China’s Looming Currency Crisis

Mass capital outflows continue despite stymied Beijing’s efforts to boost the economy. Expect the yuan to tumble.

By Anne Stevenson-Yang and Kevin Dougherty

The Chinese are moving record amounts of money overseas or purchasing foreign companies and assets.

The Chinese are moving record amounts of money overseas or purchasing foreign companies and assets. Photo: Bloomberg News
After initial declines in the Chinese market to start the year, the past few weeks have seen signs of what some would call a rebound. Lending in China rose by 67% in January, iron-ore prices initially rallied by 64% and housing sales in the top four markets surged. The yuan gained back half of the nearly 7% it had lost against the dollar since November, sending hedge funds that had shorted on the currency running for cover. And yet there remains no sign of life in the underlying Chinese economy.

More than $800 billion in credit that had been pushed into the economy in January failed to boost production or increase sales. Producer prices remained negative, dropping 5.1% in January-February, while the manufacturing PMI fell to 48 in February from 48.4 in January, indicating worsening contraction. That’s because the rally was the result of a coordinated government effort to restore confidence in the China Dream of limitless growth at home and glory abroad. The market, apparently, isn’t so easily convinced.

From hiding capital outflows to propping up real-estate values, manipulating futures markets and squeezing short-sellers of the yuan, Chinese authorities have been trying to bring back the old, quasisuperstitious belief in Beijing’s omnipotence. But the political desperation behind these efforts betrays a different story: that an impending currency crisis is a signal of the dream’s undoing.

That’s why in China getting money out of the country is now the major preoccupation of both families and corporations. Risk-averse individuals are trading out of the wealth-management products they used to buy for 10% yields and moving their money to safety in the U.S., Australia, Canada and Europe. Chinese companies are making extravagant bids for overseas assets such as General Electric GE -0.23 % ’s appliance division, the equipment maker Terex Corp. TEX 1.35 % , the near-dead Norwegian web browser Opera, the Swiss pesticides group Syngenta, SYT -0.52 % technology distributor Ingram Micro IM -0.08 % and even the Chicago Stock Exchange.

In the first six weeks of 2016, Chinese firms committed to spending $82 billion on such acquisitions. Last year saw nearly $1 trillion in capital outflows, including a decline of $512.66 billion in the foreign reserves. Although no one is sure how much of China’s reserves are liquid and available, it’s safe to say that, at this rate, China can’t afford capital flight for more than another year.

One way to stem the crisis would be through depreciation. That would be sound policy for the people of China, but it’s a dreaded last resort for a leadership that wants, more than jobs for its people, to bolster buying power and save political face overseas. Yet history shows that holding the line on the currency is a losing strategy. Tightened liquidity causes more pain to the economy and simply delays the inevitable.

National leaders, when faced with a disorderly adjustment, will inevitably resist markets, promise major structural changes (which are then slow to materialize), inject liquidity into financial markets and insist that everything is under control. But these measures rarely work and in fact have never worked when imbalances are as severe as they are in China today.

In other countries, currency crises usually followed a sudden and irreversible loss of confidence. The Asian Tigers were booming and then fell apart rapidly. Same in Russia. China faces the added difficulty of having little institutional memory and few tools to manage the economy in a time of capital scarcity. And there is no sign that capital-outflow pressure will ease.

And so a painful adjustment will be unavoidable: Property values will decline by an estimated 50% from the current reported average of $142 per square foot in tier-two cities, roughly equivalent to the national average in the U.S., where incomes are much higher. (Current price-to-income ratios in China are generally over 20, while the U.S. averages about three.) Excess industrial capacity will shut down. People will lose their jobs.

But Beijing still has a choice: Either let the yuan take some of the pressure of adjustment, or let all of it fall on the domestic market. Placed in such stark terms, a currency adjustment seems inevitable.

A likely depreciation of at least 15% against the U.S. dollar would take the renminbi back to where it was on the eve of the global financial crisis, before speculative capital inflows flooded into China and drove up the currency’s value. This would be a “reset event” globally. All forecasts for inflation/deflation, interest rates, currency crosses, growth and commodity prices would have to be ripped up and recalculated. It would likely lead to an emerging-markets crash. As a percentage of global gross domestic product, China today is nearly twice the size of Asia (excluding Japan) in 1997.

