IT'S THE DOLLAR, STUPID
By Reginald H. Howe
www.goldensextant.com
March 26, 2000
The Fed increased interest rates by the widely expected 25 basis
points, and the stock market responded not just with relief but
with exuberance. What is more, as The Wall Street Journal
observed ("Why the Fed Hasn't Fazed Big Borrowers," March 22,
2000, p. C1): "It isn't only the stock market that is defying the
Federal Reserve. So are (get ready for a big list) the bond
market, the mortgage market, the corporate-loan market. In short,
a lot of what has to do with borrowing."
Asked about the Fed's action, Treasury Secretary Summers chimed:
"With these sound fundamentals, supported by fiscal discipline, I
believe this expansion has a long way to run." Were the
fundamentals really as sound as Mr. Summers suggests, he would
have made an unqualified denial of any intervention by the
Exchange Stabilization Fund in the gold market. Instead, last
week the Treasury Department produced answers to the questions of
the Gold Anti-Trust Action Committee in the form of two letters,
one from an acting assistant secretary for legislative affairs
and the other from its inspector general.
As will be elucidated more fully in my next commentary, neither
letter read carefully directly addresses possible intervention in
the gold market by the ESF -- a sui generis body under the
exclusive, unreviewable control of the secretary of the treasury
and the president. Coming more than two months after Federal
Reserve Board Chairman Alan Greenspan's personal letter to Sen.
Joseph I. Lieberman responding for the Fed to GATA's questions,
these letters from lower-level Treasury functionaries bear every
indication of an exercise in Clintonese.
Last week too the Commerce Department reported that the January
trade deficit hit a record $28 billion, with $34.7 billion of net
goods imports offset by $6.7 billion of net services exports.
Regional balances included a negative $5.6 billion with Japan, $6
billion with China, $3.6 billion with Western Europe, and $2.5
billion with the so-called NICs (newly industrialized countries
of South Korea, Taiwan, Hong Kong, and Singapore). A department
undersecretary commented (The Wall Street Journal, March 22,
2000, p. A2): "So long as the United States has a very healthy
rate of return on investments in U.S. enterprises, we'll continue
to attract the financing we need to carry the trade deficit." His
observation comes much closer to the truth than anything said by
Mr. Greenspan or Mr. Summers.
The following table of international monetary reserves is taken
from the International Monetary Fund, International Financial
Statistics, March 2000 (figures mostly as of December
1999/January 2000), and World Gold Council calculations based
thereon (www.gold.org/Gra/Statistics/Reserves.pdf), with
corrections for Dutch and British gold sales through March 2000.
All figures except metric tonnes of gold are in U.S. dollars in
billions, with gold converted at US$295/oz. and Special Drawing
Rights translated at a rate of SDR1 to US$1.37. Although foreign
exchange reserves are stated in dollars, their composition while
predominantly dollars also includes other hard currencies (e.g.,
euros, yen, pounds). Other reserves are primarily IMF SDRs and
IMF reserve positions.
Country/ Gold Gold at Foreign Other Percent
Area/Org. (Tonnes) US$295/oz. Exch. Res. in Gold
Euro Area 12457 118 225 25.5 32.1
Germany 3469 32.9 51.5 8.1 35.6
France 3025 28.7 33.8 5.7 42.1
Italy 2452 23.3 18.3 3.6 51.5
Netherlands 912 8.6 6.2 3.4 47.5
Portugal 607 5.8 8.1 .4 40.4
Spain 524 5 32.1 1.9 12.7
Austria 408 3.9 13.9 1.1 20.5
Belgium 258 2.4 8.4 2.5 18.3
Fin.,Ire.& Lux. 55 0.5 11.1 2.3 3.7
ECB 747 7.1 41.6 (3.5) 15
Switzerland 2590 24.6 30.2 2 43.3
United Kingdom 590 5.6 24.5 5.7 15.6
Swe.,Den.,Greece 384 3.6 51 3 6.3
Japan 754 7.2 283 8.9 2.4
China 395 3.7 155 3 2.3
Hong Kong 2.1 0 96 `0 0
Taiwan 435 4.1 107 0 3.7
India 358 3.4 32 0.7 9.4
Russia 415 3.9 8.5 0 31.7
So. Korea 13.6 0.1 77 0 0.2
Indo.,Malay.,Sing. 134 1.3 134 1 1.0
------- ----- ------ ----- ----
Sub-Totals 18527 176 1223 50 12.1
United States 8139 77.2 32.2 28.3 56.1
IMF 3217 30.5
BIS 203 1.9
All Others 2821 26.7 451 22 5.4
------- ----- ------ ----- ----
Totals 32907 312 1706 100 14.7
There are a number of points about this table worth noting. Among
the more salient are: (1) long- continued U.S. trade imbalances
have caused huge dollar reserves to build up in a relatively few
surplus nations; (2) virtually all these nations continue to run
large trade surpluses with the United States as evidenced by the
most recent trade figures; (3) the Euro Area, given its large
gold reserves and continuing substantial trade surpluses, has
some $200 billion in unneeded foreign exchange reserves; (4) gold
reserves outside Europe and the United States are relatively
tiny; (5) at US$295/oz., gold provides less than 15 percent of
official world liquidity but gold remains the next largest single
component of international monetary reserves after the dollar;
and (6) despite its position as a chronic deficit country, the
United States declines even during periods of dollar strength to
expend dollars to build up its foreign exchange reserves.
