Jim Rickards’ new book, "Currency Wars," has been getting plenty of attention recently as its launch has seen it rocket up the best sellers lists, and not just in the financial and economic world. Jim has also had an interesting spat with Nouriel Roubini recently on Twitter, which still seems to be rumbling on. The title of Jim’s book seems to be rather prescient at this time as we look across the eurozone and watch the markets generally. Jim advises that we are in the middle of the third great currency war, we find his arguments compelling, and the release of his book is perhaps timely.
Market attention is still largely focused on the eurozone and a currency at considerable risk. Pressure is building on a wider range of constituent parts of the European currency union as notably Germany finds a debt auction a little more than half subscribed. Germany is no island of fiscal solidarity as Kyle Bass points out in an excellent interview with the BBC’s "Hard Talk" (many will have no doubt seen this after ZeroHedge helped kick it viral[ish]). Bass cites Germany’s 81% debt to GDP ratio and the fact that, as Professor Peter Bernholz finds in his book "Monetary Regimes and Inflation," Germany has defaulted twice in the last 100 years. We would join Bass and others in believing that the German balance sheet is not strong enough to backstop the eurozone’s problems. We also think it less than likely that Germany will opt to act as such a backstop anyway.
Surely Angela Merkel’s continued refusal to even table a eurobond initiative is evidence of this. Even if Merkel were willing to pursue a eurobond, this solution could be mal-adaptive anyway. The European currency union’s structure allowed certain debt imbalances to build up in its prior guise, and such a collective pooling fiscal sovereignty and liability required to issue a eurobond would once again open an agency issue. Andrew Lillico of Europe Economics refers us to previous research by Gneezy et al, published a few years ago in the Economic Journal, which found going to dinner with friends on the basis that the bill would be split equally (as opposed to paying for what one consumes) lead to an average bill that is 36% higher. We would urge that this finding is problematic for this suggested pooling of eurozone debt, which would in fact facilitate continued over-spending.
Against this backdrop of a recent failed German debt auction, Italy conducting a successful but painfully expensive debt auction of its own last week (at a price of 6.504%, the highest since August 1997, and double the October 26 auction price of 3.535%), and the Spanish deciding to cancel their planned 3Y auction, pessimism is the mood du jour. The EFSF which as a policy response looked concerningly like a fart into a thunderstorm, now appears to potentially be such a small financial backstop that it fails to have a raison d'être. As a policy response Peter Tchir of TF Market Advisors finds this wholly unacceptable and comments that:
"On a side note, several EFSF members should be fired, replaced or demoted, for their performance. Trying to raise money on something so complex without even a pitch-book is just pathetic and would not be condoned at even the worst run investment bank."
At just over one trillion euros the initially presented EFSF ran a significant risk of being just too small anyway, and now a number of EU technocrats blame "market conditions" for preventing the desired leverage of around 4:1 being achieved. "Market conditions" ranks up there with "evil speculators" for fall back phrases over-used by the political class. Leveraging the EFSF was the main solution (given that debt pooling is not being entertained by German) put forward to stop fallout from Greece spreading to European banks and its largest economies, particularly Italy. The aforementioned Peter Tchir bemoans this lacklustre policy response in an excellent analysis called "EFSF, we hardly knew ye…."
In his analysis Tchir suggests that the Fed should buy EFSF bonds and opines that the Fed could justify buying EFSF bonds (at low yields) in an effort to promote market stability and hence employment, and if they do it in euros the combination of "printing" and "buying euros with that newly printed money" should put a lot of pressure on the dollar. In spite of the inflationary risks associated with that, Ben wants the dollar weak so exports can be helped. Could such a policy option allow the Fed to play another hand in what Jim Rickards calls the "third currency way?" Well, let’s wait and see, but as Kyle Bass points out, as an aside, there is something rather comical and ironic in that fact that Europe currently has a German Pope but an Italian central banker.
