-- Posted Tuesday, 9 March 2010 | Digg This Article | | Source: GoldSeek.com

The Federal Reserve is set to raise its key overnight interbank rate by a surprise 0.25 per cent next Tuesday when the Federal Open Market Committee meets, a senior banker from a top global bank specialized in currency trading told ArabianMoney last night.

This will signal an end to the brief era of near zero interest rates as a policy response to the worst global financial crisis since the Great Depression. It will serve both as a check to inflation and bolster confidence in the US dollar while reminding investors that asset prices have become inflated.

Window jumping

The interbank rate rise will follow last month’s unexpected increase in the discount rate from 0.5 to 0.75 per cent. The discount rate is the interest rate charged to commercial banks and other depository institutions on loans from their regional Federal Reserve Bank’s lending facility, the so-called discount window,

The interbank rate is the effective benchmark for all loans made in the US financial system. Any change in the latter has major implications for the US economy and by default the rest of the world.

By raising interest rates at this point in the cycle the Fed will be both proving its confidence in the tentative economy recovery that chairman Ben Bernanke has proclaimed, and underlining its commitment to preserving the value of the US dollar at a time of mounting deficits and bond issuance programs.

But there is much downside risk to this strategy. If the recovery is actually weaker than thought then the raising of interest rates could help push the economy into a double-dip recession.

Crash or correction?

There will also be an inevitable revaluation of financial markets to reflect the higher cost of money. Again there is a risk that if confidence is not as strong as generally held then financial markets will crash rather than undergo a healthy correction.

Recovery in economies and markets is seldom in a straight line, and the Fed will be only too aware of the dangers of fueling up an even bigger bubble in US equities and bond prices.

Reflationists will throw their arms up in horror at this action as imperiling a very fragile recovery. But it is a very fine judgment call, and a lot will depend on how much credibility the markets give the accompanying statements from the Fed about the likely speed of additional rate rises.

However, the Fed has to keep its street-cred and being a part of the gradual global tightening of interest rates – after a long period of loose monetary policy – should actually be better for the long-run health of the economy.

The shift in interest from gold as a raw material for jewelry manufacture to pure investment use mainly accounted for a 15 per cent fall in gold imports to Dubai last year.

Yet the City of Gold still traded a whopping 576 tonnes of the yellow metal, albeit down from 674 tonnes in 2008, with $29 billion worth of gold passing through the city.

Real demand unclear

This was actually better than the World Gold Council’s estimate of a 28 per cent fall in regional gold demand to 250 tonnes in the fourth quarter. But it is far from clear if these figures include all gold transactions.

There is talk in the market that one Gulf oil state is presently swapping 200,000 barrels per day of oil for bullion, and of flights into the region from Australia laden with gold.

The official figures have certainly been dented by lower jewelry sales. High gold prices traditionally put off jewelry buyers who unlike investors like to buy at low and not high prices. There have also been less tourists as a result of the global economic crisis, and they have been spending less.

But let us not get too carried away. According to the World Gold Council, the consumption of gold by jewelers in the fourth quarter in Saudi Arabia stood at just 17.1 tonnes and the UAE 16 tonnes.

Investment demand

Investment demand for the yellow metal is far harder to quantify. Purchases of gold by Arabian investors that now sit in foreign vaults will not show up in the Dubai figures.

It would therefore be wrong to conclude from these figures that the Arabian love affair with precious metals is over. Far from it, anecdotal evidence all points to far greater interest in bullion as a means of protecting against possible currency instability in a world of massive budget deficits.

Inflation has always been the traditional refuge of governments with large debts and inadequate revenues, and that means that cash will lose its purchasing power. Gold as a currency that cannot be printed, and silver as poor man’s gold, are still on the way up, and increasingly recognized as vital for any Gulf investment portfolio.

-- Posted Tuesday, 9 March 2010 | Digg This Article

About Peter Cooper:
Oxford University educated financial journalist Peter Cooper found himself made redundant by Emap plc in London in the mid-1990s and decided to rebuild his career in Dubai as launch editor of the pioneering magazine Gulf Business. He returned briefly to London in 1999 to complete his first book, a history of the Bovis construction group.

Then in 2000 he went back to Dubai to become an Internet entrepreneur, just as the dot-com market crashed. But he stumbled across the opportunity to become a partner in www.ameinfo.com, which later became the Middle East's leading English language business news website.

Over the course of the next seven years he had a ringside seat as editor-in-chief writing about the remarkable transformation of Dubai into a global business and financial hub city. At the same time www.ameinfo.com prospered and was sold in 2006 to Emap plc for $27 million, completing the career circle back to where it began a decade earlier.

He remains a lively commentator and columnist as a freelance journalist based in Dubai and travels extensively each summer with his wife Svetlana. His financial blog www.arabianmoney.net is attracting increasing attention with its focus on investment in gold and silver as a means of prospering during a time of great consumer price inflation and asset price deflation.

Order my book online from this link

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