On the Road: The Dollar, Interest Rates, and Gold

"Everything has its limit - iron ore cannot be educated into gold." -Mark Twain

"We turned at a dozen paces, for love is a duel, and looked at each other for the last time." -Jack Kerouac, On the Road

We were on the road last week and had some of the most interesting conversations since we started accepting macro clients. Two key areas of discussion were the U.S. Dollar and interest rates. On the former, the discussion centered around whether this "dollar crisis", as we are calling it, is really anything more than a trade into more risky assets globally. That is, investors are just selling the safe haven U.S. dollar and shifting into riskier asset classes like emerging market and small capitalization equities.

The second debate centered around the next move of the Federal Reserve. The most contrarian point we heard was that the Fed may not raise rates for more than a year and a half from now.

As in the Mark Twain quote above, everything has its limits, even the U.S. dollar. With the U.S. dollar down dramatically in the last 3-months and the U.S. stock market one of the worst performing global equity indexes, the facts clearly suggest that what is going on globally is a vote against the U.S. economic system. That statement may sound unpatriotic, but it is simply a fact.

While we have seen the appetite for risk assets increase over the past couple months, it is difficult to attribute the decline in the U.S. dollar to this asset shift. There is clearly something else going on as investors have been buying gold in that period, as we outline in the chart below, which is considered a safe haven in periods of heightened risk. In fact, global political rhetoric is almost as much evidence as we need to convince ourselves this is not the case. Over the past few days, there have been some public statements by Russian President Dmitry Medvedev, in particular, which highlight this point. His quotes are below:

The dollar is not in a spectacular position, let's be frank, and its prospects cause various questions as do the prospects for the global currency system.

And as it relates to a new global currency Medvedev said:

This idea has potential, even though some of my G-20 colleagues aren't actively discussing it at the moment. However, for example, in the opinion of our Chinese colleagues it is quite a possible step. The most important thing is not to walk away from discussions on this topic.

In the last statement, Medvedev is obviously appealing to The Client (China), who have voiced similar concerns as recently as this week with Treasury Secretary Geithner's visit to China. Over the past 9 - 12 months, this call by the Chinese has been getting louder and louder. In a April 17th note entitled, "Is China Advocating for the Bancor?", we quoted Dr. Zhou Ziaochuan, a primary player in determining Chinese fiscal policy, who wrote the following in an essay:

Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named "Bancor", based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. (Emphasis is Research Edge's.)

We can theorize about why the dollar is crashing and whether it is a crisis or not, but I don't think any of us can ignore the drum beat of the people that are buying U.S. dollars and Treasuries. A key catalyst in this political rhetoric will occur on June 16th, when Russia meets with Brazil, India, and China in the Russian city of Yekaterinburg, which is in the Ural Mountains. The Russians and Chinese have already played their cards, and they will only turn up the volume on the rhetoric during and post this conference and encouraging their Indian and Brazilian "colleagues" to do the same.

Jack Kerouac, who is of course the famous beatnik author, wrote the line at the start of this note in his novel, On the Road; likely he did not intend that quote to be used as a euphemism for the global currency markets, but the quote is an apt description as any of the global currency dual that is going on. To consider this merely a shift to a higher risk assets, would be very shortsighted indeed.

We make our calls based on the facts in front of us and don't have a specific view on when rates will increase, but ultimately if the voices from abroad continue their heightened anti-dollar rhetoric this will also become a political issue in the U.S. Clearly, in the short term anyways, one of the quickest ways to strengthen the U.S. dollar is for the Fed to raise rates. To some extent, their hand will likely be forced on the inflation front in that regard as well. That is, if the U.S. dollar continues to break down, reflation will turn into inflation, and the Fed will start raising rates. As the yield curve is signaling (outlined in the chart below), this could happen much sooner than many equity investors expect. After all, as most global macro fundamental analysts already know, bond markets are not lagging indicators.

Comments

[capt Brian:]

More rhetoric and no substance, in other words go fish, and good luck.

wimper sob, oh for some hard evidence of the future. Nope, not gonna be easy, try to go with the flow and take little bites out of the mid ranges, put the bulk of your money in nice single premium deffered annuities
Capt B

Jun 09 08:48 AM

[wg:]

From your piece, I understand you buying gold. But then you invest in a dollar "Bullish" stock and also a dollar 'Bearish" stock. Why not just put that money someplace and let it draw interest. Or under your mattress where its safe?

Jun 09 08:49 AM

[Bar Lock:]

Demand for gold from traditional sources is off 24% while the demand from ETFs is up 540% in Q12009. ETF demand for gold has risen from 5-8% in 2007/2008 to almost 45% of total demand in 2009. The question long term investors should ask is whether this sharp rise represents a paradigm shift on the demand side for gold or whether a dollar rally will drive the ETF demand for gold back to its traditional levels..Either way the level of demand from the ETF investors is worth watching going forward as it represents the most volitile component of the PM pricing equation.

Jun 09 09:37 AM

[holderofthe...:]

"it is difficult to attribute the decline in the U.S. dollar to this asset shift. There is clearly something else going on ..."
"We can theorize about why the dollar is crashing..."

Duh. There is a little oh boy with his very own printing press who's allowed to print as many US Dollars as he wants.
Soon it will be toilet paper.

Wheeee!! Do it again. Do it again!! Wheee!!

Jun 09 12:23 PM

[DONE_SONZ:]

dollar crisis", as we are calling it, is really anything more than a trade into more risky assets More like less risky.

