Tag Archives: Gold

A Question of Degree:

I wrote some time ago of “The Race to the Bottom” wherein the four mega currencies of the World, namely the US Dollar, the Yen the Euro, and the Pound Sterling were being manipulated by their central banks in a race to inflate (as opposed to deflate) relative values and stimulate consumer demand. The strategy is accomplished by ‘quantitative easing’ new words for printing money.

Now it appears as though the US Dollar may have lost the race and is now increasing in value compared to Gold and the Euro. The currency markets seem to be telling us that,compared to everyone else, (that is with the exception of China where nobody really knows) the prospects for the US Economy are better than say Europe and Japan.

The World is awash in trillions of US Dollars that have now been the International medium of exchange for seventy years.  During the later part of this period, these dollars have been recycled by immense balance of payments deficits run by the US, and by the issuance sovereign (or national) debt to finance America’s wars of retribution. Its’ all rather like a huge bathtub, lets call it the ‘tub’, with the dollars all sloshing around,and the taps always on. The dollars in this tub are extremely volatile and will seek safe haven and yield in the blink of an eye.

The ‘Tub’ is the playground of the traders, more particularly the commodity and currency traders. This is where the action is that sees trillions of dollars change hands every single day. Commodities, led by oil, have been linked to US Dollar in a global economy where buyers and sellers now try to lock in returns on future sales. It was not always so.

Back in the good old days of dollar hegemony, just about all commodities were the subject of long-term agreements, that relied on fixed exchange rates, that were pegged in a narrow band. Then came the NIxon Shock (the de-indexing of gold) and the stagflation of the 70’s and all hell broke loose. Marc Rich, founder of what is now called Glencore, the largest trading company in the World, almost singlehandedly started the spot market for oil and things have never been the same. Hence the ‘tub’

In the past eighteen months two very significant events have occurred that have had the effect of tightening the taps in the bathtub and thereby raising the value of the US Dollar when compared to the Yen, the Euro, and gold.

First and most significant, domestic oil production in continental USA had increased by nearly two million barrels a day.This marginal production has displaced imports of the same amount ( a $200 million credit/ day to the balance of payments) At the same time China, having nearly filled its strategic reserve, has cut back on purchases thereby creating a temporary glut of crude oil on the spot market.

The possible knock-on result of converting the US Economy from a net importer to net exporter of oil maybe enough by itself to defer, for now, the  re-evaluation of the Dollar. Despite the utopian desire to reduce carbon emissions, and oil consumption, it is still very much all about ‘oil’; those that have it will prosper, while those who do not will struggle. Oil is still priced in US Dollars so the effect on net pricing will be even greater.

The second event is an enormous reduction in military spending by the US, as the Wars in Iraq and Afghanistan are wound down, allowing for a one-third reduction in the current account deficit (or the need to borrow the same amount) This again, if continued, can have a salutary  effect on the value of the dollar.

So right now the future looks bright for the dollar, but it is very much a matter of degree. If the Fed screws up and does not start to raise interest rates soon enough, inflation or more likely stagflation, can quickly ruin the party. And what of the promise to re-purchase the trillions of dollars in US Treasury Bonds involved in ‘quantitative easing’. Will the Fed resist pressure from Congress, to keep the good times coming, and actually start to shrink the money supply.

Stay tuned.

Dollar Crisis Redoubt:

The Breton Woods post Second World War monetary system, designed and maintained, at great cost by the Americans, fell apart in August 1971. This is when the convertibility of the dollar into gold at a fixed price of $35 was officially ended.

The beginning of the end started much earlier in 1967 /68 when a crisis in monetary confidence bought on by the devaluation of the British Pound, created a run on gold and the depletion of almost half of the 650 million ounce gold reserve of held by the Americans at Fort Knox Kentucky.

There had been a serious wobble before, when the Cuban Missile Crisis caused a buying panic on the Gold Bullion Market in London. The sudden and unexpected demand for gold, as a safe haven against possible nuclear Armageddon, led to the formation of the London Gold Pool. This unofficial agreement between Central Bankers, known only to a few, was to lend reserves of gold bullion held in the national accounts, of  The US, Britain, a few European Countries, so as to maintain order in an unregulated market.  This seemed to work for a while but was totally inadequate  when the dogs of speculation were let loose on the International Markets in 1967.