Commodities, emerging-market equities and multinationals with exposure to China have already started to realize significant losses. Soon major corrections will reach other assets boosted by the Chinese economy, such as property values in Hong Kong and Singapore. When this unfolds, U.S. government bonds may be the world’s only safe haven. The end of the China story is at hand.

Ms. Stevenson-Yang is co-founder of J Capital Research Ltd. Mr. Dougherty is chief investment officer of KDGF Asset Management.


High tech meets low finance

For all the money spent on technology, banking is not efficient

TECHNOLOGY ought to have revolutionised finance more than any other industry. After all, modern money is mostly an entry on a computer—capable of being transmitted instantly and virtually costlessly around the world. Stockmarket activity is now dominated by high-frequency traders, who make deals faster than they can blink.

The finance sector spends more on technology, as a proportion of its revenues, than any other industry. Nevertheless, compared with the world of e-commerce, banking still sometimes gives the impression of a Volkswagen Beetle instead of a Formula 1 racing car. It took many years of effort to get to a world of “T+2”, where securities are settled two days after the trade is made, rather than the “T+3” system that preceded it.

The international payments system still looks like a “spaghetti junction”, in the words of Andrew Haldane, the Bank of England’s chief economist, with money passing through several hands on the way from payer to recipient. The annual revenues earned by the banking system for processing payments are huge, at $1.7 trillion, and rising (see chart).

One reason for this inefficiency is that technology has been tacked on to a centuries-old banking model. Much bank spending on technology is devoted to maintaining existing systems, a desperate effort to keep the show on the road.

Hence the hype around “fintech”—the hope that the whole system can be overhauled by disruptive innovators, much as Uber is revolutionising the taxi business and Airbnb is taking on hotels. Fintech firms operate in many areas, from digital payments to automated wealth management. But at a London Business School conference this week, the greatest excitement was reserved for blockchain technology. A blockchain is a “distributed ledger” under which transaction records are held by a wide number of participants in a network; it is the technology behind Bitcoin, a digital currency.

Technology experts seem to think a distributed ledger is more secure. A hacker would be required to break into a wide range of sites rather than a single, central register. But there are doubts over whether such a system could handle the sheer volume of payments in the financial system—hundreds of thousands of transactions every second.

Even if those technological hurdles could be overcome, a register could develop in two different ways. An open system would be good for customers, allowing them to exchange money quickly, cheaply and anonymously. But it would be a nightmare for regulators trying to crack down on tax evasion and money-laundering. No longer would the unscrupulous need to keep high-value notes under the mattress. A supervised system would get round this problem, but it would also give the authorities much more power to pry into people’s financial lives. Customers would understandably be far less keen.

A largely unregulated technology sector is bumping up against a heavily regulated finance industry. The result may be that advances in this area will be slow as regulators clamp down on anything that seems too anarchic. The big banks, conscious of the ability of regulators to fine them for aiding and abetting money-laundering, will proceed with caution.

Susan Athey, an economist with links to Silicon Valley, argues that blockchain technology might be most useful for other purposes—to register asset ownership, for example. People in developing countries find it difficult to establish their ownership of land; a reliable digital register could reduce that problem. And a digital land registry in America would eliminate the need for homeowners to pay for expensive title insurance.

Forecasting how new technology will change an industry is never easy. As Bill Gates once said, and tech types constantly repeat: “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.”

But monetary policy may be giving new financial models a lift. Very low interest rates encourage investors to search for yield. One beneficiary is peer-to-peer lending, in which investors extend credit to people and businesses directly. And imagine what would happen if negative interest rates became semi-permanent and were passed on to retail depositors—a tax on bank accounts. The appeal of digital currencies that were out of the reach of central bankers would increase exponentially. Never mind disrupting commercial banks.

What about doing the same thing to central Banks?

Has the China-ASEAN Affair Come to an End?



For decades, rapid economic expansion in China has had a positive spillover effect on the Southeast Asian region, sparking unprecedented economic growth among smaller nations that lifted millions of people out of dire poverty and swelled the ranks of their middle class.

The wealth effect gave impoverished villagers access to benefits Western nations take for granted: better roads, health care and education. Meanwhile, major infrastructure projects such as hydroelectric dams, bridges and airports opened up remote areas where previously only the indigenous and hardy were able to tread.

The long-running, double-digit economic growth enjoyed by China specifically bolstered manufacturing south of the border, resulting in exports to China from the Association of Southeast Asian Nations (ASEAN) surging by about 20% a year for more than two decades.

ASEAN comprises ten countries: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.  

