Posts Tagged ‘USD’

Is there any benefit for Aussies to invest in gold?

Tuesday, November 16th, 2010

Recently, one of our readers who bought How to buy and invest in physical gold and silver bullion wrote to us,

I live in Perth so am looking to buy bullion from the mint, just down the road, literally, however I?m concerned about how the fluctuating US dollar affects my investment. Surely during hyperinflation of the US dollar gold will obviously go up, but also the Aussie dollar will strengthen significantly at the same time. If the Aussie dollar goes up more than the gold price, I actually loose money in Aussie dollars for which i use to pay my gold (If I use us money trading account…i will loose money when i finally exchange us to aus $$ if the exchange rate is super high)…is this a realistic situation or in a case of hyperinflation, is gold likely to spiral upwards whereas the Aussie dollar marginally increase in relation to the US$…….i.e will the spiralling gold price and hyperinflation in the states cause equivalent hyperinflation worldwide and therefore maintain the “approx” AU/US $$ exchange rate.? I can see gold skyrocketing but if the Aussie dollar also sky rockets also…this is of no benefit is it>>> or is it???

our dollar is very strong at the moment and predicted to get stronger, hence, i will loose money by investing in gold or silver, but i have no trust in the US financial system. Is there a way i can hedge myself against a strengthening Aussie dollar??

I realise u don’t have a crystal ball…I’m not holding you to anything i just want your opinion.

As we can all see, currently there?s a correlation between Australian dollars (AUD) and gold price. Hence, from the point of view of Australian investors of gold, a rising gold price (in USD) does not benefit them. We see that correlation working out in 2007 and today. Today, even though gold prices had hit a record high in USD terms, it is still below the record high in AUD terms- gold hit a record high of around AU$1500 in 2009 when the AUD was very ?weak?.

To answer our reader?s question, we have two points to make:

Back to the basics?

First, let?s revisit the basics. As we wrote in How to buy and invest in physical gold and silver bullion, when we invest in gold, we are not so much into ?making? money. We are doing so to hedge and protect our existing wealth. In other words, gold is not so much of an investment. Instead, it is more of an insurance policy. Therefore, we wouldn?t be so concerned if our ?investment? in gold is not turning out well in terms of AUD. However, what we are more concerned is the possibility of an AUD currency crisis. We have written about that in Will there be an AUD currency crisis?. We are not saying it will happen. Instead, we are suggesting that there?s a possibility that it may happen and by ?investing? in gold, we are hedging ourselves against that.

USD the reserve currency

Regarding the mess in the US financial system, it would be quite an entertaining spectacle if the US is just an inconsequential banana republic like Zimbabwe (which incidentally fell into hyperinflation- a object lesson for the US to learn). In that case, the case for ?investing? in gold will be much weaker.

Unfortunately, the US is not an inconsequential banana republic. It is a superpower whose currency is the world reserve currency. As we wrote in How to buy and invest in physical gold and silver bullion,

The United States, with ?helicopter? Ben Bernanke at the helm of the Federal Reserve, is committed to money printing to solve America?s economic woes. To the extent that the US dollar is the world reserve currency, it will affect the rest of the world.

Because it is the world?s reserve currency, China ?saved? most of the fruits of its hard work in the form of that reserve currency (a cool US$2 trillion worth). Same thing for Japan. Ditto for many other countries.

By printing money, the US is devaluing the world?s reserve currency. But the world cannot afford to have its reserve currency devalued towards the value of confetti. As we wrote in Why did the foreigners bail out cash-starved financial institutions?,

China?s trillions of US dollars reserve is a form of savings that will be used to acquire their future needs for resources to power their economy in the long term. Therefore, any threat to the long-term value of their savings will be a long-term threat to their economy.

So, what is the solution to the devaluation of the reserve currency? As we wrote in What if the US fall into hyperinflation?,

Now, in this age of freely fluctuating currencies, the currency?s value is a relative concept. For example, a falling US dollar implies a rising Australian dollar. Therefore, one way to ?maintain? the value of the US dollar relative to the Australian dollar is to devalue the Australian dollar. Perhaps this is the route that central bankers will concertedly take to instil ?confidence? in the US dollar in order to create the illusion that the US dollar is still a reliable store of value? Well, they can try, but growing global inflation and skyrocketing gold price relative to all currencies will be tell-tale signs of such a dirty trick.

That?s why there?s a threat of a currency war between the US and China right now. The US is accusing the Chinese of manipulating their currency while the Chinese are pissed off with the US for exporting their inflation to China. As the US prints and devalue its reserve currency, China will be hard pressed to devalue theirs too (in the form of a currency peg). If China let their yuan soar in value, their exports will collapse, which will severely affect their economy and social stability. Japan is in the same situation too. A strong yen (relative to the USD) is very bad for their economy too. That’s why Japan recently cut their already super-low interest rates and there’s talk of more money printing on the Japanese’s part.

