martes, septiembre 23, 2014



The Return of King Dollar

By Larry Kudlow & Stephen Moore

Russia CB buys more gold and builds bilateral trade with China

As Russian central bank buys more gold in August, ever-closer trade ties will make them strong players in any future global currency realignment.
Author: Lawrence Williams

Posted: Monday , 22 Sep 2014 

While we will probably have to wait another few days until the IMF publishes its latest statistics for the global picture, the Russian central bank has announced that it has added another 9.3 tonnes of gold to its official gold reserves. This is as tensions now seem to be diminishing in Ukraine which could, if the latest agreement holds, lead to Western sanctions against Russia being gradually withdrawn.
Russian gold reserves now stand at 1,113.5 tonnes, the world’s fifth largest national holding, thus climbing even further above China’s 'official' 1,054 tonnes. However few out there seem to believe that China doesn’t have more gold than it announces to the IMF, but is holding considerable amounts in some other government controlled accounts. Overall Russia has just about doubled its gold reserves since the 2007/2008 financial crisis and its central bank has been a net buyer almost every month since. The figures suggest that that the monthly increases have primarily come from the central bank taking in a significant proportion of the country’s domestic gold output which averaged around 20 tonnes a month in 2013; last year Russia was the world’s third largest producer of gold and this year could surpass Australia and move into the No. 2 position behind China.
Gold producing nations
2012 output  
2013 output
Russian Federation
South Africa

Source: Metals Focus/Mineweb
In parallel with its pursuit of gold, Russia continues to build its bilateral financial and trade relationships with China. At the beginning of this month Russia’s President Putin and Chinese Vice Premier Zhang Gaoli officially launched the construction of the first part of Russia’s Gazprom’s Power of Siberia pipeline - which will deliver 4 trillion m3 of gas to China over 30 years. While some aspects of construction may yet be delayed because of the impact of Western sanctions against Russia, the pipeline schedule calls for first natural gas deliveries in 2019.  When completed, at an estimated cost of some US$70 billion, it will have been, according to the Russian and Chinese officials, be the world’s largest construction project with the pipeline running for just under 4,000 km, plus associated infrastructure, and supply gas to China’s populous northeastern region, as well as Russia’s Far East. China is due to start pipeline construction at its end next year.
At the inauguration ceremony Russia Today quoted President Putin as saying “The new gas branch will significantly strengthen the economic cooperation with countries in the Asia-Pacific region and above all - our key partner China”. The 'key partner' phraseology is undoubtedly significant as it further suggests that Russia is looking to dramatically reduce its dependence on the West for oil and gas exports and probably in a number of other trade aspects too, while China looks to diversify and build trade with the other global superpower (after the U.S. and itself) as it seeks powerful allies to boost its case for becoming at least a significant participant in any new global reserve currency that will probably arise sooner rather than later. Reserve currency change looks inevitable in the medium to long term as global economic balances shift and may bring China into increasing economic conflict with the U.S. although this will likely be downplayed by both governments. But, as we noted in another recent article, China is very much a long term player in the global economic game.
Russia, like China, perhaps somewhat belatedly, has come to see its gold holdings as a significant positive in any new world financial order that may develop over the next decade.  American financial policy has dominated world trade for almost a century but there are powerful economic forces out there – notably involving various countries, including China and Russia, building trade ties in their own domestic currencies and thus starting to bypass the dollar. Energy trade is particularly significant in this respect as the U.S. dominance in setting the terms of world trade has been very much down to the virtually total dominance of the dollar in global oil and gas transactions.
Historically the country with the most gold has been able to dominate global trade – barbarous relic or no – and while the West may see this coming to an end there is an enormous, and ever wealthier, part of the world’s population which still believes in gold as the key global monetary asset. China and Russia are both strong believers in gold and the potential negotiating position it enables. At some stage soon the validity of their belief is going to be put to the test.

Long-Term Outlook - Bleak!


U.S. growth and inflation are both in a long-term downtrend.

Few, if any, economists consider this fact. Most think it is temporary or irrelevant.

The implications of these 2 trends are very worrisome.

