What Does Central Bank Monetary Policy Hold For Gold In 2016?

‘It’s all about the Fed’ is about the most typical soundbite on Wall Street these days. If you expanded on that then few macro analysts would argue that this can be usefully expanded to ‘It’s all about the major global central banks, that is the Federal Reserve, People’s Bank of China, Bank of Japan and the European Central Bank.’

What’s true for global financial markets is obviously going to be true for gold. Lose monetary policy, sooner or later, causes inflation and gold is the classic hedge against inflation because the central banks are not able to create gold out of thin air. They talk algebra rather than alchemy. 

ECB QE

At the end of last week two announcements set the scene for what to expect in 2016. From the ECB’s President Mario Draghi we heard that his massive quantitative easing program may be extended and expanded. The euro slumped against the dollar on that statement.

Then on Friday global stocks leapt for joy as the PBOC cut its key benchmark interest rate for the sixth time since November and its one-year deposit rate was reduced by 0.25 to 1.5 per cent. No matter that in the recent past such measures have done little to boost the Chinese economy or its stocks market for very long. The yuan devaluation strategy continues.

This is the most aggressive Chinese monetary policy has been since its epic stimulus in the global financial crisis of 2008-9, the largest ever in economic history and equivalent to half-a-year of Chinese GDP. The latter certainly worked until the Chinese economy began to seize up some 18 months ago, albeit at the cost of huge asset price inflation. 

Meanwhile, in neighboring Japan - whose economy is only marginally smaller than the very much more populous People’s Republic - the central bank’s money printing continues in top gear, although the country is close to sinking back into recession. Could Japan get its electronic printing presses moving a bit faster in 2016? Does it have any choice? 

Global Macro View

All three of these giant global economies - and remember the 28-state European Union’s GDP is actually larger than the United States, it’s only smaller if you stick to the eurozone, that is the 19 nations using the euro single currency - want to devalue against the US dollar, and their central banks are determined to achieve this. Only by regaining their competitive advantage in global trade by such devaluation can they hope to achieve higher economic growth, or in the case of Japan going backwards.

Now Wall Street banks like Goldman Sachs would have us believe that the Federal Reserve will be able to start raising interest rates against this global background for central bank policy. Clearly the US dollar is already being pressured in one direction already. How can it possibly tighten monetary policy without sending the US dollar to the moon? What would that do to the overseas’ earnings of US multinationals when converted back into greenbacks?

It is just not going to be possible to raise US interest rates unilaterally. Indeed, the Fed is going to face pressure to do the reverse, not least from a stalling US economy. Have you noticed all the layoff announcements from top US companies over the past six months? They are running at around double the level of a year ago. This does not show up in US unemployment data, but then that data series rivals Chinese GDP for the title of the biggest lie in global macroeconomics. 

Why are the earnings of most US companies coming down if the US economy is still expanding? The more obvious conclusion is that the weak recovery of the past few years has given way to a cyclical downturn. Citi chief economist Willem H. Buiter has the US in recession in 2016. HSBC’s formidable bond traders expect US 10-year treasury yields to fall from two to 1.5 per cent next year. In other words, to follow China, Japan and Europe lower. 

Goldman Sachs

This is a very different scenario that the core argument against holding gold that Goldman Sachs has being promoting this year and which it reaffirmed last week. Goldman Sachs still expects the Fed to raise rates in December, and that will just be the start of a rate ‘normalization’ process that will take the dollar exchange rate higher and make non-interest bearing gold look an unattractive asset class to hold.

Who has got this right? Goldman Sachs or HSBC and by extension Citi? Possibly if you lock yourself in a boardroom in New York with a map of North America on the wall then it is possible to ignore the rest of the world and be cheered by US auto and Big Mac sales. But we live in an integrated global economy and the US dollar is the global currency. Glorious isolation was a policy of the Great Depression and ended with World War Two.

It’s highly unlikely that the Federal Reserve will choose economic suicide knowing what importance it puts on looking at economic data when it makes its decisions. So unless we have this wrong and China, Japan and the EU are actually healthy economies and not in severe difficulty and about to embark on some epic money printing, then the Fed will not only continue but probably intensify its monetary loosening next year. 

Gold Prices

The last time things got this bad, with global trade in the doldrums and industrial commodity prices on the floor, monetary stimulus was used to considerable effect. The gold price more than doubled and silver prices surged five-fold, and they were the first major asset prices to pick-up until they peaked in 2011. 

Do we learn nothing from experience? Even the Fed can’t fight the three largest central banks of the world. It’s not all about the Fed. It’s all about the global central banks. 

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