Now, look at Australia. Let?s imagine that the AUD reaches US$1.20 and is threatening to march forward to $1.40 and beyond. If the AUD gets too strong, it will hurt the Australian economy. In such a situation, Australia will be hard pressed to devalue its currency too (e.g. by cutting interest rates, direct intervention). Or maybe impose capital controls.

In other words, the world is in a situation where there?s a competitive devaluation of currencies. In the recent G-20 summit, countries are pledging not to engage in that. Well, if you doubt their words, then you will sleep better to have your own reserve currency in the form of gold.

In any case, it?s going to be very rough ride in the forex markets. If you are forex speculator, this is heaven. If not, then it is going to suck.

Expectation of US Dollars (USD) printing creates an Australian Dollar (AUD) bubble?

Sunday, October 10th, 2010

Everyone on the streets know that the Australian Dollar (AUD) is rampaging towards parity with the US Dollar (USD). Joining the media circus, some forex pundits are even prophesying that the AUD could reach $1.20 against the USD. The masses in Australia are cheering because it is now cheaper to buy stuffs overseas due to the ?strong? AUD. Politicians (Wayne Swan) are cheering because it is a great excuse to brag about the ?strength? of the Australian economy under the stewardship of their political party. Businesses that has their costs paid directly or indirectly in terms of USD are cheering (e.g. retail import). Businesses that receive their revenue in terms of USD (directly or indirectly) are in pain (e.g. mining, tourism).

We wouldn?t be surprised if the next round of readings for consumer confidence in Australia will show a marked increase. We have no doubt that this in turn will add fuel to more cheering by politicians and the media circus.

But as contrarian investors, you have to understand the context and big picture behind the surging AUD. Do not be like the masses by being caught up with the euphoria. Instead, be prepared and even profit for what is to come.

Firstly, it is not just the AUD that is rising against the USD. The euro, yen, base metals, gold, silver, etc are also rising too. However, the expectation of more interest rate rises by the Reserve Bank of Australia (RBA) is acting like rocket boosters to the already rising AUD (see Return (and potential crash) of the great Aussie carry trade). In other words, it is more of the USD that is deprecating, not the AUD appreciating. As we wrote in What if the US fall into hyperinflation? on April 2008,

Now, in this age of freely fluctuating currencies, the currency?s value is a relative concept. For example, a falling US dollar implies a rising Australian dollar. Therefore, one way to ?maintain? the value of the US dollar relative to the Australian dollar is to devalue the Australian dollar. Perhaps this is the route that central bankers will concertedly take to instil ?confidence? in the US dollar in order to create the illusion that the US dollar is still a reliable store of value? Well, they can try, but growing global inflation and skyrocketing gold price relative to all currencies will be tell-tale signs of such a dirty trick.

Already, the Japanese central bank are cutting interest rates, taking token measures to intervene in the forex market to weaken the yen and even talking about buying government bonds (i.e. ?printing? money). Basically, the Japanese want to devalue the yen. For Australia, we would hazard a guess that one of the major contributing reasons why the RBA did not raise interest rates last week is because of the surging AUD (that was also the suggestion of one of the economists in CommSec).

To put it simply, the depreciating USD is creating a bubble-like conditions for the currencies of foreign countries. That is problematic, not the least because it is making their exports uncompetitive (just ask any Australian mining company). What is the solution for these countries? Devalue their currencies too (if it can be done without the masses being aware, all the better).

The next question is: why is the USD depreciating?

The reason is simply because of the expectation that the Federal Reserve is going to embark on a second round of massive money printing (see Bernanke warming up the printing press). What is the background behind the Federal Reserve?s money printing idea? To answer this question, we would refer to the late Professor Murray Rothbard?s book, Mystery of Banking:

In Phase I of inflation, the government pumps a great deal of new money into the system, so that M increases sharply to M?. Ordinarily, prices would have risen greatly (or PPM fallen
sharply) from 0A to 0C. But deflationary expectations by the public have intervened and have increased the demand for money from D to D?, so that prices will rise and PPM falls much less substantially, from 0A to 0B.

Unfortunately, the relatively small price rise often acts as heady wine to government. Suddenly, the government officials see a new Santa Claus, a cornucopia, a magic elixir. They can increase the money supply to a fare-thee-well, finance their deficits and subsidize favored political groups with cheap credit, and prices will rise only by a little bit!

It is human nature that when you see something work well, you do more of it. If, in its ceaseless quest for revenue, government sees a seemingly harmless method of raising funds without causing much inflation, it will grab on to it. It will continue to pump new money into the system, and, given a high or increasing demand for money, prices, at first, might rise by only a little.

