Dollar Dissonance And The Remonetization Of Gold

Submitted by John Butler  –  AMPHORA Commodities Alpha 

Two years ago, prior to travelling to Sydney to present at the Annual Precious Metals Symposium, I prepared an article for the Gold Standard Institute Journal titled Cognitive Dollar Dissonance: Why a Global De-Leveraging Requires the De-Rating of the Dollar and the Remonetisation of Gold (see here). This article highlighted the growing inconsistency between those arguing on the one hand that the dollar’s role in international trade and finance was clearly diminishing; yet denying that it was in any danger of losing the near-exclusive monetary reserve status it has enjoyed since the 1940s.

This apparently contradictory yet mainstream thinking about the future of the international monetary system continues to the present day. Indeed, earlier this month the Economist magazine ran a special feature on fading US economic power replete with dollar dissonance.[1] The experts cited note the accelerating trend towards bilateral trade settlement, say between Russia and China, who plan to finance their multiple ‘Silk Road’ infrastructure projects using their own currencies and their own development bank (The Asian Infrastructure Investment Bank or AIIB: Seehttp://www.aiib.org/). They also observe that Russia, China and the other BRICS are no longer accumulating dollar reserves (although curiously overlook that they continue to accumulate gold). They acknowledge that not only the BRICS but many other countries have repeatedly expressed their desire that the current set of global monetary arrangements should be restructured in some way, although they are not always clear as to their specific preferences.

Note the sharp contrast in these two paragraphs, both on the very same page of the Economist feature:

“This special report will argue that the present trajectory is bound to cause a host of problems. The world’s monetary system will become more prone to crises, and America will not be able to isolate itself from their potential costs. Other countries, led by China, will create their own defences, balkanising the rules of technology, trade and finance. The challenge is to create an architecture that can cope with America’s status as a sticky superpower.”

And:

“Today’s world relies on a vastly bigger edifice of trade and financial contracts that require continuity. Trade levels and the stock of foreign assets and liabilities are five to ten times higher than they were in the 1970s and far larger than at their previous peak just before the first world war… China and America are not allies. The greater complexity and risk involved in remaking the global order today create a powerful incentive for current incumbents to keep things as they are.”

Does anyone else hear the clear dissonance, confusion even? On the one hand we have a complex system prone to debt and currency crises, a growing lack of cooperation between the two largest players and a need for a ‘new architecture’. Yet on the other we are supposed to accept that there is sufficient common incentive to cooperate in monetary matters? Really?

Now consider the developing global economic context. Although the mainstream tend to be quiet on these issues, they cannot possibly fail to notice that, seven years on from the 2008 global financial crisis, following unprecedented economic and monetary policy intervention, dollar interest rates are still zero; quantitative easing has failed to achieve its stated objectives; global imbalances have risen to record levels; emerging market balance-of-payment crises are springing up all over; leading indicators in every major global economy have rolled over; and financial markets, in particular the credit markets, are beginning to tell you that another major crisis may lurk in the near future. It is thus entirely reasonable if unfashionable to hold the view that the dollar monetary reserve system has become unstable and is overdue a fundamental restructuring or reset of some kind. None other than IMF Managing Director Christine Lagarde has hinted at this in multiple speeches over the past two years. [2]

The Trojan Horse Battle For The Euro

Submitted by John Butler  –  AMPHORA Commodities Alpha 

At a recent conference hosted by a major global bank in London I sat on a panel alongside a macro investment strategist who referred to the euro as a ‘Trojan horse’ intended to force fiscal austerity on traditionally profligate countries such as Greece. While that is true, I believe there is also a second euro Trojan horse, this one intended to force through greater fiscal, banking and political integration, enabling the creation of a European ‘superstate’ to rival the US and China in economic and political power. What we are witnessing now is the inevitable battle between the two horses to win over German public opinion, on which the euro’s future most depends. In my opinion the battle will have several national casualties, resulting in a smaller but more competitive euro-area. While this could be negative for European government bonds, it could be supportive of stocks, eventually.

THE FOUNDATION OF EURO MACRO STRATEGY

Although my career in international finance began in New York, in 1995 I moved to Germany. By that time it was generally assumed that European Monetary Union (EMU) would begin, more or less as planned, in 1999. In my role as a macro investment strategist it thus became necessary to develop a methodology for asset valuation and investment strategy in the presumed future single-currency area.

