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Gold is the ultimate anti-dollar. It has rocketed by 30pc over the last four months largely because the dollar has been in the steepest dive for almost half a century. One is a function of the other.
You can come up with many compelling reasons for the sudden spike through $2,000 an ounce: the Reichsbank debasement hypothesis, the fastest rise in America’s M3 money supply since 1943, or the deepening plunge in negative real yields. But at this juncture it is dollar dynamics that matter.
If you are betting on a further rally in gold, you must therefore also be right that the dollar’s decade of exorbitant strength is definitively over and that the world’s paramount reserve currency is going into a supercycle of secular decline – supposedly against an all-conquering euro.
It must be said that a weaker dollar is what the global economy needs as we limp our way out of Covid-19, but there is a high risk that it will not in fact happen.
The currency has been too strong for global comfort. The Federal Reserve’s broad dollar index hit an all-time high early this year. This had the effect of draining liquidity from an international financial system that has never been more dollarised.
The dollar squeeze was torture for offshore borrowers with $13 trillion of dollar liabilities, whether East Asian property companies or the likes of Brazil, Mexico, Turkey, and South Africa.
It was the Fed that saved the day in March by expanding its dollar swap lines to fellow central banks, acting as the world’s lender-of-last resort and preventing a Lehmanesque seizure of the funding markets. Claims that dollar hegemony is finished – to be replaced by what? – are premature, and that is the problem for the legion of dollar bears and goldbugs.
HSBC’s currency guru David Bloom says nothing has fundamentally changed to justify a precipitous derating of the dollar. “There is plenty of life in the old dog yet,” he says.
Despite pandemic turmoil, the US will suffer a smaller economic contraction than the eurozone this year (-5.3pc vs -8.1pc on market forecasts). It will emerge less damaged because it is a closed economy, somewhat shielded from the collapse in trade volumes, and because it is better able to mobilise a fiscal bazooka of sufficient scale. I have little doubt that a second jumbo package will be agreed on Capitol Hill before recess.
America’s flexible labour markets will smooth the switch from dying sectors to the post-Covid champions more easily than Europe's rigid job protection regime.
It is possible to sketch a scenario where the Fed winds down monetary stimulus and perhaps even sounds hawkish by next year, which would set off a blistering dollar rally, ceteris paribus. But does anybody in their right mind think that the European Central Bank could contemplate lifting interest rates or tightening policy this side of the mid-2020s?
The ECB went through an entire cycle of global expansion without managing to extract Euroland from a "lowflation" trap. It ended up semi-paralysed with rates at the rock-bottom floor of -0.5pc.
Europe has since been hit with the biggest economic shock since the Second World War, pushing Italy’s sovereign debt ratio to 160pc of GDP. The ECB is a permanent prisoner of negative rates. Any hint that it planned to step back from the bond markets would set off a run on Italian debt.
Athanasios Vamvakidis from Bank of America says the "short dollar" trade is based on faith in a "V-shaped" recovery for the rest of the world that is not actually happening, and on the false conclusion that Europe has met its Hamilton Moment and embraced debt mutualisation.
“We are concerned the consensus is too optimistic on the global economy; too optimistic on a vaccine; too pessimistic on the Covid-19 situation in the US compared with that in Europe. We disagree with the view that the EU Recovery Fund sets a precedent; the consensus is focused too much on the deterioration of the US debt and is complacent about similar trends in the rest of the world,” he said.
“We do not know when and which G10 central bank will start tightening monetary policy first after the pandemic, but we certainly would not expect the ECB to do so before the Fed. The ECB balance sheet could expand well beyond that of the Fed,” he added.
Ultra-dovish monetary policy usually leads to currency weakness so why have speculators and fund managers pushed up the euro so exuberantly over the last four months, lifting the ECB’s trade-weighted index to a six-year high?
Morgan Stanley says the dollar is “the most oversold in 40 years” and leveraged funds are running a record net short position of $50bn. It is a mood music trade, based on impressionistic chatter that Europe has got its act together. There is talk of a blow-off spike in the euro to $1.30, lifting sterling to nearly $1.40 along with it.
A forensic study by Bank of America’s Evelyn Herrmann and Ruben Segura-Cayuela should destroy any illusion that the EU’s €750bn Recovery Fund does what it says on the tin – especially since a Covid resurgence risks wrecking what’s left of the Club Med tourist season.
They think Euroland needs fiscal stimulus of 10-11pc of GDP “now” to prevent lasting damage. The national plans together add up to just 4pc. “The recovery fund might be able to top that up with another 1pc by next year, at the very best. That still leaves a stimulus gap of north of 6pc of GDP, if all goes well,” they said.
The money does not start to trickle through until mid-2021 and is then stretched until 2026. Only half the funds are in the form of pure fiscal transfers. These will begin at just 0.2pc of EU-wide GDP next year before peaking at 0.75pc in 2004 and then tailing off. Such sums scarcely move the macro-economic needle.
Bank of America warns that some of the money will be used to displace spending that is already planned, adding no actual stimulus. Not all of the loans will ever be activated given the tough conditions. Ergo, it is nowhere close to €750bn.
The net fiscal transfers to Italy through the first half of the 2020s will average less than 0.4pc of GDP a year. This amounts to an “error margin” in the current drama.
The Recovery Fund is certainly a statement of political solidarity but it remains a one-off instrument for a specific emergency. It does not entail "joint and several" debt issuance (ie, eurobonds). The bonds are therefore not quite a European "safe asset" akin to US Treasuries. The constitutional structure returns to the ante quo ante.
You can argue that Europe has set a precedent and will double down with bigger fiscal transfers if the crisis deepens, but first you have to have the crisis, in which case the euro is not about to rocket to $1.30.
It is true that real 10-year yields in the US have collapsed to an all time low of minus 1.08pc as the Fed guns the money supply and attempts to "run the economy hot" while at the same holding down the yield curve by financial repression. But real yields are even more deeply negative in Germany, and deeper yet in the UK.
By all means buy gold if you think that the major central banks are all debasing their currencies in a beggar-thy-neighbour race to the bottom, carrying out stealth defaults on their debt mountains – leaving hard assets as the final store of value. But don’t do it on spurious grounds that the dollar is broken.
Indeed, prepare for an upset in November. The odds are that Joe Biden and the Democrats will win a clean sweep, ushering in a New Deal II, a net spending boost of $2.5 trillion, and a watershed expansion of the American state.
Love it or hate it, such fiscal reflation is a recipe for resurgent currency. The Biden dollar may be the great surprise of 2021.