Murray Rothbard wrote this book more than 25 years ago. Yet, it is pertinently relevant for today?s context. The US government?s budget is in great deficit. It will get worse as they have to spend even more money to prop up and stimulate the economy. The current environment of deflationary expectations is providing an excellent cover for Bernanke to print money (see Bernankeism and hyper-inflation).

But as Murray Rothbard continued,

But let the process continue for a length of time, and the public?s response will gradually, but inevitably, change. In Germany, after the war was over, prices still kept rising; and then the postwar years went by, and inflation continued in force. Slowly, but surely, the public began to realize: ?We have been waiting for a return to the good old days and a fall of prices back to 1914. But prices have been steadily increasing. So it looks as if there will be no return to the good old days. Prices will not fall; in fact, they will probably keep going up.? As this psychology takes hold, the public?s thinking in Phase I changes into that of Phase II: ?Prices will keep going up, instead of going down. Therefore, I know in my heart that prices will be higher next year.? The public?s deflationary expectations have been superseded by inflationary ones. Rather than hold on to its money to wait for price declines, the public will spend its money faster, will draw down cash balances to make purchases ahead of price increases. In Phase II of inflation, instead of a rising demand for money moderating price increases, a falling demand for money will intensify the inflation.

Given the large and exponentially growing debt of the US government, monetary inflation is the only path they can take as far as the eye can see.

There is a lot more in Professor Murray Rothbard?s Mystery of Banking if you want to learn how money and credit are related to each other through the banking system work. You can read a sample of this book here (at the right of that page, click on the ?Read First Chapter Free? button).

Notice the change of narratives in the financial markets?

Tuesday, July 6th, 2010

At around January-February this year, when the global financial market first suffered a correction, the narrative was about the sovereign debt of Greece. That had the implication on the Euro. Back then, the US dollar rose and gold fell. The fact that gold fell was not something that can be rationally explained. That?s because if there?s a lack of confidence in a major fiat currency (the Euro in this case), then the alternative should be gold. But as we wrote in How To Foolproof Yourself Against Salesmen & Media Bias, there?s a difference between what should happen and what will happen. This is example of a divergence between the two.

In May this year, the narrative was again on Greece, the other PIIGS countries and by implication, the Euro. Gold and US dollar rose. This time round, gold?s move was rational.

Fast forward to today.

There?re a lot of indication that the narrative is back in the bears? favour (see Mr Market is in the bear camp). But this time round, there?s a difference between May?s bearish narrative and today?s bearish narrative- European sovereign debt (and by extension, the Euro) story is no longer part of the narrative. The more prominent story is the growing expectation of a double-dip recession. As we wrote in Keep up spending- Who?s right? Europe or America?,

The expected (assumed is the more accurate word) recovery in the United States seems to be stalling. China is enacting policies to slow growth. Europe is mired in sovereign debt problems.

This narrative carries the implication of a return to deflation. The signs of deflation include rising US dollar and falling asset prices. Our guess is that in the context of this new narrative, gold in US dollar terms may be under pressure. A rising USD implies a falling AUD, which will mitigate some of the falls in gold price in AUD terms.

In the near term, stocks may be oversold and may rebound slightly. But according to the narrative of the bigger picture, the bears are still in charge.

What will be the next market panic?

Tuesday, November 17th, 2009

It is an open secret that the zero interest rate policy (ZIRP) by the Federal Reserve is fuelling a carry trade bubble as described in Return (and potential crash) of the great Aussie carry trade. In fact, the Chinese are seething with anger as they blasted the Americans as the root cause of blowing asset price bubbles all over the world. As this article wrote,

The US Federal Reserve is fuelling ?speculative investments? and endangering global recovery through loose monetary policy, a senior Chinese official warned on Sunday just hours before President Barack Obama arrived in China for his first visit.

As far as Wall Street and their buddies in the US government is concerned, an orderly decline of the US dollar is not their problem. It is the problem of

  1. The American people because a depreciating US dollar means a lower standard of living for them via price inflation
  2. Export-oriented economies because it makes their wares more expensive to Americans
  3. Countries who more or less peg their currencies to the US dollar because lose American monetary policy implies a lose domestic monetary policy, which helps to ignite asset price bubbles.

Right now, there are two possibilities for the US dollar: a short-term rebound or a Black Swan trigger that turns an orderly decline into a disorderly rout.

The first possibility should be familiar to you- it will probably look similar to the Panic of 2008. Based on technical analysis, the USD is extremely oversold and ought to be very vulnerable to a rebound. Most likely, it will turn out that way: a ‘surprise’ deflationary event (e.g. see Looming Black Swan that can bring the market back into panic) triggers a USD short covering (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar), which will result in a return of fear and panic and then followed by more money printing, stimulus and bailouts.

