It's pretty bad, but not for Gold, not in the fabled "long-run".
As you read on, keep in mind The Privateer's concept of Gold as the "reverse barometer" of global economic and financial conditions. Under this context, the worse conditions actually are and the more pressure there is on the "orderly functioning" of financial markets, the more pressure is exerted to force the $US price of Gold down - in contrast to what Gold "should" be doing in reaction to these pressures.
First of all, US Treasurer John Snow has come down with a case of "Diplomatic Flu", officially announced as a chest cold. This cold will keep Mr Snow from attending the G-7 meeting taking place this weekend (February 4-5) in London, England. It will not, however, keep Mr Snow from attending Mr Bush's unveiling of his next budget on Monday, February 7 in Washington.
Mr Snow's "contribution" to this G-7 meeting was slated to be the same as the contribution made by him and his predecessors for many years now. It was to re-iterate the "strong Dollar" policy and to urge the rest of the world to speed up their "growth" and thereby take the load off the US as being the sole and prime engine of global "economic growth". Translated into English, the second part of this "mantra" simply asks the rest of the world to get off their butts and inflate faster than the US is inflating so as to share the load around.
Second, we have the spectacle of the rapidly flattening yield curve on US Treasury debt paper. We have added a new chart to the page on Treasury yields for Privateer subscribers. This chart shows the spectacular fall in the spread between two-year and ten-year Treasury yields over the past eighteen months. In August 2003, the spread between two and ten year yields was 276 basis points. As of February 4, 2005, it had plummeted to 79 basis points.
As a more recent example, Since June 30, 2004 and the first Fed rate rise, the Fed funds rate has increased from 1.00% to 2.50% - that's 150 basis points. Ten-year bond yields hit their 2004 high of 4.89% on June 14, 2004, two weeks before the Fed raised rates for the first time. On the same day, two-year yields stood at 2.93%. Today (February 4, 2005), ten-year bond yields stand at 4.08% - 81 basis points LOWER than they were in June last year - BEFORE the Fed started to raise rates. Two-year rates now stand at 3.29% - 36 basis point higher than they were in June 2004.
The one INFALLIBLE warning sign of a coming recession, the one signal agreed on by economists and investment analysts from all "schools of thought", is an inverted yield curve in which short-term rates are higher than long-term rates. The US does not have such a curve - yet. But the spread between short and long term rates has been narrowing for eighteen months and the speed of that narrowing has been increasing ever since the Fed started to raise official rates last June.
Now we come to the third point, the big one. As is usual in situations like the one facing the US and global financial system at present, this one is political - it is geo-political in fact. To see the background, here is a link from Yahoo news dated February 2 and titled US Senate to mull deadline for China to revalue yuan. Yep, it's political alright. Not even economists are that stupid.
According to the report, a dozen Senators, from both parties, agreed to "co-sponsor" a bill which gives China "a window of 180 days" to stop fixing its currency to the US Dollar and "revalue" it. If China does not comply, the bill states that all Chinese manufactured goods exported to the US will face a tariff barrier of 27.5%!! Breathtaking, isn't it?
There is NOTHING that we can think of - and we are fairly knowledgeable and have well functioning imaginations - which could better illustrate the true nature of the fiscal and financial dilemma now facing Washington than this bill. There is NO WAY that the US government can be ignorant of the potential effects on their own economy of slapping a 27.5% tariff on Chinese manufactured goods. In addition, there is no way that the US government can be ignorant of the fact that by setting a deadline on a LARGE Chinese currency revaluation, they are setting a deadline on China realising a HUGE loss on the mountain of $US based assets they now own - or are expected to acquire in the future to go on offsetting the effects of the US trade/budget deficits.
No matter, as this link from the "Carolina Channel" titled: Graham Wants Big Tariffs On Chinese Products illustrates. The bill imposing the 180 day deadline for the Chinese revaluation and the 27.5% tariffs if they do not revalue was introduced on February 3. The introduction of legislation does not automatically mean that it will be passed, but this bill has bi-partisan support and is expected to pass, according to its two sponsors Senator (R-SC) Lindsey Graham and Senator (D-NY) Charles Schumer.
The Chinese government does not usually comment on this kind of thing, but they made an exception for this bill. The official rejection was almost instant. Here is the link from AFX News dated February 3 and titled: China rejects threatened US Congress deadline on yuan revaluation. Even the higher echelons of the Bush Administration are baulking - Congressional move to pressure China on currency unproductive. The source of this is US Treasury Undersecretary John Taylor, the man replacing Secretary Snow at the G-7 meeting this weekend.
China fixed its currency, the yuan/renmimbi, to the US Dollar in 1995. For nearly seven years, up until January 2002, the Chinese currency went UP with the US Dollar. No-one, least of all the US, complained about the lessening international competitiveness of Chinese goods which this entailed. Since January 2002, the yuan/renmimbi has been going down along with the US Dollar - as have most other Asian currencies. Over the same period, the Chinese have become the biggest US trading "partner" and Chinese goods exports form a significant portion of the US trade deficit. Successive US Treasurers have been complaining ever more stridently about this ever since it started.
ALL US economists, financial analysts, and even politicians are agreed on one aspect of the US economy. This is that anywhere from 65-75% of the growth of US GDP is directly attributable to consumer spending. Picture the future of US consumer spending if this bill is passed and these tariffs imposed on Chinese imports. The impact on the prices of goods on the shelves of Wal Mart would be shattering, to say the least. And, of course, the prices of other imported goods, and US manufactured goods too, would rise.
On top of that, there is the small problem of the continuation of Chinese buying of $US denominated debt instruments. This, as is well known, is what is "financing" both the US trade and budget deficits and what is holding longer-term US interest rates down. Would the Chinese keep buying, would they stop buying, or would they START SELLING if this bi-partisan bill was to actually pass?
Finally, the parallells to the Smoot-Hawley tariff act of 1931, which ushered in the crash dive into the depths of depression less than a year later, are too obvious to elaborate here. There is just this difference. In 1931, the US had a comparatively tiny budget deficit which had been falling for a decade. It had a trade surplus, not a deficit. And it was an international net creditor nation. Look at the US now.
China is present at this weekend's G-7 meeting in London on an "observer" basis. The Chinese government has already made known its "displeasure" with the introduction of this bill on the floor of the US Senate. Financially, the passage of this bill would not be a case of the US government shooting the US economy in the foot, the bullet would go straight between the eyes. To threaten the nation which stands between you and financial apocalypse with tariff retaliation if it does not revalue its currency, thereby taking HUGE losses on its purchases of your debt paper and almost guaranteeing it will not only stop buying more but start selling what it has, is an act of political lunacy.
And THIS is the situation in which the US Dollar price of Gold is going down. Truly, the Gold "reverse barometer" has never worked this well. The true state of the US financial system has never been so starkly, if unintentionally, brought to light. Only those who see financial calamity straight ahead would propose a measure which guarantees financial calamity - in six months time.