        This required first an aggregate economic statistical dataset for the future euro-area taking many months to develop, with the greatest challenge finding ways to harmonise differing national calculation methodologies for key aggregates. But by focusing as we did primarily on the larger prospective members: Germany, France, Italy, Spain and the Netherlands, the goal was nevertheless achievable and in early 1998 we presented our harmonisation methodology, initial dataset, model suite and key investment recommendations on a ‘roadshow’ to major investors in Europe and around the world. (Subsequently I presented regular updates on these data and associated thoughts on European macro investment strategy on a financial television show jointly hosted by the Wall Street Journal and CNBC Europe, The Eurozone Barometer.)

        Now it wasn’t exactly easy to get investors’ full attention in early 1998 due to the Asian currency crises unfolding at the time. Nor did it become any easier as the year went on. In August, Russia defaulted. In the fall, the massive hedge-fund Long-Term Capital Management blew up, with the Fed brokering a deal to contain the substantial potential fallout. But there was sufficient interest in EMU as a historic international monetary development that we nevertheless managed to get meetings with senior officials at many major central banks and other financial institutions who would be the amongst the largest future holders of euro-area sovereign debt. They wanted to know how to value and estimate the risks of such debt, issued by sovereign borrowers with the power to tax but lacking a national central bank to set interest rates and serve as a potential ‘lender of last resort’ in a crisis.

THE STRONG DOLLAR RESTS ON PILLARS OF SAND

Submitted by John Butler  –  AMPHORA Commodities Alpha 

Recent dollar strength has been a surprise to many but a strong dollar was also a key component of the Asian currency crises of 1997-98. These contributed to sharply lower oil prices, which in turn helped to trigger the 1998 Russian debt default, European bond spread de-convergence and spectacular blowup of hedge-fund Long Term Capital Management (LTCM). It is worth recalling that, when LTCM failed, the dollar abruptly gave up a full year of gains. While history rhymes rather than repeats, I suspect something comparable is likely in 2015, although with US total economy debt much higher, the potential for a sharp decline in the dollar is that much greater.

TIME HORIZONS AND TIME PREFERENCE

Back when I managed macro strategy teams at investment banks, I had a simple set of guidelines that I required junior strategists to follow when making investment recommendations, that is, in addition to those required by the firm or the regulators. These included:

• Recommendations must be supported by a broad range of fact-checked evidence, rather than one or two ‘cherry-picked’ pieces;
• Recommendations must be ‘actionable’ in a practical way by the target clients and one or more of these must be specified;
• Recommendations must not only provide a specific price (or return) target, but also an estimate of risk (or volatility) and reference to a specific time horizon;
• Recommendations must include one or more conditions under which the particular investment would no longer be as attractive, if at all.

In practice, most analysts managed in their initial draft recommendations to follow the first two but struggled when it came to the third and fourth. The reason for this is most probably the inclination that many if not all quantitative-analytical types have for expecting that financial assets be priced ‘correctly’, according to whatever analytical framework is applied. If something is out of line, so the thinking goes, it should start correcting as soon as the analysis in question is complete and should completely correct over the short-to-medium term time horizon of primary importance to the bulk of those active in the investment management industry.

        While that might seem reasonable, the problem is that, notwithstanding claims to the contrary, investors are not rational. Indeed, I would hold that no economic actors are rational in any meaningful, measurable way. This is due in part to my view of human nature and modern psychology seems to uncover new ways in which our minds are biased and irrational with each passing day. But if all investment opinions are biased and irrational to some degree, the sum of all such opinions—the financial markets—is most probably also biased and irrational.

        So-called ‘behavioural investing’ tries to address these biases in a systematic way in order generate excess investment returns over time with acceptably low risk. However, the problem with any such ‘fight the irrational herd’ approach is, to paraphrase Keynes, “The herd can remain irrational longer than the rational investor can remain solvent.” On top of this there is the added complexity of the so-called ‘beauty contest’, also mentioned by Keynes, in which investors constantly try to out-guess each others’ intentions, irrational, behavioural or otherwise, so what in fact is ultimately decisive in price determination at any point in time arguably has little if anything to do with any underlying, fundamental, rational investment process.

As The “Sanctions War” Heats Up, Will Putin Play His ‘Gold Card’?

Submitted by John Butler  –  AMPHORA Commodities Alpha 

The topic of ‘currency war’ has been bantered about in financial circles since at least the term was first used by Brazilian Finance Minister Guido Mantega in September 2010. Recently, the currency war has escalated, and a ‘sanctions war’ against Russia has broken out. History suggests that financial assets are highly unlikely to preserve investors’ real purchasing power in this inhospitable international environment, due in part to the associated currency crises, which will catalyse at least a partial international remonetisation of gold. Vladimir Putin, under pressure from economic sanctions, may calculate that now is the time to play his ‘gold card’.

