Exactly three weeks ago, on July 14, the Japanese Central Bank finally made it "unanimous". After six years of not having an official interest rate at all (alright, it was 0.00%), the Bank of Japan "raised" the rate to 0.25%. In effect, Japan once again HAD an official interest rate. And with that action, Japan joined ALL the rest of the world's Central Banks in raising interest rates.
As you probably know, back in March, the US stopped publishing their "M-3" (broad money) data. Four months ago (in issue # 549), The Privateer headlined its Early April 2006 issue thus: "The Global Squeeze Is On" The "global squeeze" referred to the inexorably increasing pressure on Central Banks all over the world to raise their official interest rates.
The first "bout" of global rate rises took place in late March - early April. That one led to a takeoff in the Gold price which saw Gold gain more than $US 180 in less than two months, peaking just above the $US 720 level on May 11. The second bout took place in early/mid June. This time Gold was in the process of plummeting. by June 14, it was down to $US 562, having given up almost 80% of its 2006 gains in the space of a month. Gold was not the only thing that was plummeting. Across the world, stock markets and bond markets tumbled while currencies gyrated wildly and commodity prices of all descriptions crashed.
As you know, the US Fed has been raising its rates like clockwork for over two years now, 0.25% being added to the Fed Funds rate at every FOMC meeting since the one on June 30, 2004. What has happened this year is that the rest of the world has begun to raise their rates too. They have been doing this because the global price increases brought about by the gigantic US "twin deficits" have started to show up in their economies with a vengeance. The past two or three years has seen by far the greatest accumulation of US Dollars and Treasury paper (AS RESERVES) in the basements of Central Banks all over the world in history. When a Central Bank has more reserves, it can bring more of its own currency into existance, either directly through its open market operations or more usually indirectly through increased lending by the commercial banks. That is what had been happening, to the extent that it was now seen as imperative everywhere to try to choke off this out of control credit expansion before it spiralled out of control.
The best evidence that it WAS spiralling out of control was, of course, the HUGE run up in the Gold price between mid March and mid May this year.
And, perversely enough, the best evidence that it is STILL spiralling out of control is the huge Gold correction since mid May, a correction which is still "intact", Gold at its current level of $US 644 having as yet only recovered half of its mid May to Mid June fall, despite the fact that the US Dollar as measured by the $US index (USDX) is now only 0.31 points above where it was on May 11 when spot future Gold closed at $US 721.50.
Now that the last holdout, the Bank of Japan, has succumbed, we have another bout of Central Bank rate raising over the past week. On August 2, the Australian Central Bank raised by 0.25% to 6.00%. On August 3, the ECB raised by 0.25% to 3.00% and strongly hinted at more rises to come. On the same day, in a TOTALLY unexpected move, the Bank of England raised 0.25% to 4.00%. And then on August 4, the Bank of Italy announced that it was radically altering the makeup of its foreign exchange reserves by selling US Dollars and Treasury debt paper for British Pounds. More on this in the Early August issue of The Privateer (#558 - published on August 6).
And while all this has been going on, while another bout of global rate rises is gearing up and a major European Central Bank does the previously unthinkable and SELLS US Treasury debt, what has been happening in the US. Well, this week, Wall Street and the US futures markets have decided that the Fed and Mr Bernanke are NOT going to raise rates again when they meet next Tuesday (August 8). The catalyst for this has been two economic reports. The first was the recent announcement that second quarter US economic "growth" was down to 2.5% (less than half the reported "growth" of the first quarter). The second was the July employment figures which came out on August 4 and showed that job growth in the US was running well below expectations.
This was, of course, instantly siezed upon as evidence that economic "growth" and therefore "inflationary pressures" were on the wane in the US and that therefore the Fed had no good reason to raise rates and a very good reason NOT to raise them. Having come to that conclusion, US Futures traders put their money on it, bidding Treasury yields on all maturities over one year back down below the 5.00% level! Don't forget, the CURRENT Fed Funds rate is 5.25%!!
The most dangerous financial myth in the world today is being tenaciously embraced by the professional investors and analysts on Wall Street and in the US futures markets. They have managed to convince themselves that nothing that happens outside the US has or should have the slightest effect on the economic and financial future inside the US.
This week, Australia, the EU and Britain have raised rates while the Italians have actually sold official reserves of US Dollars and Treasury debt. Judging by their actions, none of this has appeared anywhere on the Wall Street "radars". They are totally fixated on the domestic US economy and have decided that no "sane" US Central Bankers would go on raising rates in the face of the sure evidence of US economic slowdown which is mounting up all around them.
The "negative" spread between longer-dated US Treasury debt paper and the Fed Funds Rate has now blown out to its highest level since early 2001. In early 2001, the Fed was just embarking on the lunatic series of rate CUTS which culminated in a 1.00% Fed Funds rate in mid 2003. More important, in early 2001, the US Dollar was still in a BULL MARKET which was at that point celebrating its sixth anniversary. The US Dollar bull market actually topped out in July 2001 and had a "secondary" top in January 2002.
Contrast that with today, when the US Dollar is mired in a bear market which is actually entering its fifth year. On top of that, foreign (especially Central Bank) holdings of US Treasury debt have blown out to an extent unapproached in history since 2001, the Bush Administration has added nearly $US 2.5 TRILLION to Treasury funded debt, and the US current account deficit is on track to approach the $US 1 TRILLION level this calendar year.
The assiduously fostered attitude that higher interest rates are "bad" for Gold remain in place. Central Bankers have no choice but to perpetuate this myth because they know that in reality, higher interest rates are in fact reflectors of a higher RISK PREMIUM demanded by those who hold the currency or "assets" denominated in the currency.
What the US is REALLY facing is, of course, a repeat on a vastly larger scale of what they faced in the 1970s when US economic growth was cratering while real goods prices were exploding upward and US interest rates were rising to levels never approached before - or since.
The longer the high powered "money men" of Wall Street and the US futures markets and hedge funds refuse to recognize what is staring thems in the face, the more dangerous US (and global) paper asset markets become and the more downward pressure is exerted on the US Dollar. And with that, the temptation will grow in the rest of the world's Central Banks to emulate what Italy has just had the temerity to do.
The reality is simple. Higher interest rates illustrate a rising distrust of paper currencies. As long as the rising rates compensate for the increasing perceived risk in holding the currencies, the holders will stick. But if the perceived risk keeps rising while the rates do NOT, the currency holders will see themselves as NOT being compensated for the risk and will start looking for the exits. As it was in the 1970s so it will be again - the FIRST "exit" chosen is always Gold.