Global Stock Markets Hooked on the Gold Standard
SEVERE EDIT
By Gary Dorsch, - Editor Global Money Trends magazine
Do you believe in conspiracy theories? Sometimes they are difficult to refute. Such was the case last week, just after the Euro had soared towards a 12-month high of $1.30, and the British pound, itself ridden with large trade and budget deficits, stood mighty tall at $1.90, with traders setting their sights for $2 for the pound. The US dollar lost 7% in just six weeks against America's main trading partners, and was 28% lower since January 2002, to stand just 1% above its 1995 low.
Then on Sunday May 14th, currency traders in London, picked up an obscure report from the UK’s Observer newspaper, that indicated the International Monetary Fund was in behind-the-scenes talks with the EU, Japan, the US, China and other major powers to arrange a series of top-level meetings to tackle imbalances in the global economy, and address the dollar sell-off that was rattling global stock markets.
Fearing a surprise rescue package for the US dollar, London currency traders began to lock in profits from the Euro’s six week old rally to just shy of $1.30. As always, the first line of defense in the currency market is jawboning, and finance officials in Europe, Japan, and the US were out in full force, talking the Euro and Japanese yen down, and the US dollar up. Timely jawboning by G-7 finance ministers, helped to keep a lid on the Euro just below $1.30, and rescued the dollar at 109-yen.
G-7 central bankers understand that a weaker US dollar can exert upward pressure on the cost of US imports, which rose 2.1% in April, and account for 17% of Americans purchases. And a sharply higher Euro and Japanese yen against the US dollar, also subtracts from profit margins of European and Japanese exporters, which is unraveling the EuroStoxx-600 and Nikkei-225 stock market rallies. European and Japanese central bankers have worked very hard to inflate their equity markets for the past four years to stimulate consumer demand through the “wealth effect.”
G-7 central bankers and finance officials are also alarmed by gold’s spectacular surge against all major currencies over the past eight months, a clear signal that global investors have lost confidence in the purchasing power of fiat (paper) currency. A global flight from G-7 government bonds and into gold since September 2005, has lifted bond yields to multi-year highs in Japan and the US, the world’s largest debt markets, and in a long delayed reaction, triggered big shake-outs in global stock markets in mid-May.
However, a guardian angel came to the rescue a half-hour before the London a.m. gold fix on May 15th, by unloading a big chunk of the yellow metal, hitting all bids $35 per ounce lower to the $680 level. Within hours of the gold sell-off, dazed gold traders were hearing Japan’s finance minister Tanigaki and the ECB’s Noyer threatening intervention on behalf of the US dollar, and conducting jawboning exercises about the virtues of currency stability for the global economy.
Then on May 19th, leaving gold bugs on a sour note heading into the weekend, US Treasury Secretary John Snow insisted on CNBC television that the Bush administration still backed a strong dollar. “It’s a policy we’ve made clear, that Japan signed on to, the statement coming out of the G-7 finance ministers' meetings, which said open, competitive markets are the best way to set currency values," Snow said, adding, "I say our policy is the strong dollar."
Gold tumbled as low as $638 per ounce on May 22nd, on concerns that the Bernanke Fed would back up the Treasury’s rhetoric about a strong US dollar, by lifting the fed funds rate 0.25% to 5.25% at its June meeting. "I have full confidence that Chairman Bernanke and the Federal Reserve are committed to price-stability and understand that this is their number one priority," Snow added.
Foreign Central Banks Switching out of US Dollars
The United States needs to draw in more than $3 billion every working day just to break even from external deficits, and prevent the US dollar from falling further and keep interest rates from rising too far. The US current account deficit is the broadest measure of trade, including financial transfers along with goods and services, and widened $136.9 billion from 2004 to $804.9 billion in 2005, representing 6.5% of US gross domestic product, up from 5.7% in 2004.
However, Treasury data showed that central banks only bought a net $1.6 billion of US stocks and bonds in March, the lowest since they were $14.4 billion net sellers in March of 2005. Japan, the largest foreign holder of US government debt, sold a net $18.2 billion in Treasuries in February, but still holds a total of $640.1 billion. China bought a net $1.6 billion in US debt in March and holds $321.4 billion. Middle East oil kingdoms recycled $16.8 billion petro-dollars through British banks, and UK holdings rose in March by $16.8 billion and total $251 billion.
