File under confirmation bias:
A point of interest we came across on the Philly Fed’s site is its regional July Business Outlook survey (pdf). The apparent downturn in sentiment in early 2010 appears to coincide with our “strong dollar” call in January 2010, which was based heavily on increasing verbal hawkishness (pdf) from the Obama administration on fiscal matters:
The timing could very well be coincidental, but we think sentiment and fiscal expectations are related at some level, which may be supported by some other interesting features in that graph, from a “sectoral balances” point of view.*
One is that business sentiment was most buoyant at the time of President Bush and the GOP’s major fiscal easings in 2001 and 2003 (blue circle); the other is the steady downward trend in sentiment as the Clinton administration’s and Dole-Gingrich GOP’s widely revered budget surpluses were materializing (green line):
Again, this is purely circumstantial evidence, and would require much more analysis to see if anything academic can be made of it. But it does fit nicely with the theoretical frameworks we’re relying on to guide clients through these “interesting times”.
It might also be reassuring that the USD has taken a slight break from its strengthening trend (the red line below is the inverted trade weighted USD index inverted, and the blue line is foreign commercial paper, a measure of foreign credit and business activity in the private sector).
While it’s not at a level that augurs an imminent return to the headiness of 2007 and early 2008, some stability at current levels would be a welcome sign for the world’s credit, goods, and services markets:
…more than 10 [banks] based in Europe…swapped gold with the Bank for International Settlements in a series of unusual deals that caused confusion in the gold market and left traders scratching their heads…
The Financial Times has learnt that the swaps, which were initiated by the BIS, came as the so-called “central banks’ bank” sought to obtain a return on its huge US dollar-denominated holdings. The BIS asked the commercial banks to pledge a gold swap as guarantee for the dollar deposits they were taking from the Basel-based institution…
Some analysts speculated that the swap deals were a surreptitious bail-out of the European banking system ahead of last week’s publication of stress tests…
…two central bank officials said some of the commercial banks…needed the US dollar funding and were keen to act as a counterparty with the BIS. The gold swaps began in December and surged in January, when the Greek debt crisis erupted and European commercial banks were facing funding problems…
In other words, large banks on the continent were more than willing to swap gold for USDs with the BIS when facing credit strains and stress tests. This is something to keep in mind among all the gold bug chatter — unbacked paper or “fiat” money can become dear, even relative to precious metals. Witness gold’s long term decline against the Yen as Japan’s balance sheet recession and negative turn in age structure unfolded:
The wrench, as we always try to point out, is the USD’s global reserve status. More dovish monetary policy in the U.S. (which can only be accomplished via renewed “quantitative easing” and its distorting impacts) could very well stoke renewed inflationary pressures abroad, with feedback effects on certain components of U.S. price levels. In fact, the deep decline in Yen per gold ounce might have been driven in part by the absence of Yen carry trade mechanisms. Once those mechanisms were in place and more widely available (circa late 1990s or early 200s?), Yen-gold was freed to the upside.
The fact that the USD is the traditional carry trade currency is a reminder that USD-gold could still have plenty of room to run, and that uncertainty is why we are not placing any bets on gold prices, either to the upside or the downside. But to the extent that any rally is driven by Ponzi-style leverage — which is still quite possible due to the anemic and slow moving nature of some of the reform measures in Dodd-Frank – gold will, like residential real estate before it, eventually come crashing back down to more normal levels.
It may even be near “normal” levels now. The caveat we’re trying to put forth is that if fiscal, trade, or monetary policymakers err on the hawkish side in the next five to ten years, then USDs will be in scarcer supply, and all else equal, that would mean lower prices generally — even for gold.
One last note — preliminary second quarter GDP came in light at 2.4%. This is a steep fall from recent quarters, and it too lends some support to our argument (and others’) that federal stimulus played a significant role in driving and/or supporting private sector activity in 2H09 and early 2010. That’s why we think that any concerted move towards fiscal tightening in the quarters ahead — whether through tax cut expirations (we’re talking to you, Democrats) or spending cuts (ahem-ahem-ahem, GOP) — will substantially raise the probability of a second recession.
* We note that the New School’s History of Economic Thought (HET) website has yet to publish anything on the recently deceased Wynne Godley, who helped to articulate the intersectoral balances approach. As with age structure, underappreciation implies to us that Godley’s balances framework can be put to an investor’s advantage.
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