Next week, on June 28-29 to be precise, the Federal Open Market Committee (FOMC) meets. If they do what everybody expects them to do (if they do nothing at all), they will have held the Fed Funds rate unchanged at 5.25 percent for an entire year. It is interesting, in this context, that this year in which the Fed has stood pat on official US interest rates is also a year (actually more than a year) during which Gold has failed to hit a new high in US Dollar terms. As we have pointed out in recent reports on this page, that's the first time this has happened thus far in the $US Gold bull market.
Here is a small exerpt from an Associated Press commentary dealing with the big (185 point) Dow sell-off on June 22:
"Investors have been grappling with concerns about whether the economy will heat up and prompt the Federal Reserve to put off cutting, or perhaps even raising, interest rates."
In the current issue of The Privateer (Number 580 - published on June 17), we point out that the recent big upmove on Treasury yields has now broken a trend of lower highs and lower lows stretching all the way back to 1981. This is of course, the nearly three decade era of "asset price inflation". The 1970s were a decade of steadily rising interest rates and steadily rising REAL asset prices. The prices of economic goods of all descriptions (including precious metals) rose. But once US interest rates peaked and began to fall after 1981, the subsequent period has been a nearly three decade era of rising FINANCIAL asset prices. The prices of financial "assets" denominated in US Dollars - stocks, bonds, debt of all descriptions and an ever growing avalanche of derivatives rose.
In both eras, the cause of the rising prices was the same. It was an inexorable and ever accelerating orgy of credit expansion released by the severing of the US Dollar, and therefore all other global currencies, from the discipline of Gold.
Since the end of the 1980-82 recession, the world in general and the US in particular has seen an unbroken series of financial "bubbles", each one bigger than the last. And because that sequence now stretches for more than a quarter of a century, it has long since become economic orthodoxy, especially on Wall Street and at the Fed, to equate economic growth with the rise and Rise and RISE of financial assets.
In this context, go back to that Associated Press quote (see above): "Investors have been grappling with concerns about whether the economy will heat up." This is not talking about the REAL economy. Pretty well everybody in the US, including even most of those on Wall Street, knows that the producing (manufacturing) US economy is comatose and has been for years if not decades. When Wall Street talks about the "economy" heating up, what they are talking about is the financial markets heating up.
And how are the financial markets in the US to be expected to "heat up" any more than they already have? The real estate bubble has more than burst, it has imploded and the effects are inexorably being felt more and more acutely not only by the borrowers, but also by the LENDERS. When the Dow slumped 185 points on June 22, a major reason was given as being the "troubles" Bear Sterns are having with two of their big hedge funds, both of which have lost heavily due to their exposure to the subprime mortgage market. US bond markets have been falling ever since early May as yields inexorably rise. And the US Dollar is on the skids again, despite the desperate claims that rising rates are "good" for the Dollar.
In fact, the very last "heat" on US investment markets over the past three or four months has come from the US STOCK market, which recovered from the China induced sell-off at the end of February and has since gone on to set new highs on an almost daily basis for most of the past two months. That was up until the high set on the Dow on June 4. Last week, the Dow rose to less than 40 points below that peak. This week, it has lost a bit more than 2 percent with the big fall coming on Friday (June 22).
This growing uncertainty about the last vestige of US economic "growth", an ever rising stock market, is well on the way to reducing Wall Street to a state of almost terminal confusion. Up until the end of April this year, the "betting" was all in favour of the Fed starting to cut rates in the near future because the bursting of the real estate bubble had taken the "heat" out of the economy. Then the subprime horrors took hold, the US Dollar tanked and confidence in an imminent rate cut was snuffed out.
Now, the spectre that the Fed might even be contemplating RAISING rates has emerged. Despite what that quote from the Associated Press says, this concern has nothing to do with the market "heating up". Instead, the fear is growing that if the Fed doesn't do "something" - and soon - to defend the US Dollar, the markets are in growing danger of collapsing as the appetite of the rest of the world for US Dollars dries up. There is already abundant evidence that this is starting to happen.
Here at The Privateer, we certainly don't think that the Fed will be raising official US rates in the coming week. Nor do we think that they will raise official US rates until they are backed into a corner where no other course of action is available to them. The insoluble problem facing the Fed is that they are no longer in control of domestic credit creation, they have lost control of US MARKET interest rates, and they are fast losing any influence over what the rest of the world chooses to do with its official interest rates.
The spectre which confronts Wall Street markets is the growing suspicion that the Fed is on the way to being reduced to just another (albeit large) Central Bank. Were this to happen, the days of Fed manipulation to suit the US "economy" (read investment markets) and the hell with the rest of the world would come to an end. Were this to happen, the US Dollar would no longer appear immune to Fed interest rate manipulation. Were this to happen, the Fed would lose the great advantage which being the purveyor of the world's reserve currency has given them. They would no longer be able to "export" their own inflation to the rest of the world with no adverse effect on them or on the US.
Were this to happen, the almost three decade and almost unbroken surge of US investment "assets" would come to an abrupt halt, and then reverse with a vengeance. The last vestige of this "surge" is the US stock markets, and while they have not gone into reverse or collapsed yet, they have definitely hit a ceiling this month. If they cannot break through that ceiling and go on to set new highs, the jig is up. There will be NO source of US "economic growth" as it has come to be indentified over nearly three decades if ALL US investment markets are going DOWN.
That is the growing fear which haunts the US financial establishment. That is the reason for the desperate assertions that higher US rates are "good" for the Dollar. That is also the reason for the assertion that higher interest rates are "bad" for Gold - which doesn't pay interest.
In reality, higher interest rates ALWAYS signal a growing concern with the future course of the currency. The higher they go, the more acute the concern and the more concentrated is the search for an "alternative". Rates are climbing EVERYWHERE at present, which indicates a growing concern, not just with the US Dollar, but with the viability of the entire global currency system based on the US Dollar as the reserve.
Inexorably, the demand for an "alternative" will grow. Just as inexorably, the desire for the "alternative" itself and not some paper claim to it will grow too. There has never been a currency crisis of any magnitude in history when that has not happened. The more acute the crisis is, or is perceived to be, the greater the demand for the "alternative" and the greater reluctance to accept any "substitute", especially any PAPER substitute. The "alternative" is, of course, Gold - and to a lesser extent Silver.
As we said at the start of this piece, it has been a year since the Fed moved official US rates in either direction. And over that entire period, the $US Gold price has hung below its bull market highs. While this has being going on, the facade of economic "growth" through paper asset appreciation has been hollowed out. It now hangs by a thread. When that final thread snaps, the Gold bull market will resume.
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