Recently, Southeast Asia further sharpened its clout as a trading bloc with the launch of the Association of Southeast Asian Nations Economic Community (AEC).

But the gravy train could now be screeching to a halt. Fiscal realities are setting in, with China’s GDP growth slowing amid slumping commodity prices, regional currency devaluations and stock market volatility. It is a fall from grace that could threaten the broader region.

“China’s growing prominence as a key market for ASEAN exports has increased the vulnerability of many ASEAN countries to China’s economic slowdown,” says Rajiv Biswas, Asia-Pacific chief economist for IHS Global Insight.

Chinese Dominoes

Chinese economic growth slowed to an estimated 6.9% in 2015 and is expected to decelerate further to 6.3% this year, potentially the worst performance since the country’s economy was opened to the global market by leader Deng Xiaoping in the midst of the Cold War. His policies fueled a resources boom that enabled China to transform itself into the world’s factory floor and second largest economy.

China expanded overland routes into Laos, Cambodia, Vietnam, Myanmar and Thailand through heavy investment that incorporated much of Southeast Asia into Chinese supply chains. Annually, ASEAN enjoyed 20% export growth. That growth gave China stature in the region, tempered by caution. However, few seemed to care while so much money was rolling in even as China asserted spurious territorial and maritime sovereign claims.

But an economic bubble has been looming, fed by over-construction and soaring debt, and its bursting will have widespread ramifications. “People need to readjust and live with a much lower GDP. In my view, it is unrealistic to expect that China can grow at even 8% or 9% forever,” notes Andreas Vogelsanger, an equities and political analyst with Asia Frontier Capital. “We will probably need to readjust to growth rates of 5% to 6%.”

Chinese government debt figures vary widely, mainly because the central government relies on provincial bureaucrats to report and update figures. But according to consulting firm McKinsey, Chinese debt has grown from a manageable $7 trillion in 2007 to more than $28 trillion today. “China’s debt as a share of GDP, while manageable, is larger than that of the United States or Germany,” it noted in a report, before last year’s currency rout.

A sharp deterioration in the Chinese renminbi began in August 2015 with a near 2% devaluation of the currency amid falling commodity prices and then the biggest sell-off the Chinese stock market has ever seen, which has continued into 2016.

As China devalued its currency, Southeast Asian countries were forced to follow suit just to keep their exports competitive, resulting in the biggest falls experienced by regional currencies since the 1997-98 Asian financial crisis that wreaked havoc on government budgets. “The impact of China’s slowdown on the East Asian manufacturing supply chain and both manufacturing and commodity exports has already hit many ASEAN countries hard,” Biswas of IHS notes.

Commodities Hammered

The International Monetary Fund expects the global economy to grow by just 3.6% and recently revised down its ASEAN economic outlook for 2016 to 5% GDP growth, from 5.3%.

The figure is an uptick from 4.6% in 2015.

These numbers, however, are paltry by developing world standards and the IMF left open the possibility of further downgrades, arguing growth rates could moderate over the next 12 months due to several factors, including weak commodity prices, political uncertainty and weaker growth in China.

Keith Loveard, a risk-assessment analyst with Jakarta-based Concord Security, notes that substantive differences exist among the 10 countries that make up ASEAN, and their exposure to China varies just as greatly. “The ASEAN economies are tied closely to China, and any major contraction in the market will naturally hurt ASEAN,” he says. “The extent of the dependence of ASEAN economies to the Chinese market clearly varies according to the degree of sophistication of the economy and the capacity to expand trade partnerships.”
ASEAN comprises a mix of nations, ranging from affluent Singapore to the less well-heeled Cambodia and Laos. Religious and political differences are just as great but trade is their all-important common denominator — with commodity-based economies having fared worse.

Among them, Indonesia, Malaysia, Vietnam, Brunei and Myanmar have witnessed receipts from oil and gas, palm oil, coal and other commodities dwindle sharply.

The magnitude of the declines, naturally, depends on “the level of exposure, particularly to basic commodities such as iron ore, coal and palm oil,” Loveard says. He adds that Indonesia, the most powerful member of ASEAN, had seen exports in December 2015 decline 17.66% to $11.89 billion, from the same month a year earlier.

“Indonesia is clearly the biggest loser in this equation. It failed to capitalize on the advantages of strong coal sales as China built a dominant steel industry to feed its infrastructure development program, and peak prices in its other major export commodity, palm oil,” he says.

