GOLD & US$ - Chapter II
by Eric Hommelberg
Last Updated March 26, 2005
Gold & US$ is chapter II
of the Gold Drivers 2005 report. It discusses the forces dragging down the US$.
The US is facing a Current Account Deficit exceeding 6% of GDP which raises many
alarm bells. The US economy is addicted to an inflow of $2 billion dollars every
single working day. This is simply not sustainable since it requires
almost 80% of world savings. FED officials are pointing towards a lower
dollar. Foreign Central Banks just started selling US dollars in order to
diversify its currency reserves. A Dollar devaluation seems to be inevitable and
is very Gold friendly since Gold is still a monetary asset and trades like a
currency. If the Dollar goes so will Gold but in opposite direction.
The 30-year long-term chart on the right says it all. A falling dollar will prop up the price of Gold. OK you'll say but why should the dollar fall ? Didn’t Dick Cheney said that deficits don’t matter and that the world is happy to finance these deficits ?
Sure he did, and yes, it wasn’t and still isn’t in the interest of the Asian countries to see the dollar crashing. It would severely hurt their own economies but a simple calculation learns that the dollar simply has to fall. Again, in order to finance the current account deficit an inflow of about $2 billion is required every single working day. This is about 80% of world savings. You don’t have to be a genius in order to understand that this can’t go above 100% and we’re getting close to that at an alarmingly high speed. That’s why FED officials are pointing towards lower dollar levels down the road : President of the Dallas Fed, Robert McTeer is straight forward. He said :
“over time, there is only one direction for the dollar to go – lower." END.
So what about other officials on the US$, do they agree with the President of the Dallas Fed ? And if that's the case shouldn't we see some evidence of Central Banks diversifying out of the dollar ? And does a growing current account deficit really matter ? Let's focus on the following issues here :
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1. Growing Current Account Deficit : Does it really Matter ?
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2. Others on the US$ and Current Account Deficit
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3. Central Banks diversifying out of the US ?
1 - Growing Current Account deficit : does it really matter ?
The current account deficit is approaching 6% of GDP which raises many alarm bells since many analysts see this as a threshold whereby the classic current account adjustment process will be triggered characterized by a weaker currency. (see Caroline L. Freund, "Current Account Adjustment in Industrialized Countries," Board of Governors of the Federal Reserve System International Finance Discussion paper #692, December 2000). This thesis is supported by the fact that at present 70 – 80% off all world’s savings is required (inflow of 2$ billion dollar every working day) in order to sustain current dollar levels. Needless to say this can’t continue for much longer. As former Fed Chairman Paul Volcker says :
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"the United States economy is growing on the savings of the poor… A big adjustment will inevitably become necessary."
So when will this end ? When are foreigners going to stop acquiring ever increasing quantities of US dollars ? Isn’t the FED worried about the huge current account deficit ? And what about other officials ? What do they have to say ?
2 - Others on the US$ and Current Account deficit
After many years of denial Alan Greenspan finally agrees that the huge current account deficit really matters. On November 19, 2004 he said :
Alan Greenspan - US Needs to Cut Budget Gap -
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"Current account deficits, even large ones, have been defused without significant consequences, (but) we cannot become complacent," Greenspan said in remarks prepared for delivery to a European bankers conference in Frankfurt. END.
So by saying “we cannot become complacent” Greenspan admits that huge Current Account deficits really matters.
Former ECB president Wim Duisenberg ishares the worry regarding the tremendous Current Account Deficit. He was quoted by Spanish Newspaper El Pais, he said :
Wim Duisenberg - Former ECB President -
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”A dollar devaluation seems inevitable due to the tremendous US Current Account deficit.” END.