Jun 09 01:15 PM

[Morrison Bo...:]

Whatever the short termp prospects for the U.S. dollar, the world will not continue to tolerate a system where the primary global currency is one country's national currency. The next major realignment of the world's major currencies should be to a
common currency managed by a monetary union central bank. If the world is lucky and plans ahead, we will avoid a major currency crisis. When such a currency supports countries with 40-50% of the world's GDP, that currency will become the defacto Single Global Currency, and the "tipping point" momentum will favor its continued growth, until it supports all the countries of the world. Thus will come the Single Global Currency managed by a Global Central Bank within a Global Monetary Union, and the benefits
can be measured in the trillions, annually.
Such a Single Global Currency will provide what the people of the world want - stable money.
The primary problem for the euro and every regional monetary union today is that they must still exist in the multicurrency world where the value of its currency will fluctuate against other currencies.
If 16 countries can use the same currency, why not the 192 U.N.
members? Those 192 countries now use 141 currencies and the number is dropping annually. The euro is definitely a harbinger of the future, and soon all 25 EU members will be part of the EMU, and by then, there will be more EU members to add. Several of the remaining non-euro EU members are now seeking admission as soon as possible. The IMF has even urged several EU members to "euroize" even before completing the standard accession process.
In addition to eliminating currency fluctuations, the use of a Single
Global Currency would eliminate the current foreign exchange trading expense of $400 billion annually, eliminate currency risk, eliminate current account imbalances, eliminate the need for foreign exchange reserves (now totaling more than $6 trillion); and bring other benefits worth trillions, such as reducing the impact of global financial turmoil such as we are now experiencing.
The Single Global Currency Assn. (singleglobalcurrency.org)
promotes the implementation of a Single Global Currency by 2024, the 80th anniversary of the 1944 conference. That’s only 15 years away.
The world is moving toward a Single Global Currency through the
creation, expansion and merger of regional monetary unions. Other
routes are through "ization" (as in "dollarization"and "euroization") and international monetary conferences proposals and
agreements, such as were seen at Bretton Woods. The merger of the eurozone with one or two other currencies is one possible route to a Single Global Currency.
The challenge now is to reach that goal deliberately, as soon as
possible, with as little cost and as few crises as possible. If the
eurozone were to merge with the U.S. dollar of the yen, or if the yen
and the U.S. dollar were to form a monetary union, the road to a Single Global Currency would be clear.
The only remaining questions about implementation of a Single Global Currency are: when? and how much cost and turmoil will the world endure before that implementation.
See the book, "The Single Global Currency - Common Cents for the World."
Morrison Bonpasse
Single Global Currency Assn.
Newcastle, Maine, United States

Jun 09 01:31 PM

[Roger Knights:]

"I don't think any of us can ignore the drum beat of the people that are buying U.S. dollars and Treasuries."

Huh?

Jun 09 01:42 PM

[JoeSixPack:]

One wonders if the collapsed $1 QUADRILLION derivatives bubble may play a part in all this?

Jun 09 04:31 PM

[Donald Ingram:]

The U.S. dollar along with all other global fiat currencies are heading for the tank. The key trigger for this to happen will be higher interest rates. People will lose confidence in paper money, which will lead to a collapse of global fiat currency systems.
Gold and silver will go much higher. Stay away from the ETFs. They are just paper certificates after all. Hold the physical.

Jun 09 05:25 PM

[user396040:]

The second chart suggests that the dollar has retraced to where it was in September before the crisis unfolded. This is not surprising - the dollar shot up because of the security blanket effect; now that people are becoming comfortable with the notion that we will not have a major financial institution fail every three or four days and we will not have a new Bernie Madoff revelation every month, people are moving into riskier assets. Meanwhile, however, the dollar is grossly overvalued against the Chinese yuan - remember a year or so ago when this was THE BIG POLITICAL ISSUE?? Well, the facts haven't changed. My wife and I recently traveled in central China - away from the tourist areas but in large sized cities. The dollar equivalent prices were absurd - $40 for a room in the best hotel in the city, 65 cents for a simple meal, $18 for a sleeper car train ride across half of China. Even in Beijing, we took a very, very long cab ride in from the airport, paid much less than it costs to travel half the distance at home, and then learned that we were RIPPED OFF and paid three times the normal fare. I had an all you can eat lobster dinner in one of the best hotels in Beijing for $28. If all else fails, I am going to move over there and have them forward my Social Security checks. Obviously, this cannot go on. I have the greatest respect for the Chinese people and what they are accomplishing. I also think that they are not anxious to take action which would result in a revaluation of their currency against the dollar. The international trade implications of revaluation or a change in the reserve currency situation must be taken into account and there are many key players with strong stakes in keeping things the way they are.

Jun 09 06:42 PM

[White Shield:]

somewhat related:
Jim Willie lets 'er rip -
www.321gold.com/editor...


On Jun 09 09:37 AM Bar Lock wrote:

> Demand for gold from traditional sources is off 24% while the demand
> from ETFs is up 540% in Q12009. ETF demand for gold has risen from
> 5-8% in 2007/2008 to almost 45% of total demand in 2009. The question
> long term investors should ask is whether this sharp rise represents
> a paradigm shift on the demand side for gold or whether a dollar
> rally will drive the ETF demand for gold back to its traditional
> levels..Either way the level of demand from the ETF investors is
> worth watching going forward as it represents the most volitile component
> of the PM pricing equation.

Jun 10 12:25 AM

[White Shield:]

How do you feel about funding international bankers/private stockholders of the Federal Reserve everytime we use "American" FR notes?

Market manipulation by shell corporations commonly known as "governments" really sucks, doesn't it?


On Jun 09 07:58 PM poortrader wrote:

> OIl need to be at $10 barrel. I'm tired of funding terrorists with
> petro dollars.

Jun 10 12:32 AM