When the outlook is golden, start worrying
William Rees-Mogg
timesonline.co.uk
On Friday I telephoned my colleague who edits this page and said that I was thinking of writing this column about gold and currencies. I outlined my argument, that the dollar is still too high, that the US external deficit is not sustainable, that the European and Japanese economies are suffering from low growth, that the euro and the yen are attractive only compared to the dollar. I added that gold was making new highs, and that the preference for gold showed the lack of confidence in the main currencies.
On Saturday morning I opened the Business section and found an article by Richard Lambert headlined “US dollar faces year of living dangerously”. He makes many of the points I was planning to make, and makes them very well — the overvalued and declining dollar, the “enormous” US deficit on current account, “the sorry state of the world’s second and third biggest economies, Japan and Germany”, the Asian central banks propping up the dollar, the sharp rise in the price of gold.
On such occasions one’s first thought is to turn to some other subject. However, I admire Richard Lambert’s journalism. If he thinks that the problems of the world’s currencies are the most urgent subject for his first article of the new year, that makes it more, not less, likely that it is the right subject for me as well. If this is worrying both of us, and it is, then it is probably right for us to be discussing the difficulties and possible dangers. As Richard observes, “the moment of maximum uncertainty is probably close at hand”.
For the past 30 years I have been following the price of gold. In some circles I am regarded as a “gold nut”. I have no objection to the term and may, on occasion, have earned it. But it is not an altogether accurate description of my interest in gold. I regard gold as the alternative to the central banks’ currencies, and as a counter-indicator of the realities of the world’s currency markets.
Gold is very different from paper money. It has had very long-term price stability, whereas currencies normally lose 90-100 per cent of their value in each century. Its price does not determine the export costs of the nation of issue. It cannot be created except by an expensive mining process and in small quantities; it cannot, therefore, be over-issued for political reasons, to win an election or pay for a war. It is an asset which is not represented by somebody else’s debt or liability. It is the only form of asset that is both liquid, like a currency, and real, like property. For these reasons, it is the canary in the mine; major changes in the world exchange system usually show up early in the gold market.
In the past three years the world gold market has certainly been singing. Last week, it closed with gold above $350 an ounce; only a few weeks ago we were wondering whether it could break through $320. Not long before that the question was whether it could go above $300. The last time I wrote about gold, I commented that gold had been a better investment than equities and that I expected it to continue to outperform them.
It has, and on a worldwide scale. For the past three years gold has been a much better investment than equities, in Japan, Germany, Britain and France, let alone the United States. Gordon Brown insisted on selling a large part of the Bank of England’s gold reserve near the bottom of the market. Chancellors make rotten speculators.
There have been a number of reasons for this strength of the gold price. Between 1997 and 2002 the US current deficit tripled from an annual rate of 1.5 per cent of gross domestic product to just below 5 per cent. Some projections expect it to reach 7 per cent by 2007; even the present deficit is unsustainable.
The Clinton presidency in the years of the boom between 1997 and 2000 lost control of the US current balance; despite an economic slowdown, the Bush Administration has not regained it, and does not even appear to have a proper understanding of the problem. Gold is priced in terms of dollars. Gold has risen by 36 per cent in terms of the dollar since 1999; that revaluation probably has further to go. Some American commentators now believe that gold has entered a ten-year bull market against the dollar.
The falling dollar does have one positive consequence; it will help to restore the trade balance of the US. American export prices will be reduced and import prices will rise. After a time, higher exports and lower imports should start to close the gap. Unfortunately, a weak dollar will export the problems of the US. A weak dollar means a strong euro and a strong yen. It means more inflationary conditions in the US, but more deflationary conditions in Germany and Japan.
As both of these economies are already suffering badly from low growth, and depend on exports for any hope of economic recovery, their governments view a stronger euro or yen with horror. What might be a partial answer for the US would be a disaster for them. And though the dollar has been brought into balance, it would, of course, be a foolish gamble for the UK to join a euro which is beginning to be priced out of its export markets.
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.
After all, the United States is by far the leading world economy, Japan is second and Germany is third. The US has a serious problem with the deficit and the overvalued dollar; Japan and Germany have equally serious problems of low growth, financial deficits in the banking and insurance sectors, and non-competitive prices caused by their overvalued currencies. The big three all have sick economies. Their economic diseases may be different, but in each case the cure, if there is a cure, will be painful. Both the dollar and gold are telling us that a perilous adjustment in currencies and in real economies lies ahead. |