Morgan Stanley's Stephen Roach seems to agree with Greenspan and Duisenberg :
Stephen Roach - Morgan Stanley -
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The enormous US trade deficit should be a wake-up call to America and the rest of the world. It is a direct manifestation of a lopsided global economy that remains biased toward unprecedented external imbalances. As long as the US continues to live well beyond its means and as long as the rest of the world fails to live up to its means, this seemingly chronic condition will only get worse. The imperatives of global rebalancing are reaching a flashpoint. END
A few more worried people :
The world's second richest man Warren Buffet is losing confidence in the dollar :
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Buffett says he is losing faith in the soundness of U.S. currency as an investment vehicle because the United States is running a huge trade deficit -- close to $500 billion, and rising rapidly -- that is causing income to flow out of the country at such a rapid rate that it will soon become unsustainable .END.
Rubin: Dollar Decline Could Accelerate
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NEW YORK - Former U.S. Treasury Secretary Robert Rubin warned Monday night that the dollar's recent decline could accelerate and interest rates could rise if politicians in Washington don't act quickly to narrow the federal budget deficit. END.
Nicolas Sarkozy - Former French Finance Minister -
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“U.S. deficits which are forcing the dollar down were more a reason for concern than the rise of the euro.” "The markets are worried by the strong U.S. current account deficit.” END.
Not only the World's second richest man is losing faith in the dollar but joining him now is the World's richest man :
Bill
Gates, World's Richest Man, Bets Against Dollar
Jan. 29 (Bloomberg) –
Bill Gates, whose net worth of $46.6 billion makes him the world's richest person, is betting against the U.S. dollar.
``I'm short the dollar,'' Gates, chairman of Microsoft Corp., told Charlie Rose in an interview late yesterday at the World Economic Forum in Davos, Switzerland. ``The ol' dollar, it's gonna go down.''
``It is a bit scary,'' Gates said. ``We're in uncharted territory when the world's reserve currency has so much outstanding debt.''
Gates's concern that widening U.S. budget and trade deficits are undermining the dollar was echoed in Davos by policymakers including European Central Bank President Jean-Claude Trichet and German Chancellor Gerhard Schroeder. END.
Then out of the blue a few very strong warnings came out again from former chairman of the FED Paul Volcker, his successor Alan Greenspan and again Warren Buffet who said :
Paul Volcker -
former FED Chairman -
At a conference recently held at the Stanford
Institute for Economic Policy Research
"Below the favourable surface [of the economy], there are as dangerous and intractable circumstances as I can remember.... Nothing in our experience is comparable…But no one is willing to understand [this] and do anything about it…"
"We are consuming… about six per cent more than we are producing. What holds the world together is a massive flow of capital from abroad… it’s what feeds our consumption binge... the United States economy is growing on the savings of the poor… A big adjustment will inevitably become necessary, long before the social security surpluses disappear and the deficit explodes."
"We are skating on increasingly thin ice." END.
Greenspan sounds warning on US deficits
Consequences
`could be severe,' Fed chief says
Mar 3, 2005
Debt worries clouding outlook for economy
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WASHINGTON—U.S. Federal Reserve Board chairman Alan Greenspan issued one of his toughest warnings yet to Congress yesterday about the danger of letting the country's giant budget deficits persist, saying "the consequences for the U.S. economy of doing nothing could be severe." END.
Buffett deepens dollar worries
March 05, 2005
"Warren Buffett has warned that the US trade deficit risks creating a "sharecropper’s society" as his letter to shareholders sounded an increasingly bearish tone about the value of the dollar."
"r Buffett’s bet against the dollar also grew. Foreign exchange contracts – mostly short positions against the US dollar – nearly doubled over the year to $21.4bn, generating $1.8bn in gains as the greenback fell against other major currencies."
"Mr Buffett stepped up his warning about the US trade deficit and the need to finance it with foreign investment, devoting more than two full pages of the annual report to the topic."END.
Greenspan again :
Greenspan
: Budget Deficits Pose Big Threat
Washington Mar 10, 2005
On trade, Greenspan expressed hope that further declines in the value of the U.S. dollar would narrow the trade deficit, which mushroomed to an all-time high of $617.7 billion in 2004.
A weaker dollar makes U.S. exports less expensive to foreign buyers and thus more competitive on overseas markets. A weaker dollar also can raise the prices of imported goods flowing into the United States. END.
