fed report confirmed what many analysts suspect: that asset prices would be lower without the participation of foreign central banks.
"Absent this inflow of official capital, U.S. asset prices would have to fall in order to attract additional private flows," the study posted on the Fed's Web Site on Thursday said. As U.S. Treasury prices fell, that would push market interest rates higher, while the dollar would also likely decline, the study said. END.
President of the Dallas Fed, Robert McTeer is straight forward. He recently said :
"over time, there is only one direction for the dollar to go - lower." END.
Former ECB president Wim Duisenberg isn't too optimistic either about the dollar. He was quoted recently by Spanish Newspaper El Pais, he said :
"A dollar devaluation seems inevitable due to the tremendous US Current Account deficit." END.
Furthermore he recently said on Dutch television that we can only hope and pray for a smooth economic transition in the US.
So the FED warned for a dollar fall if Asian central banks were to slow their recent heavy purchases of U.S. assets. Well, it seems this process has just begun.The Financial Times reported on November 7 :
FINANCIAL TIMES
Dollar expected to fall amid China's rumoured selling
November 7, 2004
China, which has $515bn of reserves, was also said to be selling dollars and buying Asian currencies in readiness to switch the renminbi's dollar peg to a basket arrangement, something Chinese officials have increasingly hinted at. Any re-allocation could push the dollar sharply lower. END.
Is the selling of US dollars limited to the Asian Central Banks ? No, Itar-Tass reported on November 8 :
XIANGGANG (Hong Kong), November 8 (Itar-Tass)
By selling U.S. dollars, securities and assets denominated in the U.S. currency, Russia is diversifying its currency reserves, which is in line with the policy pursued by the Central Bank of Russia, Andrei Illarionov, adviser to the Russian President on economic problems, told Itar-Tass on Monday
Illarionov spoke on the problem, because reports appeared in the British press on Monday about Russia, together with India and China, selling its assets in U.S. dollars, which may bring about a further reduction of the exchange rate of the U.S. currency.
According to Illarionov, the Central Bank of Russia makes no secret of its intention to diversify its currency reserves, including through the buying of euros. END.
The Financial Times reported on November 23 :
Dollar Down As Moscow Trails Case for Euro
By Steve Johnson and Chris Giles
Financial Times, London
Tuesday, November 23, 2004
The dollar hit an eight-year low against European currencies on Tuesday as a senior Russian official said Moscow might increase the proportion of its
foreign exchange reserves held in euros.
The markets took statements by Alexei Ulyukayev, first deputy chairman of the Russian central bank, as another signal to put pressure on the U.S. currency. The Russian move was seen by some currency traders as a possible precursor to reserve adjustments by central banks across Asia.
Hans Redeker, head of currency strategy at BNP Paribas, said: "The Russians are saying they don't see the potential for a rebound of the dollar."END.
So the Russians don't see the potential for a rebound of the dollar. Neither do Alan Greenspan, Robert McTeer, Wim Duisenberg, Bob Rubin, Warren Buffet, Stephen Roach etc…
So a dollar devaluation seems to be inevitable coming years. Why is this so important? Because the US dollar is the primary key driver for Gold, as the dollar goes, so will gold but in opposite direction, gold is the anti-dollar with a high inversed correlation to the dollar.
Does Gold trade like a currency ?
Yes, Gold does trade like a currency. Without spending too many words on this subject, just take a look at the chart below and judge yourself.
This long term chart shows perfectly clear that Gold trades in opposite direction of the Dollar. Gold Tops when Dollar bottoms and vice versa. OK, fine, the dollar trades opposite to Gold, especially when we zoom in to the last couple of years we see a very tight inverse correlation of the dollar to Gold. So when we project a chart of an inversed dollar on a chart of Gold we should see a perfect correlation. Since a Euro comes close to an inversed Dollar it's good to project the chart of Gold on top of an Euro chart as well. See chart below.
You may tell, does Gold trade like a currency or the Euro like a commodity ?
It should be obvious that if the Dollar goes (down) that so will Gold but in opposite direction.
Highlights :
- Current Account deficits exceeding 5% of GDP raises many Alarm Bells
- US economy is addicted to an inflow of $2 billion dollars every single working day. This is simply not sustainable since it requires almost 80% of world savings.
- FED officials pointing towards a lower dollar
- Foreign Central Banks just started selling US dollars in order to diversify its currency reserves
- A Dollar devaluation is very Gold friendly since Gold is still a monetary asset and trades like a currency. If the Dollar goes so will Gold but in opposite direction.
Total US Debt & Exploding Trade Deficits
As said before it goes far beyond the scope of this article in order to explain what causes the growing Current Account deficits and how they interact with the dollar. However I do think it's important to discuss just a few items regarding total US debt.
Former IMF consultant and Financial Sector Specialist of the World Bank Richard Duncan describes in detail (Richard Duncan : The Dollar Crisis - Causes Consequences - Cures) how the US economic growth of the last 20 years has been fueled by credit (Thanks to Alan Greenspan who made easy credit available by lowering interest rates to a 40 year low thereby encouraging consumers to take out cheaper mortgage loans and to spend it) thereby creating a total US debt exceeding 340% of GDP (see chart below).
As said before Greenspan made easy credit available by lowering interest rates to a 40 year low thereby encouraging consumers taking out cheaper mortgage loans. So consumers were happy to take the credit being offered and spent it thereby fueling the US economy. Consumers buying tonnes of cheap foreign manufactured goods contributed to an ever growing Current Account deficit (see chart below).
If a total Debt of 37$ trillion wasn't already bad enough, what about future fiscal liabilities exceeding $50 trillion ? . Peter Peterson, secretary of commerce during the Nixon administration and Prof. Laurence Kotlikof, senior economist at the President's Council of Economic Advisors (CEA) during the first Reagan administration, published excellent books lately ( "Running on Empty" , "the coming Generational Storm" ) in which they explain in greatest detail why the US is heading towards bankruptcy. They project a fiscal liability of more than 50$ trillion which requires a budgetary resource that only inflation can provide. Inflation and higher rates to come ? How does that interact with Gold ? Well, that's food for thought for next week's chapter II Gold & Inflation, Interest rates, negative real rates.
Readers interested in the entire report can drop a mail. I'll send the entire report somewhere in December in PDF format.
Eric Hommelberg
ehommelberg@planet.nl
November 25, 2004
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