A View from the Trenches, April 4th, 2011: "Gold, the Fed, Ron Paul and Napoléon Bonaparte"
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We don’t trade upon technicals but we take note of them. On Friday, we think gold went through an important test. After the announcement, at 8:30am, that the US unemployment rate had fallen to 8.8% (the lowest for the past two years), gold sold off to $1,415/oz. This fall came after having briefly touched $1,440/oz the day earlier. We were disappointed, because the markets in our view, had misinterpreted the new information. Relative prices on Friday morning seemed to reflect this line of reasoning: The lower unemployment rate, given the “stable” inflation rate, will push the Fed to hike rates sooner rather than later. Why? Because it would seem that the so-called stimulus of QE2 is working. If it is working, the Fed can now focus on fighting inflation.
What is wrong with this view? In our opinion, it is simply absurd. The Fed is not stimulating anything. The Fed is only massively monetizing the US fiscal deficit. Therefore, a lower unemployment rate is actually worse, because a lower unemployment rate implies higher wages, sooner rather than later. And if wages rise, people will have more purchasing power to afford the increasingly higher commodity prices. The higher wages will validate the higher prices of food and oil. In the process, the supply of money, ceteris paribus, will decrease. If the US fiscal deficit continues unabated (our key assumption here), the Fed will be forced to engage again in quantitative easing. For this reason, we think that the unemployment rate announced on Friday was actually bullish of gold.
By the end of the session, gold had bounced back from $1,415/oz (making a higher low, vs. the previous of $1,409) and consolidating around $1,430/oz. We don’t trade upon technicals, but we certainly took note of this consolidation and we think higher highs are soon to come.
Continuing our analysis of the Fed, we applaud the result of Bloomberg and News Corp.’s Fox News Network LLC lawsuit against the Fed for records under the Freedom of Information Act. The US Supreme Court rejected the Fed’s attempt to block the disclosure of records related to its discount window operations. The release of this information showed how the Fed made significant loans to overseas banks, that is, banks outside the US currency zone.
At “A View from the Trenches” we have repeatedly discussed the role that these loans, including cross-currency swaps, have in magnifying global leverage. The first to point at cross currency swaps between central banks as a potential transmission channel for global imbalances, was M. Jacques Rueff, who blamed them for the “…long duration of the substantial credit inflation that preceded the 1929 crisis in the United States (our note: under the gold-exchange standard)”. M. Rueff, who was Financial Attachée in the French Embassy in London, made this opinion public for the first time on a letter dated Oct 1st, 1931, to France’s Prime Minister (J. Rueff, “The Monetary Sin of the West”, 1971).
These loans and cross currency swaps are the “leverage of the leverage”, so to speak. With them, other central banks give up their sovereignty and the Fed effectively becomes the world’s lender of last resort. For instance, when the Fed loans US dollars to a German bank, as it did, the European Central Bank can no longer act as lender of last resort, should the German bank default on its obligations with the Fed. But, would this in reality occur? Of course not! If the German bank was not able to repay its US dollar denominated loans, the Fed would simply roll over the liquidity line. This is a very troubling scenario because the Fed in fact expands the supply of US dollars worldwide (global leverage), without any counterbalancing reduction of credit in the US currency zone.
In our view, these “global” discount window operations are the necessary (but not sufficient) step towards the collapse of fiat money. If we are ever going to see the end of fiat money, it will be thanks to global loans from the Fed. Without them, other central banks will always retain their sovereignty and become alternatives to the US dollar. But with them, once the loans are out and a wave of defaults is triggered, the Fed becomes the easy prey for the collective gold longs. This of course, is ironic, because Ron Paul, who wants to end the Fed and is chairman of the House subcommittee overseeing the Fed, will seek to stop such loans and swaps from being offered. We, on the other hand, would follow Napoléon’s advice, when he said: “N’interrompez jamais un ennemi qui est en train de faire une erreur” (Never interrupt an enemy, when he is making a mistake).
Martin Sibileau
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