Let's repeat one sentence here :
"Greenspan expressed hope that further declines in the value of the U.S. dollar would narrow the trade deficit."
To me it sounds that a further decline in the dollar is considered as a given fact !
But what about CB intervention in order to prevent a dollar decline ? The ECB is getting nervous and describes the recent rapid rise of the Euro as being ‘brutal’. So they don’t seem to be very pleased with a steady dollar decline. Are they going to intervene ? Will they be successful ?
As said before you can’t manipulate a currency against its primary trend for a long period of time. In a question and answer period after his speech, Greenspan said last year :
Alan Greenspan :
November 19, 2004
Central bank intervention in currency markets to support the dollar -- such as through buying dollars to drive up its exchange rate -- could have only a limited and short-term effect. END.
Also the US government made it clear that they won’t join any kind of intervention effort in order to stop the dollar decline.
With all these kind of
bearish news coming out lately when it comes to the dollar, you may wonder why
only so very few picked upon it during last couple of years. Why didn't we hear
these kind of warnings before ? Why didn't others warn for things to come some
years ago ? The dollar decline is already THREE years underway !
Well, as said before denial was the tune of the day. When investment gurus like
Warren Buffet were betting against the dollar in 2003 analysts were saying that
the old man had lost his touch with the markets. Some esteemed Gold Gurus's like
Jim Sinclair and James Turk were calling for a top in the US$ years ago and time
has proven them right.
Jim
Sinclair was among the first currency traders who
called for a confirmed top in the dollar back in 2002. (The Millennium
transition - Gold ……From Commodity to Currency). Ever since then he has warned
for the triple deficits – current account, trade and federal budget. But also
from the White House itself there were few who recognized what was coming but
unfortunately their voices weren't being heard. Just look at what former White
House Economic Advisor Dr. Lawrence Lindsay had to say years back in 2001
:
Dr. Lawrence
Lindsey,
Former White House Economic Advisor
April
30, 2001
“I do think it is important that we all keep this in mind: we have had 20 years of expansion - 18 actually, going on 19. And it has been an extraordinary period. But that does not mean that everything is AOK”
"We are in uncharted territory - - it's unprecedented - - it cannot go on - - something has to give."
“it is unlikely that we could forever borrow 4% of GDP from the rest of the world. Or more precisely if you look at trends, we are borrowing increasing amounts from the rest of the world. Imagine going to your banker and saying "we thank you very much for the $280 (billion) you lent us in 1999, and the $400 (billion) you lent us in 2000, and it looks like this year it is going to come in about $520. We are going to need $650 in additional cash in '02, probably $800 in '03." Getting the picture? This is otherwise known as "evergreen" financing. And it won't work. At some point, it is going to have to be adjusted.” END.
Now many years later it seems to be more accepted these days that the huge current account deficit of the US is a worry indeed and as said before it requires an inflow of about $2 billion dollars each working day in order to finance these deficits which in turn requires about 80% of world savings. So what if other central banks start slowing down their purchases of US paper, wouldn't that force the dollar down ? Isn't that what the FED is afraid of ? Well, it seems they are :
NY Fed-Slower Cenbank Buying Would Hit Dlr, Rates
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NEW YORK (Reuters) - U.S. interest rates would rise and the dollar would fall if Asian central banks slowed their recent heavy purchases of U.S. assets, the New York Federal Reserve warned in a report on Thursday. END.
It seems that foreign central banks not only are slowing down their dollar purchases but started diversifying out of the dollar as well. Just read the following headlines and judge yourself :
3 - Central Banks diversifying out of the US$ ?
The US government still insists that concerns regarding Asian Banks selling dollars are misplaced. Treasury Undersecretary for International Affairs John Taylor told Dow Jones (Mar 11, 2005):
"There is no evidence we have seen that Central Banks are changing their portfolio proportions." END.
Well, maybe Mr Taylor doesn't read Newspapers, it's just too hard not to disagree with Mr. Taylor after reading the following headlines :
Financial Times
Dollar expected to fall amid China's rumoured selling
November 7, 2004
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China, which has $515bn of reserves, was also said to be selling dollars and buying Asian currencies in readiness to switch the renminbi's dollar peg to a basket arrangement, something Chinese officials have increasingly hinted at. Any re-allocation could push the dollar sharply lower. END.
