***For the United States, the alternative policy would be
to defend the dollar by raising interest rates and lowering domestic demand. In theory, that might be the best policy option. It would reduce imports by causing a recession. It would avoid collateral damage to Japan and Germany, other than the damage done to world trade by a contraction of the US domestic market. But it is not going to happen. 2004 will be another presidential year; George Bush’s father lost the 1992 election because of a modest US slowdown. His son will not wish to repeat that. He would rather have a weak dollar than see a Democrat back in the White House. Higher US interest rates are politically damaging for the Republicans; a weak dollar is economically damaging to Japan and Germany. One does not need to guess which will happen.
The Iraq war is a shorter-term issue of policy. The rise in oil prices, partly due to the Iraq crisis and partly to the Venezuela strike, has somewhat increased the US deficit. It has helped to weaken the dollar and raise the gold price. If Saddam Hussein is overthrown there will eventually be a fall in the world oil price, which will temporarily ease the situation. But this will not change the underlying problem of the deficit, which existed before the Iraq crisis and will still have to be dealt with after Iraq is settled.
There has been another major reason for the rise in the gold price. Asian central banks and the Asian public have been buying gold. Japanese consumers have been buying gold chains to increase the family reserves. They do, of course, pause from time to time. The Central Bank of Japan has $461 billion of reserves, on the October figure, up by $66 billion in the first nine months of last year. The reserves of the Bank of China have risen at a similar rate.
If China and Japan already have more dollars than they want, and are accumulating still more of them at a rate of more than $100 billion a year, they must be under pressure to diversify their reserves. Given the deep economic problems of Germany, the leading European economy, the euro is not an attractive alternative. Gold is a rational central banker’s solution to an excessive accumulation of dollars, particularly as the dollar is falling and is expected to fall further. Again, the rise in gold price can be seen as a devaluation of the dollar.
For the investor, such an analysis may help to answer some central investment questions. The dollar is likely to continue to fall, and the yen and the euro are likely to remain firm. The US economy will continue to grow faster than Germany or Japan. The gold price is likely to outperform most other assets. But such an analysis does not give any cheerful answers to the problems of the world economy and world trade.*** |
