Paulson's Dollar Bluff
Financial journalists seem to be pretty excited about the prospects for intervention to support the dollar, but how realistic is this or the idea that a couple rate hikes from the Federal Reserve are enough to crush inflation?
When asked about the U.S. possibly intervening to support the dollar, the Treasury's Henry Paulson said it was "never off the table." When asked the same question later in the day, the Federal Reserve's Richard Fisher said, "I watched the Paulson interview. I'll leave it as it was. You never take anything off the table. The key thing is to get our own house in order."
Notice how Fisher wasn't as aggressive on the intervention front as Paulson and focused more on getting "our own house in order." That's probably because Fisher knows the only lever the U.S. has to support the dollar is interest rates, which can't rise until the banking system and economy are righted.
As I'm sure Paulson well knows, (in my opinion he's just bluffing like the rest of them) the U.S. has no foreign currency reserves to speak of with which to intervene even if it wanted to (other than gold). That's what happens when you run a record trade and current account deficit year after year, but it's never really mattered before since the U.S. dollar was the world's reserve currency. That's where today's situation is somewhat different from any other post-1980.
Today, the only way the U.S. can intervene in the currency markets is if foreign central banks intervene for them and support the dollar by "printing up" their own currency and buying dollars (or through swaps allowing the U.S. to do so). Either way, foreign central banks have to be willing to accept more of the inflationary burden for them to do this, since their currency would weaken against the dollar. However, inflation would remain the same and therefore worsen from the foreign central bank's standpoint due to their own currency's depreciation vs. the dollar.
In the case of the ECB, it clearly doesn't want to carry more of the inflationary burden for the U.S. and won't be riding to the rescue to push down the euro anytime soon, even though it would clearly prefer the euro to be weaker for trade reasons as long as it was combined with lower inflation. But when given the choice, the ECB clearly appears to have chosen fighting inflation over favoring growth via a weaker euro in its most recent statement, and that means the euro is going higher, given that the U.S. cannot follow with rate hikes of its own.
Actionable ideas, Instant analysis. Real-time from bell to bell.
Minyanville's Buzz and Banter- 14 day Free Trial
These statements by Paulson regarding intervention amount to a giant bluff, and like the Fed's comments about inflation, they are merely designed to buy more time by trying to prevent the dollar's decline from becoming disorderly. Talk will only go so far, however.
The same can be said for "Gentle Ben" Bernanke's "tough guy" comments last night on inflation as well. After all, this guy has been talking tough against inflation every meeting since he began easing in September. Now the market is finally forcing him to raise the volume of the rhetoric somewhat by pushing oil to levels that six months ago would have been beyond the wildest dreams of most.
There's no doubt that the Fed will eventually be raising interest rates at some point, but it won't be until the banking system is in better shape. And even then, the creep higher in interest rates that the Fed is likely to undertake will remain well below the rising rate of inflation for some time (i.e.- real rates will still be negative even as the Fed is raising rates). Even the Fed's Fisher, the supposed "hawk," said today that any future rise in interest rates would be "very deliberate'' and "gradual."
This Fed bluff against inflation is no different than Paulson's intervention bluff on the dollar. yes, the Fed will eventually be raising rates, but by the time it does, it will be so far behind the curve that it won't matter much.
As I've noted before, it was after the dollar index bottomed in 1978 that inflation really accelerated during that particular stagflationary period. It was also after that low in the dollar index and after Volcker began raising interest rates that gold went up four-fold too. The Fed's first rate hike is not the signal of the end of inflation. Instead, it's typically the signal that inflation is about accelerate. Monetary policy works with a lag after all.
The Fed has been quite successful at running the printing press and cushioning the housing bust and the resulting credit crunch, but the price of that "printing" is going to be more inflation. There are no free lunches.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved.
nice insight into what the treasury/fed can and cannot do. I agree wholeheartledly.
However, I remain cautious on the precious metals and continue to stay in Norwegian, Australian and Canadian dollars and make just under 5% interest while I wait for some sign of the day of reckoning.
SLV seems less risky to me because of the relative price of an ounce and the fact that it may be a jewelry replacement for gold...and the fact that it is still consumed. I own some SLV that I have been in and out of.
I have been most frustracted by the price action in gold lately. Using GLD we had a correction from 100.44 to 83.59 so far (-16.85), almost hit the old 1980 high of 850 an once and then bounced up to 92.10 or about +8.51. This advance was almost exactly 50% of the inital retracement. Then last Thurs we went back to 86.50 or so which was about a 78% retracement of the advance to 92.10. Then we bounced so hard I got whiplash! I thought great, finally we are headed up! But this week we have bronken 86.50 and seem now set to retest 83.50 or 850/once. Will we hold here again or is it likely we will crash through this suport this time?
I guess the action in gold suggests the market expects the gold/oil ratio to correct by oil going to 90 rather than gold going to 1300? I do believe all your fundemental arguments on why gold SHOULD go up, I just don't understand the price action lately...
BTW I reallly enjoy your articles.
Here are my thoughts on GLD from a more technical approach:
1) On a long-term monthly basis, GLD looks like a bull market that is testing/resting for a while before resuming up.
2) On an intermediate-term weekly basis, GLD still looks in good shape for a bull. This looks similar to the basing that it put in from 5/8/06 to 10/2/06 and you could argue went even to 1/3/2007. Obviously, after that it launched way way up.
3) On a short-term daily basis, GLD is in a down-trend. I think this is the start of a very short bounce up again but it won't last. I think we are in this down-ish channel at least through mid june and probably thru mid july as well.
So, in summary: I think it depends on your time frame. If you want to day trade GLD it may keep frustrating you and it moves up and down its range for a while longer. If you're looking longer term, I think you're in good shape.
Charles
Thanks very much for your comments! You are right I keep looking for the turning point in GLD and keep getting frustrated. I am glad that you are also optimistic longer term and I am happy in most of my positions to wait it out. The action keeps getting stanger though. I am actually hoping we will go back down and test 83.50 again (successfully). I think that might mean that the bull market might start again...finally. Of course if it just starts going up from here that would be great as well! If it breaks 90.00 again I would think that 83.50 is looking less likely. Tomorrow should be VERY interesting!
John