Nowadays, the US dollar is heavily dependent upon its role as the world's reserve currency, used for transactions in internationally traded commodities such as copper, crude oil, and gold. Therefore, foreign central banks must stockpile US dollars, which account for more than two thirds of all central bank reserves worldwide. This special reserve status means that the US dollar is always in demand, whatever the underlying strength of the US economy, or the level of US interest rates.
But the US dollar’s counter trend rally from January 2005 to March 2006, that rode on the back of 16 quarter-point rate hikes by the Federal Reserve, started to unravel in April, following news that Sweden's Riksbank Sweden has cut its US dollar holdings, from 37% to 20%, with the Euro's share rising to 50 per cent. Kuwait, Qatar and United Arab Emirates also said they were buying Euros. Central banks in China and Japan hold less than 2% of their combined $1.75 trillion of foreign currency reserves in gold, and instead, hold depreciating US bonds.
But it was Russian finance minister Alexei Kudrin, who on April 21st, dropped the biggest bombshell on the US$ at the annual meetings of the World Bank and International Monetary Fund, by openly questioning the dollar's pre-eminence as the world's absolute reserve currency. The Russian central bank raised the Euro's weight in the currency basket against which it targets the ruble, by 5% to 35% on August 1st, 2005, reducing the dollar's share to 65% from 70 percent.
“The US dollar’s recent volatility and the US trade deficit cause significant changes in the international situation and that is why we do not understand the US dollar at the moment as the universal or absolute reserve currency. The international community can hardly be satisfied with this instability. Whether it is the US dollar exchange rate or the US trade balance, it definitely causes concerns with regard to the dollar’s status as a reserve currency,” Kudrin declared.
SEVERE EDIT
The big-3 central banks and their finance ministries still have the ability to jawbone foreign exchange rates, or if necessary, execute outright intervention to battle with speculators.
However, the most shocking development in the global markets over the past few years was the natural evolution of a worldwide de-facto gold standard that is just starting to impose discipline upon abusive central bankers.
In other words, brazen attempts by central bankers to inflate their equity markets by pumping up their money supply, has been matched by higher gold prices. For instance, the emergence of the gold vigilantes in Europe became evident in September 2005, when the price of gold rose above a four year resistance area of 350 Euros per ounce, and zoomed to as high as 570 Euros on May 11th, 2006.
Graph
Interestingly enough, the gold market closely attached itself to the monetized EuroStoxx index, and then outpaced the EuroStoxx to the upside. In other words, the impressive EuroStoxx-600 rally was just an optical illusion in hard money terms, and was more reflective of the ECB’s ultra-easy money policy. If the ECB was forced to lift its repo rate above the true rate of inflation, both gold and the EuroStoxx index would begin to unwind some of their speculative froth.
Under the leadership of Jean “Tricky” Trichet and his cohort, Bundesbank chief Axel Weber, the ECB abandoned one of the key pillars of the Euro zone monetary policy, keeping the M3 money supply close to a 4.5% growth rate. Instead, the annual growth in M3 picked up to 8.6% in March, its highest since July 2003 and the third straight monthly rise in the pace of expansion. Loans to the private sector, which further pushes up liquidity, grew 10.8% in the year, the fastest growth since 1992. Mortgage growth topped 12.1%, the highest since 1999.
To prevent strong loan demand from lifting the cost of money, the ECB inflated the M3 money supply, and in the process, also inflated the EuroStoxx-600 market and watched the price of gold soar 74% from 316 Euros to as high as 570 Euros /oz. Although both asset markets rose in tandem to profit from monetary inflation, the EuroStoxx-600 index lost 26% to the price of gold since September 2005.
But loose money policies in expanding economies can usually lead to higher inflation, and Germany’s producer price index jumped 0.7% in April, or 6.1% higher from a year ago, its fastest rate of inflation in 24-years.
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