In the meantime it seems central banks elsewhere have been buying gold in further efforts to "diversify their reserves." What this diversification really means to us is reweighting their portfolios in favour of sounder money and away from questionable paper, or as the man of the moment, Kyle Bass, describes it "as buying a put against the idiocy of the political cycle." It seems central bankers are managing their nations’ savings with significant concern for idiocy of the political cycle as shown by the IMF’s latest central bank gold buying data for October. The numbers run like this:
- Russia bought 19.5 metric tonnes bringing their total gold reserves to 871.1 tonnes
- Belarus increased holdings by 1 tonne
- Colombia increased reserves by 1.2 tonnes
- Kazakhstan bought 3.2 tonnes
- Mexico purchased a further 0.9 tonnes from recent previous buying
Within the data it appears that Germany reduced reserves by 4.7 tonnes and Tajikistan did similarly by 0.4 tonnes. Germany was apparently selling this gold to its treasury for the production of gold coin memorabilia. This appears more of a minor transfer of public holding to private holding. It would appear that central banks are net buyers of gold for the first time in a generation in a reaction to unprecedented systemic risk and monetary instability. IMF figures are obviously only based on publically available data, and we find anecdotal reports of the Chinese central bank continually and quietly accumulating gold as unsurprising and a natural policy response. If we were a creditor nation we would also be diversifying out of dollars, euros, and pounds whilst Western central bankers make merry with their printing presses. Such central banks still have a way to go in this endeavour. If we look at creditor nations such as China and Russia, both holding major reserves of dollars and other FX, they only hold approximately 5% of their reserves in gold. Central banks are now net buyers to the tune of over 400 tonnes a year according to the World Gold Council, when only a few years ago they were net sellers of similar amounts. Eric Sprott finds this 800 tonne demand shift in a 4000 market notable; we agree. If this central bank diversification continues at current rates we believe this large contribution to increased gold demand would result in significantly higher price discovery.
Within this dynamic, we feel it is worth taking a closer look at Russia. It would appear that Russia feels it is onto something here, and it increasing its gold purchases aggressively as a result. When complaining about U.S. deficits and financial irresponsibility, President Medvedev has previously compared the U.S. to "a parasite." Russia is worried about a "flawed dollar" being the world’s reserve currency, and it presenting a significant threat to financial markets. The Russian central bank is thus re-structuring its reserves and buying more gold in an effort to protect the rouble and weather apparent stresses within our current monetary paradigm. Within this agenda Russia has also made accusations that many other participants in the precious metals markets have been making for some time, that western central banks have been acting egregiously in the gold market to suppress the price to the detriment to the wider less Atlantacist financial world. A number of macro and gold analysts have suggested that creditor nations, such as Russia and China, could use gold to reclaim financial and monetary power from the Western nations. If you believe he who holds the gold makes the rules, then you may be sympathetic to this argument.
What has been interesting about Russia’s gold buying from 2004 onwards has been the level of political affiliation and grandstanding. Over these years Putin and Medvedev have a made considerable song and dance about Russia’s activity in the gold market. Take a look at the posturing in the photos below.
Russian movements in the gold market remind us of the central bank activity that eventually exposed the structural flaws of the Bretton Woods currency system and also the London Gold pool that lasted from 1961 to 1968. The Fed’s "gold window" was meant to ensure that the world’s reserve currency and monetary focal point was apparently backed by gold. Eventually central banks with access to the gold window lost enough confidence in the dollar and American financial discipline to begin a steady drain of the U.S. gold reserves (international central banks could exchange dollars for gold at a fixed rate). These central banks also saw that the ‘official’ gold price was lower than the real or market price, as the London gold pool was found not to be strong enough to resist the market’s desire for higher prices, and were naturally keen to profit from a bit of arbitrage even an EU technocrat could identify. President Nixon had to close the gold window in August 1971, and the world entered a monetary regime that was for the first time purely fiat and a regime that Doug Noland at Prudent Bear calls Bretton Woods II. Goldcore finds that:
"Putin's calculated gesture may have been the most important statement on gold by a head of state since French President de Gaulle praised gold as the ultimate from of money and wealth: "There can be no other criterion, no other standard than gold. Yes, gold which never changes, which can be shaped into ingots, bars, coins, which has no nationality and which is eternally and universally accepted as the unalterable fiduciary value par excellence."’
If Russia and other creditor nations to the profligate West understand monetary history as perhaps they should in the face of continuing currency debasement by the U.S. and other debtor nations, the simmering currency wars of the last few years may heat up and become rather more obviously observable to the man on Main Street. We feel the circumstances continue to make it prudent for investors to act as Jim Sinclair advised many years ago when he recommended: "be your own central bank." Are individuals acting thus and generally rebalancing their portfolios towards gold? Some are but this has not become a generality yet.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am long gold and silver bullion, and mining shares. I am an executive of a precious metals investment service.