In the past few weeks we have seen probably two of the biggest mistakes in the handling of events post-Lehman Bros. The first was the attempted bail-in of insured depositors in Cyprus. The second was the enormous increase in the quantitative easing policy of the Bank of Japan. Both of these policy decisions will have far-reaching consequences of the unintended variety. Both of them are bullish for the price of gold.
The Cyprus bail-in strategy was not endorsed by all members of the major central planners involved in navigating the Western world through the current debt deflationary cycle we are experiencing. Both Ben Bernanke and Mario Draghi have been quick to distance themselves from the policy which, if you stop for a moment and think about it, runs exactly counter to the policies that have been adopted since the September 2008 financial crisis broke out - namely to secure the continued operation of mostly normal banking operations, albeit under extremely tenuous conditions.
The efforts of most of the central bank heads in Europe and the U.S. had created, up until Cyprus, a false sense of security which created faith in the U.S. dollar and, to a lesser extent, the euro. Both currencies may be sick in terms of value retention but both still functioned as a medium of exchange and within tolerable volatility bands. With the incessant back-pedaling since the initial announcement of depositor impairment in Cyprus it is clear that IMF Chief Christine Lagarde and members of the European Commission went too far and in doing so laid bare one of the funding mechanisms for resolving all of the imploding debt when quantitative easing would no longer suffice.
The only other explanation is that Germany attempted to declare financial warfare on Russia and Putin slapped Angela Merkel back down privately. That's not a scenario I take very seriously. No, the actions of the architects of the current financial world are very telling. Lagarde at the IMF and northern Europe got impatient and tried to push too far too fast over not enough money and in doing so undermined the foundation of Western banking.
The long-term effects are obvious. Capital will flee Western banks and the job of the central banks will be made even harder to maintain any semblance of control over this mess. No amount of statements to the press by the people responsible for this will placate people. Lost trust in banking is similar to a food scare. There is no percentage in taking the risk. People will withdraw their money and ask questions later. And some of them will be smart enough to get their money out of the financial system altogether and put it into gold, and to a lesser extent, silver. With physical demand already causing serious price dislocations vis a vis the futures market, adding this demand will only ensure that sentiment turns around quicker and the price will begin to leak higher.
The second policy decision - the nearly ridiculous level of quantitative easing announced by the Bank of Japan - will have a more immediate effect. In fact we are already seeing the effects and they are not only bullish for gold but also for the euro at the expense of the dollar.
The great Yra Harris, whose blog everyone should read, has made the very salient point that Japanese bond holders are, as everyone knows, primarily Japanese entities - banks, insurance companies, pension funds, individuals - and that now that the BoJ is targeting CPI inflation all of those bonds will be carrying a negative yield. Moreover, so many of them are sitting on large capital gains on the value of the bonds themselves. This policy will send money out of Japan and into high yield sovereign bonds, or at least any bond with a positive yield spread to the expected CPI inflation rate.
This means, of course, European debt. French, Italian, Spanish and Belgian bond yields have all dropped like a rock in response to this policy change by the Japanese. And, of course, the money is going to flow there because Mario Draghi not 12 hours after the BoJ announcement reiterated that the ECB stood ready to do whatever it took to keep the euro together. It sure sounds like the Draghi Put is still in place to me.
This is bullish for the euro in every way. Yes, it will strengthen and yes it will be tough on German car manufacturers like Volkswagen (VLKAY.PK) but at the same time, Germany is a huge energy importer and a strong euro with Japanese capital flowing into it faster than it is flowing into the U.S. dollar will be able to stay ahead of any rise in the price of Brent crude and natural gas.
Statoil (STO) is providing competition to Gazprom (GZPFY.PK) right at the time when the Russian gas giant (all puns intended) is having to renegotiate contracts all across Europe (see here, and here ). So, in general, we are looking at a different energy market for Europe than we have in the past few years. The euro price of Brent crude is threatening the €80 level which hasn't been seen since December 2011. Rebuilding the stricken economies of the periphery that have been put through vicious austerity measures will not occur with rising energy prices.
Domestic industry will be rebuilt with relatively cheaper energy while Japan will hollow out what is left of its economy with ruinous rises in commodity prices in yen terms. The BoJ's QE program will not only chase capital out of Japan, potentially sparking a collapse of the currency, it will also send energy prices soaring, transferring wealth back to a European economy that may sell fewer cars of European origin but they will be better able to afford to actually use them.
All of this is extremely positive for gold, as I said at the outset. Some of that capital flight from Japan will wind up fleeing into gold -- we are already seeing the beginnings of it. In Europe, the insecurity of savings will do the same thing. Moreover, the ECB will welcome a higher gold price as it supports an expansion of ECB's balance sheet relative to the liabilities against it. With U.S. bond yields already below the BoJ's inflation target of 2% with the exception of the 30 year bond, the U.S. will see limited inflow beyond from Japan. Again, this is bullish for gold prices.