I'm not a goldbug. Way back on April 16th I wrote as part of this post, "Give me a fundamentally sound reason to buy the dollar, and I will." I don't belong to the world of kneejerk hatred of fiat currencies, conspiracy theories and suchlike. For one thing, there's a big difference between the utopian world of the perfectly smooth capital market (doesn't exist) and the wholesale manipulation paranoia promoted by GATA and company. For me, being dollar bull/dollar bear is all about the macrofundies, and up to now the structural weaknesses in the dollar have precluded me from buying into the currency. At the same time gold has seemed to me a far better alternative as a means of capital preservation.
This has worked well for me in the last three years. I bought bullion at U$451/oz, and I'm a million miles ahead of the person who put his dollars into a time deposit account and now wants to buy a few ounces of gold. However the trade has obviously unwound somewhat in the last month. The dollar index [USD] has moved from under 72 to over 77, and at the same time gold has made its headline-making plummet to under $800/oz.
The question I've been mulling over this morning is "Is the current USD move from approx. USD 72 to approx. USD 77 backed up by the sound fundamentals I need?" (and if you're wondering, YES, this is the type of baloney a financial wonk thinks about while laying in bed late on a Sunday morning...sad, ain't it?).
Here's what I think: The dollar's move has been backed up by China's central bank buying into US treasuries in a direct way (i.e. via the New York Fed deposits mentioned in this post and looked at in far greater detail by the excellent Brad Setser in his blog). The $29bn noted by Setser is a very large chunk of change, and by pumping it straight into treasuries the US gov't has successfully rallied the dollar. Once the ball gets rolling, more money jumps on and the rally snowballs. Here we are today. But is it a fundamentally sound position?
To me and my fundamental mindset, this current US dollar move puts the cart before the horse. You see, the base of all this is the country's economy. A strong economy is the horse, and its currency is the cart. If the economy is strong, this will be reflected in its currency. As a couple of very simple examples (used as pure illustration of this basic point in economics), look at the relationship between Brazil's motoring economy and its ever-strengthening currency. Now look at Zimbabwe's economy and its currency. Got it?
So the "quiet bailout" (aptly named by Setser) of the US economy by the import of Chinese money is fundamentally sound in itself, but it is also an artificial method of propping up a fundamentally weak economy. Look at the development of the USA's inflation rate, its unemployment rate, its weakening consumer spending figures etc etc (I haven't even mentioned housing, you'll note). It's a relatively strong move by the dollar for sure, but even though gold has tanked because of it, it's only really relatively strong to other currencies that are probably behind the loosening curve (e.g. Euro, GBP). Gold gets caught in the crossfire, and down she goes.
The other thing about this artificial USD propping method is that it threatens to nip the recovery in US exports in the bud. The current weak dollar is a reflection of the current weak US economy. However a weak currency is also part of the long term economic recovery of its country, as it allows the country to become competitive in world terms. In the long run, it's healthy for the USA (yeah, I know...in the long run we're all dead).
But when non-market forces (they usually go by the name 'politicians' who decide to get too Keynesian on the market) create their own imbalances, these in turn have to be corrected later. This is not YET the case with the current USD move, but it would become that if allowed to continue.
Therefore, I propose one of two scenarios:
- The current Chinese "quiet bailout" is only a temporary measure. Once it stops the real structural weakness of the US economy and therefore its currency will show through again, and the USD will drop.
- The current Chinese "quiet bailout" continues indefinitely and further strengthens the USD. This will be papering over the cracks, and as the cracks get wider, more paper will be needed until the whole new edifice collapses.
Either way, I'm not buying the US Dollar right now. The horse isn't pulling the cart yet, and the relative strength in the dollar isn't backed up by the basic things it needs to continue its march. All I see today is a successful short-term scalp of dollar bears, and not a recipe for long term country and currency strength in the USA.