It was a major policy mistake with big ramifications. “While other countries expended effort to develop their manufacturing sectors, Indonesia was content to sit back and reap in the profits from the commodities boom only to see them disappear when China changed course,” Loveard, a veteran Indonesian observer, adds.

Among those to buck the initial trend were Singapore, Malaysia and the Philippines. Malaysia, which had invested heavily in Islamic banking, had weathered the Chinese economic storm until December 2015 when its balance of trade figures showed exports had fallen 2.2% amid a realization that the economy is stagnating.

The Malaysian currency, the ringgit, also took a hit which officials blamed on China while ignoring the political and financial scandals that have enveloped the current administration.

“The still-fragile growth outlook in advanced economies, coupled with downside growth risks from emerging markets, imply further uptick in global demand and hence exports could be very modest,” BIMB Securities, a Malaysian-based Sharia-compliant brokerage firm, states in a report. “We, however, remain hopeful of positive exports growth in the next few months, taking cue from a lower base for oil prices and not forgetting positive lift from the ringgit weakness.”

Economic Contagion

China’s great fall has spread beyond Southeast Asia. Its stock market slide has affected global markets, complicated by an interest rate hike in the U.S. and a descent into negative interest rates in Japan and Europe, with banking and finance stocks taking the biggest hits. Talk of global recession again dominates the headlines.

Singapore’s position as a regional financial hub has protected it to a point. But as a major base for oil-related companies and regional banks, its prospects have also dimmed. Thailand is in a similar position, but analysts explain it would be unfair to simply blame China for the economic malaise when home-grown political issues such as the coup in May 2014 and succession issues surrounding the country’s aging monarch have forced foreign investors to flee.

That exodus prompted its outgoing central bank governor, Prasarn Trairatvorakul, to warn that an erosion of investor confidence has meant Thailand is losing out to Indonesia and Vietnam. “It’s like sitting in boiling water and we don’t feel it.”

To date, only the Philippines has escaped China’s fiscal woes. Its exports are only about half of Indonesia’s and they consist largely of electronic products with the lion’s share going to Japan, thus limiting its exposure to China.

ASEAN’s poorer countries are also faring better. Absolute poverty levels have improved, giving rise to an emerging middle class, even though the gains have escaped the rural poor in Cambodia, Laos and Myanmar. According to the United Nations Development Program, Cambodia’s poverty rate has fallen to 13.5% from more than 40% a decade ago. Myanmar’s poverty rate has improved to 26% while Laos stands at 23%.

Still, ASEAN’s weaker members are not expected to remain unscathed from China’s fluctuating fortunes. As the Vietnamese government has warned, “Any changes in the global economy would have huge impacts on developing countries like Vietnam, Laos, Cambodia and Myanmar.”

Cambodia has accepted more than $11 billion in direct charity and soft loans from China over the last two decades, roughly half its entire peace-time foreign aid budget, while almost half of Myanmar’s $10 billion debt is owed to China.

Whether Beijing’s largesse can continue under current economic stress is the potent question confronting the region’s finance ministries. China has just promised Cambodia it will boost two-way trade by a further $5 billion in 2017.

Beijing cancelled Laos’ debt in 2003, but liabilities racked up since then have not been disclosed. The most pressing issue currently confronting the one-party state is whether to proceed with a massive, but perhaps unrealistic, borrowing spree to fund huge infrastructure programs including nine dams and railways linking Thailand to China and Vietnam across Laos.

The project’s total price tag has been put at more than $20 billion, which dwarf’s Laos’ GDP of about $12 billion, thus fueling outrage among economic conservatives who view it an opportunistic money-grab for acolytes of outgoing Prime Minister Thongsing Thammavong.

“There is little evidence that Laos would gain much from the railway, as much of it would traverse sparsely inhabited regions,” says Gavin Greenwood, a regional risk analyst with Hong Kong-Based Allan & Associates. “While there may be benefits for such sectors as mining close to the line of rail, the overall cost to [Laotian capital] Vientiane would not come close to justifying Laos’ own investment in the project. Indeed, the Asian Development Bank has warned that Laos risks serious economic damage if the project adds greatly, as forecast, to the country’s sovereign debt.”

Thongsing was ousted from power by the Communist Party in January 2016 amid anger within his own ranks over plans to dam the main stream of the Mekong River as well as excessive borrowings. His removal was widely interpreted as a shift away from Chinese influence.