The Stirling crisis had been coming for some time because the Socialist  Labor Government of Britain  was unable, or unwilling, to enact  the austerity measures required to pay for the massive nationalization of industry  and infrastructure that had taken place following the declaration of peace in 1945. Sharply increased wages had rendered much of Industry uncompetitive and the  national balance of payments had suffered accordingly. An initial devaluation of 40% against the  US Dollar had not been enough to reflect the dire condition of the nation’s balance sheet.

Breton Woods was greatly influenced by Keynesian Economics that favored fiscal rather than monetary discipline, and a belief that elected governments could and would keep their budgets in balance In this utopian world  bankers were seen as a second line of defence only to be called upon when needed. Experience, almost from the beginning, had shown the fallacy of this dogma and the monetary system had only survived to this point because of the hegemony of the US Dollar freely convertible into Gold.

In 1967 Britain was required to maintain a trading range for the Pound Stirling, of two cents either side of official rate of $ US 2.80   using reserves of gold and dollars held  by The Bank of England to buy and sell Stirling as required. The problem arose because the reserves of the B.O.E. were inadequate for the task at hand. So the bankers, arranged to borrow huge sums of dollars (3 billion) to throw into the caldron should the need arise. The lead banker for this rescue was the Federal Reserve Bank of New York that pledged a billion dollars and the backing of all the gold in Fort Knox to the cause.

The rescue worked for a while, but the fates were not on the side of the angles and very soon speculation about a further devaluation of the pound began once more. This time in spite of the continuing efforts of bankers to maintain the status quo the British Government capitulated and the pound was devalued to a new official rate of $US 2.40.  The effect, totally unexpected, was a loss of confidence in the dollar and a run on gold, this time on scale never anticipated.. In a matter of a few days the market for gold spun out of control with buyers shorting the dollar and forcing the American Treasury to make good on its promise to deliver gold in exchange for dollars.

So dire was the situation that The Federal Reserve Bank of New York, along with the US Treasury, was forced to suspend  gold for dollar transactions, and allow an unofficial or floating rate to prevail. The immediate effect was a spread between the official rate and the actual rate or a devaluation of the dollar of approximately $5 or 14%.

Suddenly the American dollar was vulnerable, and nobody, it seemed, knew what to do, other than suspend the market for gold. The French Government under President Charles De Gaulle , having recently created the  New Franc  to purchase the tons of gold held by French Citizens, was intransigent and refused to cooperate. Also the members of the newly formed O.P.E.C.(the Oil Cartel) who suddenly realized that they were being paid for their oil in depreciating dollars thus reducing the value of the commodity. Their answer was to hedge future deliveries by selling dollars and buying gold.

After a weekend meeting of the monetary powers, this time including Switzerland,and the gold backed Swiss Franc, along with Japan and the Yen, a new form of specie was invented to supplement gold, as the principal monetary reserve. The specie, or new currency, took the form of Special Drawing Rights (SDRs) issued by The International Monetary Fund created in 1944 at Breton Woods as the sole arbitrator on International Currencies.  At the same meeting it was decided to do away with fixed exchange rates, that had been at the heart of Breton Woods, and allow currencies to find their own value.

The initial stated value of an SDR was 0.888671 grams of pure gold. This provided a continuing  link to hard currency and gold, and had the desired effect of stabilizing the gold market, that now traded independently from the US Dollar.  But it would not be long until the final link with gold was broken and the daily value of SDRs’ was calculated based solely upon the trading range of a basket of four currencies, The Dollar, the Pound, the Yen and finally the Euro, thus excluding gold.

The number of issued SDRs’ is now a very far cry from the original stop-gap issue, and is thought by the New York Federal Reserve Bank and the other central bankers to be sufficient to curb excessive currency speculation. But no one really knows, and herein lies the problem.

What will happen if all four major currencies, are depreciated or devalued at the same time, as it appears they maybe at this time. If unlimited amounts of dollars, yen, pounds and euros are created to stop deflation and start inflation what happens to the Basket 

Stay tuned.