XIANGGANG Hong Kong (Itar -Tass)
November 8, 2004
By selling U.S. dollars, securities and assets denominated in the U.S. currency, Russia is diversifying its currency reserves, which is in line with the policy pursued by the Central Bank of Russia, Andrei Illarionov, adviser to the Russian President on economic problems, told Itar-Tass on Monday. END.
The New York Times
November 16, 2004
“The United States is spending nearly $600 billion more a year than it produces, almost 6 percent of its annual gross domestic product. Much of that spending has been financed by Asian governments, which bought more than $1 trillion in Treasury securities and other dollar assets in the last two years to help keep the dollar strong against Asian currencies.
Many analysts expect the financing gap to widen and the dollar to decline further.” END.
Financial Times
Dollar Down as Moscow trails Case for Euro
November 24, 2005
”The dollar hit an eight-year low against European currencies on Tuesday as a senior Russian official said Moscow might increase the proportion of its
foreign exchange reserves held in euros.”
Hans Redeker, head of currency strategy at BNP Paribas, said: "The Russians are saying they don't see the potential for a rebound of the dollar."END.
China Has Lost Faith in Stability of U.S.
Dollar,
Top Chinese Economist Says at World Forum
January 26, 2005
“DAVOS, Switzerland (AP) -- China has lost faith in the stability of the U.S. dollar and its first priority is to broaden the exchange rate for its currency from the dollar to a more flexible basket of currencies, a top Chinese economist said Wednesday at the World Economic Forum.”
"The U.S. dollar is no longer -- in our opinion is no longer -- (seen) as a stable currency, and is devaluating all the time, and that's putting troubles all the time," Fan said, speaking in English. “. END.
Financial Times
January 24, 2005
The Bank of Thailand said this month it was considering
reducing the proportion of its $50 billion reserves held in
dollars from 80 percent to 50 percent.END.
Dollar Declines on Report Korea to
Diversify Currency Reserves
Feb. 22 (Bloomberg) –
“The dollar fell the most against the euro in more than a week and dropped versus the yen on a report that Korea's central bank will diversify its currency reserves.”
Almost 70 percent of the 56 central banks surveyed said they increased exposure to the 12-nation currency, according to the survey conducted by Central Banking Publications Ltd., a London- based publisher, between September and December 2004. Fifty-two percent said they reduced exposure to the dollar. “. END.
Another upbeat note on the dollar from Australia :
The
Australian
February 25, 2005
“Treasurer Peter Costello's closest adviser fears the US is heading for a devastating financial crash that could ravage Australia's economic growth.”
“The financial crash feared by Dr Henry would involve a sharp fall in
the US dollar and a bond market selloff, which would push up US and
world interest rates.”. END.
Japan the next to diversify ? :
Dollar Declines After
Koizumi Says Japan May Diversify Reserves
March 10, 2005
The dollar dropped against the euro and the yen in Asia after Prime Minister Junichiro Koizumi said Japan ``in general'' needs to consider diversifying the investment of its foreign reserves. END.
And then China again. Their rumoured selling turns out to be not a rumour at all :
China Reduces Dollars
in Reserves, Increases Euros, Lehman Says
March 11, 2005
China's central bank cut the share of its currency reserves held in dollars and raised its holdings of euros, according to an estimate by Lehman Brothers Holdings Inc. END.
So after all we see that the Russians don’t see the potential for a rebound of the dollar. Neither do the Chinese, the Koreans, the Thais, the Australians, the Japanese and fifty-two percent of all central banks. Is it any wonder that Alan Greenspan, Robert McTeer, Wim Duisenberg, Bob Rubin, Warren Buffet, Stephen Roach, Bill Gates, Paul Volcker, etc…all have a cautious long-term view on the dollar ?