One Road and a Trading Bloc

The impact of China’s decline is being felt wide and deep within Southeast Asia, where governments are increasingly pinning their growth prospects on the AEC, launched on January 1 after decades of planning.

Analysts note that intra-ASEAN trade within the AEC should mitigate some of the fallout between ASEAN and China. The trading bloc includes 625 million people with a combined GDP of $2.4 trillion. As a comparison, India’s GDP stands at $2 trillion and China at $10.4 trillion, according to the World Bank.

However, there is a free flow of skilled labor within the bloc just for eight professions — doctors, nurses, dentists, engineers, architects, surveyors, accountants and those in tourism.

Moreover, the bloc does paper over enormous disparities in wealth and standards.

For example, graduates from universities in Myanmar, Cambodia and Laos will find it difficult to compete with their peers in the Philippines, Indonesia and Singapore. Tradesmen and semi-skilled workers, however, will benefit from better cross-border employment prospects on construction sites and in the hotel industry as domestic helpers and laborers, but there will be few tangible benefits for the region’s many unskilled workers.

Nevertheless, intra-ASEAN trade has risen sharply since 1993 when these countries began reducing tariffs, now down by 95%, and harmonizing border regulations as a prelude to the AEC launch. Intra-ASEAN trade now stands at almost $609 billion compared with $82 billion more than two decades ago.

ASEAN, especially its manufacturers, is also hoping to take advantage of a shift in emphasis towards higher domestic consumption and consumerism in China — contributing about 66% to GDP growth in 2015 – with tourism being another prime example.

“This rebalancing of the Chinese economy towards private consumption is creating new export opportunities for ASEAN, notably as Chinese tourism has surged,” Biswas says, noting that Chinese tourist arrivals in Thailand rose 71% in 2014 and in Indonesia by 30% in 2015.

On a second front, Biswas notes that a key long-term growth driver for ASEAN will be China’s “One Belt, One Road” initiative, which will accelerate new infrastructure financing through the recently launched Asian Infrastructure Investment Bank (AIIB) and its Silk Road Fund. Also known as the Silk Road Economic Belt, the One Belt, One Road strategy is designed to open up trade and provide much-needed infrastructure investment across Eurasia. Importantly, this will help soak up excess steel production in China.

“Many countries in Southeast Asia are expected to benefit from the One Belt, One Road initiative, which will help to accelerate the development of the Greater Mekong Subregion as a new global manufacturing hub,” Biswas says. His sentiments are echoed by Vogelsanger at Asia Frontier, who notes that China will remain an important driver of regional growth for many years to come despite the changing economic landscape. “Undoubtedly, the Chinese economy is slowly but surely, by orders from the top, transforming from a cheap manufacturing and export-oriented model to a Western-style consumer-driven society,” he says.

Whether that’s enough to enable ASEAN countries to fulfill their economic dreams and stated goals — Myanmar, Cambodia and Laos want middle-income status by 2030; Vietnam and Malaysia want to be developed nations by 2020 — is tenuous. The picture might be clearer in the coming months.