A BRIEF HISTORY OF THE CURRENCY WAR

“We’re in the midst of an international currency war. This threatens us because it takes away our competitiveness.” Brazilian Finance Minister Mantega uttered these words in September 2010, about two years after the spectacular global financial crisis of late 2008. During and following the crisis, the euro declined by around 25% versus the dollar. The pound sterling declined by nearly 30%. And while the Brazilian real also declined initially, it subsequently regained these losses in less than a year, unlike either the euro or pound. Dramatic swings in currency values can have a material impact on relative rates of economic growth. And when global economic growth is weak, the temptation to devalue and take some global market share from competitors is strong. “The advanced countries are seeking to devalue their currencies,” claimed Mantega.[1]

The decline in the value of the euro in 2008-11 was of special importance because it exposed a key fault-line across the euro-area: That between the competitive exporters of the North, such as Germany, Poland and the Czech and Slovak Republics; and the less competitive importers of the South, such as Italy, Spain, Portugal and Greece. With the euro weaker, the exporters’ economies were booming. Yet the fallout from the financial crisis fell hardest on the least competitive euro members, threatening the solvency of their banks and, by extension, the sustainability of their governments’ finances.

Commodity Signals Flashing Red

Submitted by John Butler  –  AMPHORA Commodities Alpha 

With few exceptions, commodity prices have fallen sharply in recent months, to their lowest levels in over a year. Relative to stock market indices, broad commodity indices are now at their lowest levels since the late-1990s dotcom boom. But key commodity price ratios, such as those between precious and industrial metals, are already at levels associated with financial crises such as that of 2008. In other words, there is already ‘blood on the commodity streets’, presenting investors and commodity traders with potentially attractive opportunities.

COMMODITY PRICES, RATIOS, WARNINGS

Back in 2007, before it became generally apparent that the US housing bubble had burst, commodity prices were in a strong uptrend, which accelerated into 2008. By June that year, multiple commodity prices had soared to all-time highs. Copper reached $450/pound, soyabeans soared to over $1,600/bushel, cotton rose through $200/pound and crude oil briefly exceeded $140/bbl.

Many commentators at the time argued that soaring commodity prices were indicative of a so-called ‘supercycle’ driven by soaring demand from emerging economies such as China, India and Brazil. Growth in these countries was indeed rapid in the decade leading to 2008. But commodity supply was nevertheless rising to meet demand and it has continued to do so. Following a sharp correction lower during the global financial crisis of 2008, commodity prices recovered in 2009-11, only to re-enter a downtrend which has continued to this day. Some argue that this is but a normal cyclical correction due to slowing global demand. Others believe it implies that the ‘supercycle’ is over.

From bravery to prosperity: A SIX-year plan to make scotland the wealthiest anglosphere region of all

Submitted by John Butler  –  AMPHORA Commodities Alpha 

“We look to Scotland for all our ideas of civilisation.” –Voltaire

“Simply put, there is no more creative an act than creating a new nation.” –Sean Connery

In the face of nearly universal warnings from other nations, including England, the Scots have taken a pause from their legendary bravery to vote against full independence from the United Kingdom. Yet given the evident financial and monetary failures of most major developed economies in recent years, not only the UK, the Scots should take full advantage of the greater autonomy already promised by Westminster. In this report, I present a plan, inspired by the ‘Scottish Enlightenment’ of the 18th century, that would enable the Scots, probably in less than six years, to become the most prosperous Anglosphere region in the world. It won’t be easy, but then the easy isn’t for the brave.

The Death of Money (or rebirth): An exclusive interview with James Rickards

Submitted by John Butler  –  AMPHORA Commodities Alpha 

THE DEATH OF MONEY, Jim Rickards’ second book, has met with widespread acclaim. In it, Jim refines and develops multiple topics raised in his first book, CURRENCY WARS, as well as adding some intriguing new material regarding the role of intelligence agencies in international financial and monetary affairs. Most important, he tries to draw more specific conclusions regarding the future of the international monetary system. In this interview, Jim and I discuss what I consider to be some of the more provocative aspects of his new book, and how we can apply his insights to recent international developments, including the rapidly unfolding crises in Ukraine, Syria and Iraq, and accelerating moves by the BRICS to reduce their use of the dollar for trade and as reserves.

