(Gold did not trade in the US on June 11 due to the funeral of Ronald Reagan.)
On Thursday, June 10, the Bank of England (BoE) announced that they had raised the official British interest rate (the equivalent of the Fed Funds rate) by 0.25% to 4.50%.
The BoE said that the rate rise was necessary to keep "inflation" in check. For "inflation" raad real estate prices. British house prices are currently rising at a 20% plus annual rate. The latest official British measure of "inflation", compiled quarterly, shows a rate of 1.2% in April up from 1.1% in March. The BoE predicted that the British "inflation" rate would be above 2.0%, the target set by the British government, by the end of 2006.
The end of 2006 is two and a half years away. The present official "inflation" rate in Britain is a mere 1.2%. Yet the BoE has now added a full one percent to its key interest rate over the past eight months and a full half a percent over the past MONTH.
Many commentators and financial analysts all over the world are now asking the same question: Is what the Bank of England has done over the past eight months a "portent" of what the Fed might have to do once they start raising US rates, as most expect them to do, at the end of June?
British "key" interest rates bottomed in July last year at 3.50% and were only maintained at that rate from July to November 2003. US key interest rates bottomed in June last year at 1.00% and have remained at 1.00% to this day. The Bank of England became alarmed at the profligate level of British consumer and real estate borrowing late last year and has been raising rates ever since, with the pace of the rate rises increasing markedly over the past month. The Fed has watched equally profligate consumer and real estate (and federal government) borrowing over the same period, but have thus far sat on their hands.
That is now almost universally expected to end on June 29/30 when the FOMC meets. Almost everyone expects the Fed to raise their funds rate by 0.25% at that meeting. A minority (whose numbers are increasing) of pundits is now starting to muse about the possibility of a 0.50% rate rise at that meeting. This has come about since Alan Greenspan, in a speech given via satellite to a conference in London, mused about the possibility of jacking up US rates more aggressively if that should prove "necessary".
It should be noted here that the US, home of the world's reserve currency, and the European Union (EU), home of the challenger to the status of the US Dollar, are the only two major "nations" which have NOT raised their respective controlling interest rates since 2000. Presently, the US rate stands at 1.00% while the EU rate stands at 2.00%. The governing council of the European Central Bank (ECB) meets every two weeks and has a press conference and press release at every second meeting. The most recent ECB press conference was on June 3, when the ECB left rates at 2.00%. The next ECB press conference in on July 1, the day after the FOMC decision becomes known.
It is as close as anything which has not yet happened can come to a CERTAINTY that if the Fed raises rates on June 30, the ECB will do likewise on July 1. The ECB may even raise at their next meeting (sans press conference) on June 17.
Now, getting back to the comparison between US and UK interest rates, please contemplate this table. It compares key maturity government debt yields in the two nations:
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There are several VERY important items to note about this data:
This picture would be largely duplicated in most other major nations. Germany, for example, has 10 year rates which are lower than the US rates (4.43% vs 4.80%) even though the ECB key rate at 2.00% is DOUBLE the Fed Funds rate. Australian 10-year yields are 5.96% while the Australian Reserve Bank rate is 5.25%. You get the picture - the anomaly here is the yield curve on US Treasury debt paper. Even more, it is on the fact that US Treasury debt paper of all maturities is so far above the key rate of its Central Bank.
To come back into anything resembling "balance" with the rest of the world, the US Fed's "key" rate (its Fed Funds rate) would have to at least DOUBLE (from 1.00% to 2.00%) to match what is happening in the EU. To match what is happening in the UK, Australia, and most other major western nations (Japan doesn't count since - at 0.001% - it doesn't HAVE a "key interest rate), the Fed Funds rate would have to QUADRUPLE - right now.
The longer this is delayed, the more the pressure will build on the US Dollar and on the nations which are throwing "good" money after "bad" to continue to support the US Dollar by buying US Treasury debt. The more aggressive the Fed is in raising its key rates back into some kind of "balance", the more the pressure on the grossly indebted US consumer, corporation, and government. The situation is grave.
Gold always (repeat - ALWAYS), moves higher in a climate of rising official (key and government debt) interest rates. This is especially true in a climate such as the one at present, when the higher rates are impacting against a gross debt overload. The reason is simple. The higher rates are a reflection - and are seen to be a reflection - of the increased risk to the purchasing power of the currency and the ability of debtors with debts denominated in the currency to service and repay their current obligations.
This can (and has in the past) been masked in the nation which commands the world's key (or reserve) currency because the rest of the world has a vested interest in that nation's currency retaining its purchasing power. But even such vested interests cannot sustain a key currency when it has been inflated to the extent which the US Dollar has over the past decade. Once the Fed starts raising rates, it will start playing "catch up". And it can't "catch up" (like it did in the late 1970s with 20% "key" rates) today.
The inevitable result will be a falling Dollar, and a rising Dollar Gold price. And because the Dollar still has THE key place in the global financial system, its fall will severely impact the functioning of that system. That's when Gold will start to go up again, not only in terms of US Dollars, but in terms of ALL national currencies.
The Fed is staring down an ever shortening barrel. The trigger comes down at the business end of the barrel on June 30. After that, the Fed is in a race it cannot win.