Confronting the Fiscal Bogeyman

Barry Eichengreen

 people shopping  
BERKELEY – The world economy is visibly sinking, and the policymakers who are supposed to be its stewards are tying themselves in knots. Or so suggest the results of the G-20 summit held in Shanghai at the end of last month.
The International Monetary Fund, having just downgraded its forecast for global growth, warned the assembled G-20 attendees that yet another downgrade was pending. Despite this, all that emerged from the meeting was an anodyne statement about pursuing structural reforms and avoiding beggar-thy-neighbor policies.
Once again, monetary policy was left – to use the now-familiar phrase – as the only game in town. Central banks have kept interest rates low for the better part of eight years. They have experimented with quantitative easing. In their latest contortion, they have moved real interest rates into negative territory.
The motivation is sound: someone needs to do something to keep the world economy afloat, and central banks are the only agents capable of acting. The problem is that monetary policy is approaching exhaustion. It is not clear that interest rates can be depressed much further.
Negative rates, moreover, have begun to impair the health of the banking system. Charging banks for the privilege of holding reserves raises their cost of doing business. Because households can resort to safe-deposit boxes, it’s hard for banks to charge depositors for safekeeping their funds.
In a weak economy, moreover, banks have little ability to pass on their costs via higher lending rates. In Europe, where experimentation with negative interest rates has gone furthest, bank distress is clearly visible.
The solution is straightforward. It is to fix the problem of deficient demand not by attempting to further loosen monetary conditions, but by boosting public spending. Governments should borrow to invest in research, education, and infrastructure. Currently, such investments cost little, given low interest rates. Productive public investment would also enhance the returns on private investment, encouraging firms to undertake additional projects.
Thus, it is disturbing to see the refusal of policymakers, particularly in the US and Germany, to even contemplate such action, despite available fiscal space (as record-low treasury-bond yields and virtually every other economic indicator show). In Germany, ideological aversion to budget deficits runs deep. It is rooted in the post-World War II doctrine of “ordoliberalism,” which counseled that government should enforce contracts and ensure adequate competition but otherwise avoid interfering in the economy.
Adherence to this doctrine prevented postwar German policymakers from being tempted by excesses like those of Hitler and Stalin. But the cost was high. The ordoliberal emphasis on personal responsibility fostered an unreasoning hostility to the idea that actions that are individually responsible do not automatically produce desirable aggregate outcomes. In other words, it rendered Germans allergic to macroeconomics.
The aging of the German population then made it seem urgent to save collectively for retirement by running surpluses. And an exceptional spate of budget deficits following German reunification in 1990 appeared only to aggravate, not solve, reunified Germany’s structural problems.
Ultimately, hostility to the use of fiscal policy, as with many things German, can be traced to the 1920s, when budget deficits led to hyperinflation. The circumstances today may be entirely different from those in the 1920s, but there is still guilt by association, as every German schoolboy and girl learns at an early age.
The US did not experience hyperinflation in the 1920s – or at any other time in its history. But for the better part of two centuries, its citizens have been suspicious of federal government power, including the power to run deficits, which is fundamentally a federal prerogative. From independence through the Civil War, that suspicion was strongest in the American South, where it was rooted in the fear that the federal government might abolish slavery.
In the mid-twentieth century, during the civil rights movement, it was again the Southern political elite that opposed the muscular use of federal power. Starting in 1964, in conjunction with Democratic President Lyndon Baines Johnson’s “New Society,” the government threatened to withhold federal funding for health, education, and other state and local programs from jurisdictions that resisted legislative and judicial desegregation orders.
The result was to render the South a solid Republican bloc and leave its leaders antagonistic to all exercise of federal power except for the enforcement of contracts and competition – a hostility that notably included countercyclical macroeconomic policy. Welcome to ordoliberalism, Dixie-style. Wolfgang Schäuble, meet Ted Cruz.
Ideological and political prejudices deeply rooted in history will have to be overcome to end the current stagnation. If an extended period of depressed growth following a crisis isn’t the right moment to challenge them, then when is?

Up and Down Wall Street

Why the Bull Market May Be Losing Its Mojo

Investors are struggling to determine if the bull is back or whether the stock rebound just reflects another global round of monetary easing.

Are we really headed back to the future?
It would appear that Nike (ticker: NIKE) thinks so. The athletic-wear maker last week unveiled a real-life version of a prop from the fantasy flick from three decades ago: self-tying sneakers.

With self-driving automobiles on the horizon, why shouldn’t sneakers lace themselves up in the 21st century? So what if it takes a feat of engineering to perform a task that can be mastered by 5-year-olds? It’s cool.
Technology also is being utilized in rather more productive ways, spurred on by politics.

Specifically, the campaign to boost the minimum wage would provide the impetus to put more robots to work—in place of humans.
That’s the conclusion of the latest survey of chief financial officers by the Fuqua School of Business at Duke University. Nearly three-quarters of the CFOs polled said they would trim current or future payrolls if the minimum wage were hiked to $15 an hour—the aim of various campaigns. Some 41% said they would lay off current workers, and 66% would slow future hiring. Moreover, 66% of firms said they would also cut employee benefits, and 49% would raise prices with a 15-buck wage floor.
Those impacts wouldn’t be immediate, writes Campbell Harvey, the Fuqua professor who is the founder of the survey. Most companies with employees earning less than $10 an hour would gradually invest in labor-saving techniques were the minimum wage to be hiked, he continues.