I recently posted a comment on an article by the Inflation trader. The author (whose articles I read with great interest) and I disagree on the future path of U.S. inflation. He has stated in several previous articles that U.S. core inflation will likely reach 3% by the end of 2014. He is bemused by the latest CPI data. As with most analysts/economists, the conclusions they make rely on 2 sources;

Economic models based with assumptions by the writer which are back tested over the last 30 years or so to prove the reliability of the model. If the model is reliable, when tested, it sees the light of day and economic conclusions are drawn about the future.

The conclusions of many respected economists (Freidman, Keynes, etc.) from the past.

I conclude from all of his articles that the Inflation Trader appears to rely on both.

My argument on these 2 points is;

To point 1

For economic models to be useful, the back testing done on previous periods needs to be relevant to today's economic conditions. The situation today has NEVER been seen before and I find it hard to believe that the back testing is of any real use.

To point 2

Economists lived in past times when the economic conditions were very different. If the time machine were to be suddenly operational and these economists were transported into 2014, would their conclusions be the same? I seriously doubt it. How you think is conditioned by your surroundings. We are afraid at night, if threatened, and happy on our birthdays and we react differently to each situation. The same is undoubtedly true of economists. I find it hard to believe that conclusions made by economists in the 20th century in those conditions would be the same as they would make today.

It is my opinion that the next few years will shape new thinking on economic relationships that were seen as gospel truths in the 20th century. The reasons for this are present demographics, debt dynamics and income inequality.

The long-term path of inflation and the rate of growth of the U.S. economy from 1980 to the present are shown below (courtesy of Trading economics)

As you can clearly see, both charts are in a long-term downtrend. Core inflation is coming down and the rate of growth of U.S. GDP is softening.

My first comment is that to be suggesting higher inflation, you are arguing that the present trend of over 30 years is about to change direction. I would suggest that this is a bold call. But if the model says so, it must be so!

My contention is that both the long-term inflation and growth rate trends are not about to reverse. If any model suggests that they are, its assumptions are wrong and the model is useless. Eventually a change of direction is inevitable, but these generally happen when there is a fundamental change in how we behave.

Is the present U.S. monetary policy such a change? I don't think so (but it is fundamentally different to anything that we have ever seen before). Is it changing the behavior of the mass of the population? Nope. If we were fundamentally changing the tax system, reducing our reliance on debt expansion, changing the burden of regulation or reducing income inequality, I would be looking at a possible change of direction of GDP and inflation, but we are not. The status quo is not being touched and to expect a different result - well we all know Einstein's famous quote!

However for me, this is not the most important take away from this post. I read articles by Scott Sumner, Brad Delong, Cullen Roche and others. There is a lot of discussion on why the growth rate and inflation rate are in a downtrend with lots of very mathematical formulas and difficult to understand arguments based on the work of past economists. How much of it is new - virtually none! The furthest we have got is a piece by Larry Summers suggesting that we are now in long-term economic stagnation, but no assessment of causes or solutions.

When I look at the U.S. economy (and most of the western developed world economies) I see 4 main negatives;

Debt - Present government debt levels have never been seen outside times of war. Personal debt levels and corporate debt levels are very high. The result is that U.S. total debt is over 350% of GDP. This total debt/GDP level has only been surpassed in the run up to the 2008 financial crisis. Debt pulls consumption and therefore GDP forward. The rate of personal and corporate debt to GDP level cannot expand forever (although the absolute level of debt certainly will). This is therefore growth and inflation negative.

Government debt is different and it will be interesting to see if government debt can keep expanding without any consequences. As already stated, I am not a great believer in past economic theory as a guide, at this point in economic history. Can U.S. government debt continue to expand. My common sense screams that it cannot, but I am totally unsure of whether expansion of government debt with central bank support is possible. Japan, with the worst demographics in the world, has been at it for over 30 years, on and off. Its longevity is why the Japanese bond market has been called the 'widow maker' trade for so many years.

Demographics - The last available U.S. birth rate (2012) is 1.88 births per couple. A birth rate approaching 2.1 is required to keep the population stable. We have all read the demographic problems of the baby boomers. If you haven't here is a link to the Wikepedia 'baby boomers'. In general, the conclusions are that demographics are negative for the U.S. economy until approximately 2020.