BY WAY OF BACKGROUND…

When it comes to the world of international finance, Jim Rickards has quite nearly seen it all. As a young man, he worked for Citibank in Pakistan, of all places. In the 1990s, he served as General Counsel for Long-Term Capital Management, Jim Merriwether’s large, notorious hedge fund that collapsed spectacularly in 1998. In recent years, he has been a regular participant in Pentagon ‘wargames’, in particular those incorporating financial or currency warfare in some way, and he has served as an advisor to the US intelligence community.

Stagflation is, always and everywhere, a Keynesian phenomenon

Submitted by John Butler  –  AMPHORA Commodities Alpha 

Although it might seem rather odd for a school of economics to largely ignore the role of money in the economy, this is indeed the case with traditional Keynesian economics. Declaring in the 1960s that, “Inflation is, always and everywhere, a monetary phenomenon,” Milton Friedman sought to place money at the centre of economics where he and his fellow Monetarists believed it belonged. Keynesian policies continued to dominate into the 1970s, however, and were blamed by the Monetarists and others for the ‘stagflation’ of that decade. Today, a generation later, stagflation is re-appearing, the inevitable result of the aggressive, neo-Keynesian policy responses to the 2008 global financial crisis. In this report, I discuss the causes, symptoms and financial market consequences of the new stagflation, which is likely to be much worse than that of the 1970s.

the golden age of keynesianism

During the ‘Roaring 20s’, US economists mostly belonged to various ‘laissez faire’ or ‘liquidationist’ schools of thought, holding that economic downturns were best left to sort themselves out, with a minimal role for official intervention. President Hoover’s Treasury Secretary Andrew Mellon (in)famously represented this view following the 1929 stock market crash when he admonished the government to stay out of private affairs and allow businesses and investors to “Liquidate! Liquidate! Liquidate!”

2014: A Year of Investing Dangerously

Submitted by John Butler  –  AMPHORA Commodities Alpha 

For those rich in assets, 2013 was a good year. Equity markets, especially in the US, rose substantially. Property markets continued their recovery. Even bonds, which lose value when interest rates rise, did well overall due to spread compression and the generous ‘roll-yield’ associated with steep yield curves. Indeed, declining risk premia and the associated fall in implied volatilities across all major asset classes was the single biggest financial market story of 2013. Why did this occur? Is it sustainable? In this report, I explain why it is not, and how, unseen by the economic mainstream, severe damage is being done to the global economy, in various ways, with the financial market consequences highly likely to be felt in 2014, and in the years to come.

THE PERILS OF FINANCIAL MARKET MANIPULATION IN THEORY AND PRACTICE

Other than a handful of economic officials and ivory-tower academics, few would argue that asset prices are where they are today independent of the unprecedented monetary and fiscal stimulus of recent years. Indeed, many economic officials openly admit that their actions have influenced financial market variables and that this is an important policy goal. Academic economists provide much theoretical although highly questionable support for this view.

Naturally, however, if asset prices are artificially supported by policy, then financial market participants will no doubt be concerned as to what happens when such policy is withdrawn. This is the single, best explanation for the recent, sharp correction in risky asset valuations around the world.

Now Cometh Doubt: The Keynesian Priesthood Begins Fingering Its Beads

Submitted by John Butler  –  AMPHORA Commodities Alpha 

“I say to all those who bet against Greece and against Europe: You lost and Greece won. You lost and Europe won.” –Jean-Claude Juncker, former prime minister of Luxembourg and president of the Eurogroup of EU Finance Ministers, 2014

“We have indeed at the moment little cause for pride: As a profession we have made a mess of things.” –Friedrich Hayek, Nobel Laureate in Economic Science, 1974

Jean-Claude Juncker is a prominent exception to the recent trend of economic and monetary officials openly expressing doubt that their interventionist policies are producing the desired results. In recent months, central bankers, the International Monetary Fund, the Bank for International Settlements, and a number of prestigious academic economists have expressed serious concern that their policies are not working and that, if anything, the risks of another 2008-esque global financial crisis are building.

Thus we have arrived at a ‘Crisis of Interventionism’ as the consequences of unprecedented monetary and fiscal stimulus become evident, fuelling a surge in economic nationalism around the world, threatening the end of globalisation and the outbreak of trade wars. Indeed, a tech trade war may already have started. This is is perhaps the least appreciated risk to financial markets at present. How should investors prepare?