“CFOs are telling policy makers there is a significant unintended consequence: Some jobs will be replaced by robots, and this replacement is permanent.”
The fast-food business, a primary target for the $15-an-hour minimum, would probably become a big adopter of automation. At Starbucks (SBUX), there’s already a feature for that in its Mobile Order and Pay app for smartphones. Between mandated pay hikes and the ubiquity of iPhones and Android devices, positions for fast-food order takers would most likely dwindle. And anybody who has ever tried to order in a drive-through with one of those unintelligible speakers might welcome the option of a phone App.
Other interesting findings from the Fuqua survey: The CFOs thought there was a 31% chance that the U.S. would be in recession by the end of 2016, nearly double the 16% probability predicted nine months earlier.
“Slowing emerging economies and volatile financial markets and commodity prices” were cited, according to Harvey, with the cooling in China mentioned by 59% of the CFOs as the biggest U.S. recession risk.
That’s a worry evidently shared by the Federal Reserve (about that more later).
Closely following the global concerns were worries about political turmoil in the U.S., according to the survey, which closed March 4. At least the uncertainty of whom will be heading the presidential tickets has diminished, as challenges to Hillary Clinton for the Democrats and Donald Trump for the Republicans look like exceedingly long shots after last week’s round of primaries.
That still leaves the general election campaign to be fought between two candidates with the highest negative ratings from voters in memory. The prospect of a down-and-dirty fight between Hillary and the Donald is unlikely to boost CFOs’ confidence, already shaky because of the political landscape.
On the positive side, the respondents’ next biggest reasons to fret about a recession—the stock market and the price of oil—have improved decidedly since the survey was completed. For that, they can thank the world’s central bankers.
Most of the central banks around the globe—the majors, such as the European Central Bank, the Bank of Japan, and the People’s Bank of China, plus some smaller ones, most recently Norway’s and New Zealand’s—are in easing mode.
The Bank of England last week held interest rates at historic lows amid the uncertainty of the June 23 referendum on the United Kingdom’s continued membership in the European Union. And, of course, the Federal Open Market Committee also voted last week to stand pat, prominently citing global concerns in lowering expectations for future rate hikes.
With that, the U.S. dollar has eased and commodity prices—most importantly, but not solely, that of oil—have recovered sharply. And with the softening of the greenback, formerly beaten-down commodity-related stocks have rebounded, in the process erasing the 10%-plus correction in the major indexes suffered after the turn of the year. Notable laggards have been the big technology names, top winners when the dollar was in ascent last year.
All of which has set up some unexpected intermarket relationships. The Dow transports have entered “official” bull territory, despite the better-than-50% rebound in U.S. crude prices from their February lows of $26 and change. Higher fuel costs typically are bad for airlines and truckers, but both reacted positively to the reduction in recession risks provided by the central Banks.
Bank of America Merrill Lynch strategists’ team, led by Michael Hartnett, observes that the recent outperformance of commodity-linked stocks has tracked the strengthening of the Chinese yuan (and concomitantly, the weakening of the greenback). Of course, the assertion of the GOP front-runner is that China is deliberately pushing its currency lower to spur exports unfairly.
In any case, Hartnett’s team found that a “pain trade,” pairing Facebook (FB) versus Petrobras (PBR), has tracked the yuan’s exchange rate (in the offshore market outside China).

Last year, as the dollar strengthened and the yuan slid (reflecting deflationary fears from China’s slowdown, which spilled into commodities), Facebook trounced the Brazilian oil company’s shares. As the yuan has strengthened this year (and the dollar has weakened), the rebound in Petrobras has left the social-media giant in the dust.
The question now is if the commodity-led rebound in risk assets is more than a snap-back reaction. Central banks are either in full-tilt easing mode or, in the case of the Fed and the BOE, holding back on rate hikes. Will that worldwide easing keep the rebound going? The uncertainty could keep investors tied up in knots—without any self-lacing Nikes.