Income inequality - The rich are now holding record amounts of savings and are taking record amount of earnings. This is negative as they do not spend the same percentage as low income earners. This has negative consequences for consumption and therefore GDP.

The negative employment effect of new technology - Japan has just opened its first restaurant with service by robots. The advent of new technology is reducing the need for skilled (and therefore better paid) workers. The internet is reducing the need for retail shop workers. The list of job losses due to technology is endless with the average car now only needing 9 people to make it in the most modern factories. This trend is irreversible and just makes problem number 3 much worse, as it concentrates wealth in the more affluent people and reduces the income of the poorer people as less jobs are needed. This reduces consumption as in point 3.

So that is the list of negatives. They are the reasons for the present trend in inflation and GDP. Most articles that I have read just highlight that all of the above are negatives and many forecast very poor economic outcomes. My take on this problem is that if we could understand the percentages of the reduction in growth that were caused by 1, 2, 3 and 4 above, we would know how to tackle the problem.

If the main cause is demographics and the echo boomers reduce the negative effect around 2020, the present course of monetary policy is correct and will need to stay in place until 2020. But what if demographics is only causing 10% of the reduction in GDP (meaning the other 3 are the main cause). Then the present monetary policy is probably wrong and will result in greater harm than good. If no. 3 above is the main cause, then monetary policy is absolutely wrong and will be causing real damage. If no. 4 is the main cause, then tax policy on corporations and individuals needs enormous change and present monetary policy is irrelevant.

I do not have the answers to the question 'what are the reasons for the reducing inflation rate and growth rate'. However, I am sure that if the main problem is debt, the solution will be very painful. If it is any of the other 3 it will be manageable. The truth probably lies in a combination of all 4. But that is a pure guess based on no good evidence. I dismay that we are not having a reasonable debate leading to conclusions on the above question. I am sure that it is possible to calculate mathematically, the consequences of the above 4 negatives, but it would be a very long task.

However, the present status quo (political and financial) is too set to even contemplate trying. Trying would intimate that the present monetary policy fixes are not going to work. If no. 3 above is the main cause, how would the rich feel if company taxation became 50% of the total annual U.S. tax take, reducing the individual tax contribution to 50%. Not very happy, I would assume. That would be a real change of the present status quo. The only way we will start to explore these major changes is if we have another crisis. Maintaining the status quo is too set in our system and it will not change until it has to.

Unfortunately, that is the reason that eventually we will have another crisis. We are not exploring the fundamental reasons for the long-term downtrends, so they will continue. The implications of this are that if you are a young investor you cannot buy and hold. If you are approaching retirement, you should be heavily in cash and hold some gold (and have an iron will as the market rises). Alternatively, you gamble that you have retired and annuitised by the time it arrives. In these conditions, everyone has to become a trader (as the market is going to lurch up and down from one crisis to another) and very few of us are any good at trading. Why? - because it is impossible to predict when the next crisis will arrive. It is a futile effort. The only surety is that it will arrive. The 2 graphs above tell you that. Do I have any idea when it will come? Will the S&P 500 be at 2100, 2500, 3000? No idea. Most of us will miss the signs that were obvious after the fact and as a result will be considerably poorer.

To change the investment conclusions that I have come to will require change that is really noticeable. No one will be able to miss it. The history of human nature suggests that only the conditions of a crisis will provide the opportunity for politicians to make the long-term changes necessary. They have missed the opportunity once but they are going to get another try. My problem today is that there is no discussion of what are the required fundamental changes that we need. When the next crisis arrives we will be totally unprepared to make the fundamental changes needed, as we will have no idea what they are. World central banks will find a way to sooth the immediate crisis and the world will continue on, but putting the U.S. back on a higher growth and inflation trajectory - no hope. For that we need a completely different discussion and we are not having it at present.

I have already put in the comments section of the Inflation Trader's article that I think inflation will remain around the 2% (or less) area for several years and that we will not see 3% for core inflation in 2014. What about a discussion of the long-term changes that we need to make. It is much more important!