Two points deserve special mention. First, official monetary
institutions hold a little less than one third of the above-
ground gold supply. At US$295/oz., all the gold in the world
equals around $1 trillion, or less than the total combined
current market capitalization of Microsoft and Intel. This
comparison against the market cap of just two companies is an
indication of not only current stock market madness but also the
egregious relative undervaluation of gold versus dollars.
Second, the overhang of dollars is highly concentrated in a few
central banks. Accordingly, a rush to exit dollars by just one
large holder could easily produce a stampede. So too a major move
into gold by one of the large Asian holders of dollars could
rapidly evolve into a gold buying panic.
Not shown in the foregoing table is the dramatic slowdown in the
growth of world foreign exchange reserves. The following table
shows total foreign exchange reserves as reported by the IMF for
all member countries from 1992 through 1999. The figures,
reported in SDRs, are given in billions of U.S. dollars for the
end of each period translated at the appropriate end of period
rates.
1992 1993 1994 1995 1996 1997 1998 1999
Total Foreign
Exchange Reserves 926 1030 1184 1385 1561 1610 1636 1708
Increase from
Prior Year 104 154 201 176 49 26 72
Percentage Increase
From Prior Year 11.2 15 17 12.7 3.1 1.6 4.4
The IMF's statistics cover only official monetary reserves. They
do not include private investment flows. The following table is
taken from the Federal Reserve Bulletin, March 2000 and November
1997, Tables 3.15, 3.24, and 3.25. All amounts are in billions of
U.S. dollars; 1999 figures are as of Nov. 30 or for the first 11
months.
Category 1995 1996 1997 1998 1999
U.S. Liabilities to Foreign
Official Institutions 631 759 777 760 781
Net Foreign Purchases
of U.S. Treasury Bonds 134 245 184 49 -15
Net Foreign Purchases
of U.S. Stocks 11 12 70 50 99
Net Foreign Purchases
of U.S. Bonds 87 128 134 179 236
Net U.S. Purchases of
Foreign Securities -99 -106 -89 -11 9
Taken together, these two tables suggest that the current dollar-
based international financial system is on the cusp of dramatic
breakdown. Official international liquidity has almost ceased to
grow as official monetary institutions refuse to continue to add
to their dollar reserves. The international dollar liquidity
created by U.S. trade deficits now shows up not in official
reserves but as private investment in the U.S. financial markets.
At the same time private U.S. investors have largely exhausted
their exodus from foreign financial markets.
The importance of capital and investment flows, and particularly
cross-border equity investments, in determining current exchange
rate movements is the subject of a recent article in The
Economist ("Test-driving a new model," March 18, 2000, p. 75).
Noting that the "the new correlation between stock markets and
exchange rates may be fickle," The Economist nevertheless opines
(p. 76): "The key to the dollar's future almost certainly lies in
Wall Street; a bursting of stockmarket euphoria would drive down
the dollar sharply." In the meantime, the more the United States
buys from foreigners, the more dollars return for recycling into
stocks at ever-higher valuations. What's really new about today's
American economy is not its technology. It's America's ability,
courtesy of foreigners, to buy itself rich.
None of the tables above includes much in the way of non-
interest-bearing currency, which official monetary institutions
and private investors hold only in small amounts. Steve Hanke,
the leading advocate of currency boards, estimates that 70
percent of U.S. currency circulates outside the country, as do 35
percent of German marks. See S. Hanke, "How to Abolish Currency
Crises," Forbes (March 20, 2000, p. 145)
(www.forbes.com/columnists/hanke). Of course U.S. currency
circulating overseas also represents dollars that could flood
into official monetary authorities in a dollar crisis.
Currency boards linked to the dollar are a means of sopping up
dollars outside the United States. It is perhaps not coincidental
that Congress, as Hanke points out, is now considering
legislation that would authorize the Fed to share seigniorage
with countries using dollar-based currency boards. With all due
respect to Hanke, small nations contemplating this route should
tread carefully, and he should include in his advice a full
analysis of the longer-term prospects for the dollar. More to the
point, the first table shows that smaller, less-developed
countries generally hold a small proportion of their total
reserves in gold and thus will be among those most devastated by
any dollar collapse.
Flight by foreign investors from falling U.S. financial markets
is the Fed's doomsday scenario. Nor do foreign monetary
authorities, already choking on excess dollars, want to be buried
in an avalanche of rapidly depreciating greenbacks. Against this
picture, current runaway U.S. financial markets -- bad as they
undoubtedly are -- appear almost benign. Fear of a cascading
dollar collapse explains the Fed's unwillingness to apply strong
monetary medicine, the secretary of the treasury's covert efforts
to contain the gold price through the ESF, and foreign reluctance
to rock the shaky dollar boat.
What the foregoing tables cannot reveal is the trigger or the
timing. No financial minister or central banker wants to be
blamed for launching the world into a monetary black hole. Most
would probably prefer that the crisis be precipitated by a
geopolitical event extrinsic to the international financial
system. But while none can know for certain how events will play
out, when the crisis hits, all will act in what they consider the
best financial interests of their nations.
All these tables and figures point to one inescapable fact: When
the dollar goes, gold will regain its glory. In 1971 the only
viable alternative to Bretton Woods was floating rates centering
around the dollar. No other currency had the size or depth to
perform all the necessary functions of international settlement,
let alone to do so over the objections of the United States and
with the Cold War under way. But with the end of the Cold War and
the birth of the euro, the major industrial nations of
Continental Europe are no longer willing to be the monetary
vassals of America. Having retained the bulk of their historic
gold reserves, they are prepared to proceed on a more traditional
monetary path in which gold -- not the U.S. dollar -- is the
international monetary numeraire. They may not want to rock the
boat, but they are quite prepared for the storm.
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