-- Published: Monday, 5 February 2018 | Print | Disqus
Not strong, not weak but strategically benign
By Michael J. Kosares
Trump-Mnuchin qualifiers in dollar statements tell all
“While it’s [a strong dollar] described as a desirable and intended thing, it might not be a choice. The size of dollar holdings of reserves (in dollar-denominated debt) and the dollar’s role as the dominant world currency are anachronisms and large relative to what one would want to hold to be balanced, so rebalancings should be expected over time, especially when U.S. dollar bonds look unattractive and trade tensions with dollar creditors intensify.” – Ray Dalio, Bridgewater Securities
Much is made of the direct inverse correlation between gold and the dollar, but acknowledging that relationship does not really get us anywhere. The bigger question is whether or not the dollar will continue to track lower as it has over the past 18 months or will it suddenly reverse course and head higher.
In the end, the international FOREX markets will determine the dollar’s value against other currencies. That journey, though, will be influenced by other players on the stage, i.e., central banks and governments, including the U.S. government and the Federal Reserve, whose main interest will be the value of their currency, especially against the currencies of their largest trading partners.
It is there, on the ultimate battleground of the political economy, that the plots and subplots can become as twisted and complicated as the intricacies of a John LeCarre novel. Note, for example, the couching of terms in the following two statements delivered during the Davos conference late last month:
“I absolutely support a strong dollar over the long term.” – Stephen Mnuchin, U.S. Secretary of the Treasury
“The dollar is going to get stronger and stronger and ultimately I want to see a strong dollar.” – Donald Trump, President of the United States
Those qualifiers, over the long term and ultimately, tell all and go to the heart of what the administration intends. What happens to the value of the dollar between now and ultimately? What happens before the long-term policy kicks in? In its unambiguous ambiguity the Trump administration has signaled no intention of disrupting any market generated dollar weakness. It will stand aside. Beyond that, time will tell to what degree it will project the economic power of the United States if it becomes necessary to keep the exchange rate down.
For the markets, there was no ambiguity in the statements at all. The intent of the administration was crystal clear. Its dollar policy would be neither “strong” nor “weak.” Instead it would be strategically benign. In the immediate aftermath of the Davos statements, the dollar cratered, gold jumped and the bond market went into a tail spin. For traders and speculators, the way was clear. As Marc Chandler of Brown Brothers Harriman told Financial Times: “While Mnuchin was only stating the obvious, Treasury secretaries since Robert Rubin have never really deviated from the strong dollar mantra. The mantra has never really meant much, but to deviate from it suggests that U.S. policy makers desire a weaker dollar.”
So where do we go from here?
As the first two charts below amply illustrate, the dollar has been in long-term secular decline since the start of the fiat money era in 1971. Gold over the same period has been in a long-term up-trend. So the short answer to the headline question is that gold likely will be in a very strong position for the immediate future – a prognosis hinted by its performance over the past two years of dollar declines (first chart below).
Historically, though, the dollar declines have not been against other currencies only, but against goods and services as well (second chart below). In short, if the U.S government and central bank have favored a strong dollar policy, their efforts have pretty much amounted to a prolonged failure. From time to time, it needs to be noted, the dollar’s secular down trend has been punctuated with periods of strength that then ultimately revert to the primary trend. We just recently completed one of those periods of strength in 2016 and seemingly have reverted to another period of weakness.
As you can see in all three charts, gold has served its owners well as a safe haven and asset of last resort. In fact, its history as a counter-measure to dollar depreciation has formed the basic rationale for gold ownership over nearly the past 50 years.
Now, with the dollar coming off its 2016 peak, market analysts are suddenly talking up the prospects for another episode of major dollar weakness against other currencies. However, unlike the last bout of dollar weakness in the early 2000s when disinflation bordering on deflation dominated the economy, analysts this time around are predicting the simultaneous return of price inflation.
The prospect of the two together – a crumbling dollar and inflation – spooked markets to the point that the Dow Jones Industrial Average gave up over 1000 points in a single week (1/29) and 665 points in a single day (2/2). This ramped-up scenario has all the earmarkings of a return to the stagflationary 1970s – something former Fed chairman Alan Greenspan has been predicting for some time now. In fact, two days before the February 2nd stock market reversal, he was on Bloomberg television warning of bubbles in both the stock and bond markets. Our third chart provides a clue as to how gold might perform in a 1970s redux.
(In the next section of this month’s client letter, we delve into what appears to be the first signs of inflation’s re-emergence: rising commodity prices.)
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