The battle at the Federal Open Market Committee is now on. Score the previous meeting in late July for the inflation hawks, but last week's meeting went for the doves, who are more worried about jobs. I haven't discussed the meetings with any Fed officials, but here's my reading of what has been going on.
In the statement following July's FOMC meeting, Federal Reserve Chair Janet Yellen went to great lengths to placate the hawks with several language changes (but no policy changes). Instead of emphasizing that "inflation has been running below" the Fed's 2% target, as the committee had been saying, the statement observed that "inflation has moved somewhat closer" to 2%. And instead of calling the unemployment rate "elevated," it switched to the less ominous phrase "significant underutilization of labor." Such subtleties matter at the Fed, and markets took note of the more hawkish tilt.
The hawks were not placated. Because voting rights rotate among the reserve bank presidents, this year's voters include only two real hawks. One of the them— Charles Plosser of the Philadelphia Fed—dissented from the Fed's statement that low interest rates would be maintained "for a considerable time after the asset-purchase program ends," making the July vote 9-1. The other— Richard Fisherof the Dallas Fed—did not dissent formally, but had three days earlier made his disagreement known in these pages
Last week Ms. Yellen gave no ground. The committee's hawks would like the phrase "significant underutilization of labor" removed from the statement. The Fed kept it. They want the FOMC to stop declaring that interest rates will remain at their current superlow levels "for a considerable time" after asset purchases end next month. The Yellen-led majority refused. The hawks want the Fed to stop saying that it expects to keep interest rates low "for some time" after the economy returns to normal. The Fed didn't. And there were a few more details, all pointing in the same dovish direction. 
Mr. Plosser dissented again, and this time Mr. Fisher joined him, making the FOMC vote 8-2. There almost certainly would have been more dissents if other hawks could vote. At a consensus-based institution like the Fed, this constitutes deep division. 
Yet another indicator of rampant disagreement appeared in the famous—to Fed watchers—"dots diagram," where each committee member is represented by a dot showing where he or she thinks the federal-funds rate should be in the future. Opinions on where the rate should be at the end of 2015 range from near zero all the way to 3%. The range is even wider for the end of 2016: from 0.25-0.50% to 4%. This is a remarkable degree of disagreement.
The Fed also released a new set of "principles and plans" for bringing monetary policy back to normal, finally replacing the principles it published in 2011, which said, among other things, that some balance-sheet shrinkage would come before interest-rate hikes. These new principles are rather vague, but Jeffrey Lacker of the Richmond Fed, another hawk, refused to sign on. 
Fed watchers learned two main things from the new plans. First, that as the Fed "exits," it will not rely heavily on what are called "overnight reverse repurchase agreements"—in plain English, borrowing in the money markets. Rather, it will do such borrowing "only to the extent necessary and will phase it out when it is no longer needed." Market specialists had been all aflutter about this issue, some thinking it would become the Fed's primary instrument. 
Second, while the FOMC still "intends" to exit without any outright asset sales from its huge portfolio, it hedged on that principle in several ways. For example, it said it "does not anticipate" selling any mortgage-backed securities, which prompted Mr. Lacker's dissent. Furthermore, the FOMC didn't mention selling Treasurys at all.
Regarding current monetary policy, the most notable and perhaps puzzling change in the Fed's official forecast was less optimism about real GDP growth in 2015. In its previous forecast, the "central tendency" among FOMC members was about 3.1%. Now the central tendency is about 2.8%. Not exactly an earth-shattering change. But as these things go, that's a pretty big revision in six weeks, and it isn't clear where the newfound pessimism came from. It does, however, suggest less urgency about raising rates.
The median FOMC member now thinks the federal-funds rate should be between 1.25% and 1.5% by the end of next year, and between 2.75% and 3% by the end of 2016. Both are higher than before, and a bit higher than traders expect.
One way to make sense of all this is to say, as some have, that the Fed may wait a little longer but then raise rates more rapidly once it starts. Perhaps. Another interpretation is that the Fed is projecting faster rate hikes because it is underestimating how strongly bond traders will push long-term interest rates up once Fed hikes begin. The central bank has underestimated market reactions before. 
Mr. Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, is the author of "After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead" (Penguin, 2013).