Again and again former politicians, Fed officials and high profile investors are projecting a sober outlook for the dollar caused by the ever increasing Current Account deficits so a further decline seems to be unavoidable coming years. Let's repeat once more Alan Greenspan's remark on the dollar and deficits :
"Greenspan expressed hope that further declines in the value of the U.S. dollar would narrow the trade deficit." END.
Again this sounds to me as if a further dollar decline is considered as a given fact. The end result could very well be a race for the dollar door. Bridgewater Associates reported :
The Break Down of The Dollar
System
March 10, 2005
In the early 70’s, France first, and then other countries, started to peel off the dollar standard and started to ask the Fed for gold instead of dollars. The result was inevitable as the race for the dollar door began. In the last couple of weeks the exact same dynamic began anew as Korea, then China and Thursday Japan, all expressed their interest in diversifying their dollar holdings. The race to the door is likely about to begin. END.
The message from al the quotes above should be clear and is straight forward :
The sky-rocketing current account deficit will force the dollar lower and could lead to a race for the dollar door.
Former Assistant Secretary of the Treasury in the Reagan administration Paul Craig Roberts said seems to agree :
Counter-punch
So Much for the New Bush Economy
Paul Craig Roberts
March 10, 2005
The dollar's value and status as reserve currency cannot forever stand the trade and budget deficits that are now part and parcel of America's economic policy.
Unless there are major changes soon, America's economic future is a third world work force with a banana democracy's worthless currency. END
It goes far beyond the scope of this article in order to explain what causes the growing deficits and how they interact with the dollar. For the Gold investor it only matters that growing Current Account deficits really matters and that it eventually leads to lower dollar levels. As the dollar goes so will Gold but in opposite direction.
Highlights :
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Current Account deficits exceeding 5% of GDP raises many Alarm Bells
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US economy is addicted to an inflow of $2 billion dollars every single working day. This is simply not sustainable since it requires almost 80% of world savings.
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FED officials are pointing towards a lower dollar -
Foreign Central Banks just started selling US dollars in order to diversify its currency reserves -
A Dollar devaluation is very Gold friendly since Gold is still a monetary asset and trades like a currency. If the Dollar goes so will Gold but in opposite direction.
Total US Debt & Exploding Trade Deficits
As said before it goes far beyond the scope of this article in order to explain what causes the growing Current Account deficits and how they interact with the dollar. However I do think it’s important to discuss just a few items regarding total US debt.
Former IMF consultant and Financial Sector Specialist of the World Bank Richard Duncan describes in detail (Richard Duncan : The Dollar Crisis – Causes Consequences - Cures) how the US economic growth of the last 20 years has been fueled by credit (Thanks to Alan Greenspan who made easy credit available by lowering interest rates to a 40 year low thereby encouraging consumers to take out cheaper mortgage loans and to spend spend spend spend..) thereby creating a total US debt exceeding 340% of GDP (see chart below).
http://mwhodges.home.att.net/ America’s total Debt Report
The chart on the left shows a total US Debt exceeding 340% of GDP. It’s obvious that the US is getting more dependant on more debt in order to sustain economic growth.
The chart on the right shows an obvious trend. A trend of US consumers buying tons of cheap foreign manufactured goods which in turn leads to higher trade deficits and therefore higher current account deficits. The current account deficit is approaching 6% of GDP which raises many alarm bells since many analysts see this as a threshold whereby the classic current account adjustment process will be triggered characterized by a weaker currency.
If a total Debt of 37$ trillion wasn’t already bad enough, what about future fiscal liabilities exceeding $50 trillion ? . Peter Peterson, secretary of commerce during the Nixon administration and Prof. Laurence Kotlikof, senior economist at the President’s Council of Economic Advisors (CEA) during the first Reagan administration, published excellent books ( “Running on Empty” , “the coming Generational Storm” ) in which they explain in greatest detail why the US is heading towards bankruptcy. They project a fiscal liability of more than 50$ trillion which requires a budgetary resource that only inflation can provide. Inflation and higher rates to come ? How does that interact with Gold ? Well, that’s food for thought for next chapter Gold & Inflation, Negative real rates.
- END -