The second possibility is the really unpredictable one. The flight away from the US dollar may not necessarily be towards the non-US currencies (e.g. AUD)- instead it could be towards precious metals. In that case, we can see some strengthening of the US dollar plus the soaring gold prices in all currencies. Our hunch is that the next big move in the markets is not going to follow the familiar deflationary script of the first possibility- it is just too predictable. Because it is too predictable, Wall Street, Bernanke and the authorities must have already anticipated them and manipulated the markets to prevent it from happening. Hence, perhaps the much anticipated correction will not happen in the conventional form that we expect? Perhaps the deflationists have severely underestimated the cunning of the gang?

But there is a limit to how far that gang can manipulate the markets. When they have a rival nation (China) that follows different set of rules, different forms of governments and whose national interests are incompatible, things are much trickier. We have no doubt that the Chinese, in the quest of their own national interests, are undermining the national interests of the US, whether as an deliberative active policy or as a consequence of their mercantilist pursuits. The intersection between this clash of interests is where miscalculations and loss of control of the markets happen. This is where economics and politics collide.

Our hunch is that the next panic may have something to do with currencies. Should this occur, the only safe haven we can think of is precious metals. As to when and how the panic will look like, we do not know.

How does China ‘save?’ Story of the circuitous journey of a US$

Sunday, July 19th, 2009

One of the most common expressions that we hear today is that “China has a very high savings rate.” It is said that China saves 50% of its income. But as investors, we have to be very clear what this high savings rate mean. Does it mean that Chinese families and individuals, on aggregate, save 50% of their income? Certainly, the personal savings rate in China, on aggregate, is higher than the West. On the other hand, the Chinese, especially the younger generation, are emulating the profligate and spendthrift of their Western counterparts (see Chinese increasingly overdue on credit cards)- their rising credit card debt arrears and skyrocketing mortgage debt in the major cities shows that they are learning the bad habits of the West fast.

It is fair to say that the personal savings record of the Chinese does not fully account for the 50% savings rate. So, what does this high savings rate mean?

In reality, China’s high savings rate is the result of forced savings by the government. The Chinese government ‘forced’ savings on the Chinese people by accumulating massive US$2 trillion reserves (as foreign assets, notable US Treasury bonds) on behalf of their people through the currency peg. To understand how it all works, consider how the US dollars spent by American consumers typically ends up as US Treasury bonds in the US (China recently announced changes to the rules, which will affect the steps below):

  1.  An American consumer pays US$30 for an Oral-B electric toothbrush at Wal-Mart.
  2. Most of the US$30, say US$27,  stays in America to pay for the worker’s wages, distributions costs, transport cots, Wal-Mart’s profit, Oral-B’s profits and so on. This US$27 is part of the 70% consumer spending portion of the US economy. That US$27 helps to ‘stimulate’ the US economy.
  3. The remaining US$3 ends up in a factory in southern China. The deal between Oral-B and the Chinese manufacturer is denominated in US$ (i.e. the Chinese manufacturer is paid in US$). But US$ cannot be used in China because the RMB is the currency of China. So, what happens next?
  4. The Chinese manufacturer will present the US$ to a local Chinese bank (say, the Shenzhen Development Bank). He has to show the receipts to the Shenzhen Development Bank (SDB) to prove that the US$ is earned by trade and not through speculation.
  5. The Shenzhen Development Bank (SDB) will take the US$3 in exchange for RMB.
  6. This is where China is different from the West. In Western countries, a bank in SDB’s situation can do whatever it likes with the US$- e.g. trade them for euros or yen on the foreign-exchange market, invest them directly in America, issue dollar loans and whatever they think will bring the highest return. In China, the SDB has to surrender all of its US$ to the PBOC for RMB at whatever the official exchange rate (the RMB is ultimately created from thin air by the People’s Bank of China (PBOC)- see Why is China printing so much money?).
  7. Everyday, there are thousands of transactions between the local Chinese banks and the PBOC. The pile of US$ that keep piling up in the PBOC like crazy. Please note that trade with America is not the only thing that result in US$ streaming into China. Trade between China and other countries are also settled in US$, which means even more US$ are piled up in the PBOC.
  8. The PBOC transfers the US$ to the State Administration for Foreign Investment (SAFE). SAFE must figure out what to do with the rising pile of US$ (which is currently over the US$2 trillion). Some will be parked in US stocks, bonds, euros and so on. But the great majority ends up as boring US Treasury bonds.
  9. And so, the US$ makes a round trip back to America, hopefully to be used on Chinese goods again.

From this, you can see one thing: as long as US$ keeps streaming towards China, SAFE has to keep on investing them. Most of these US$ investments will end up as US Treasury bonds because it is the only market that is big and liquid (and politically sensitive) enough to absorb those never-ending stream of US$. Therefore, no matter how much China dislikes holding its forced savings as US$ assets, it has no choice.

But lately, China had announced some changes in rules that will hopefully alter the status quo (which they detest). Keep in tune!