WITH THE MONETARY WINDS AT THEIR BACKS, the major U.S. averages notched their fifth straight winning week and recouped their losses since the Feb. 11 lows. That came despite the shocking plunge in Valeant Pharmaceuticals International exchange-traded fund (HYG) is up 9.6% since the low close of that date.
Maybe it’s just spring fever. The calendar says spring starts this week in the Northern Hemisphere, with the Easter holiday next weekend. But snow is forecast for the Northeast—a shock after the warmest winter in U.S. history. The meteorological readings will affect the economic data, which are supposed to be adjusted for seasons. So observes the ever-perspicacious David Levy, the third-generation head of the family business, the Jerome Levy Forecasting Center.
After the brutally cold and stormy Februaries of 2014 and 2015, the seasonal adjustments that take into account those miserable months make this February’s data preternaturally sunny, he explains. “However, as spring data appear and the warm-winter boost vanishes, the presently elevated data will drop back to trends, which in most cases are not very good trends,” Levy writes to clients.
He thinks the risk markets will have to adjust when the less-massaged March and April numbers are published in six to eight weeks, ending the bear-market rally. At which point, Levy says, the bubble he sees in emerging markets will return to the fore. And that, he adds, is as big or bigger than the late 1990s tech bubble and the 2000s U.S. housing bubble, which were easier to spot.
The emerging market overexpansion is a result of the repeated economic stimulus applied to offset the bursting of the preceding bubbles, Levy argues: “This time, many people see parts of the bubble, but few understand they are all part of the same gigantic, global manifestation of speculative excess.”
Contracting global trade, falling capital- goods orders, the decline in industrial commodity prices, weakness in purchasing managers’ surveys and in executive confidence (such as the CFO survey noted earlier), plus tighter bank lending conditions, all are signs of excess capacity globally, he continues.
Perhaps these are among the global factors to which the FOMC alluded in the statement accompanying its decision last week to hold its interest-rate target steady at 0.25% to 0.5%.

Moreover, the panel’s dot-plot graph of year-end rate expectations pointed to two more hikes this year, down from the four forecast in December.
Even that sounds aggressive. The federal-funds futures market thinks only one hike is likely this year, probably not until December. And Bloomberg calculates a 68% probability of an increase—hardly a sure thing.
The futures and Treasury markets have had a better record than the prognosticators. Their reluctance to pencil in multiple rate hikes is consistent with less optimism about a continued bull run.

Troubling warnings for the US from the 1930s

Western democracy faces no mortal threat but it is going through an acute stress test
When people strike comparisons with Hitler — or Munich — I usually reach for my earplugs. The same applies to the Great Depression. There is nothing on today’s horizon that compares with the Nazis or the mass privation that followed the 1929 stock market crash.

Yet there are echoes we would be foolish to ignore. Western democracy faces no mortal threat.

But it is going through an acute stress test. On both sides of the Atlantic, people have lost faith in their public institutions. They are also losing trust in their neighbours. Co-operation is fraying and open borders are in question. We can no longer be sure the centre will hold — or even that it deserves to.
The most insidious trend is vanishing optimism about the future. Contrary to what is widely believed, the majority’s pessimism pre-dates the 2008 financial collapse. At the height of the last property bubble in 2005, Alan Greenspan, then chairman of the Federal Reserve, said society could not long tolerate a situation where most people were suffering from declining standards of living.
“This is not the sort of thing that a democratic society — a capitalist democratic society — can readily accept without addressing,” he said. This came after several years of falling median income.

For most Americans and Europeans the situation is worse today than it was then. Many have since had their homes repossessed. Median incomes were lower in 2015 than when Mr Greenspan issued his warning. A majority on both sides of the Atlantic believe their children will be worse off than they are.
They may be right. Economists debate whether the sharp decline in productivity growth during the past 15 years is the result of mismeasurement. Polls suggest there is nothing wrong with the yardstick. Most people feel worse off, which is what matters in politics. In his book, the Rise and fall of American growth, Robert Gordon argues that the century-long leap in productivity that began in 1870 can never be repeated. Even if Mr Gordon is eventually proved wrong, will society have the patience to wait and see?
The second disturbing trend is a growing sense of unfairness — the feeling that elites are continually lining their pockets. Scholars talk about the “Great Gatsby Curve” — the massive rise in inequality that took place in the 1920s before the Wall Street crash. The numbers today are eerily similar to then. Labour’s share of national income keeps plummeting. Despite the US economy’s recovery, 2015 saw the sharpest rise in US wage inequality since the end of the Great Recession.
The average American’s chances of moving up an income bracket are no better today than when President Barack Obama took office. Last year he said that for too many Americans the “ladders of opportunity” had disappeared. He was right. Yet he has been unable to do much about it.

The third is a rising culture of nihilism. When people think their concerns are being ignored — and worse, that they are also being belittled — they lash out. Hell hath no fury like an angry electorate. It is easy to poke fun at the likes of Republican frontrunner Donald Trump and the leader of the UK’s Labour party, Jeremy Corbyn. They provide an endless supply of material.

But the ease with which they can be lampooned should not obscure what is driving their success. The puzzle is not that such figures are finding an audience, but that they did not emerge sooner. Do not expect them to vanish into the night.

Contrast Mr Trump’s promise of strong leadership and “winning big” with the timid incrementalism of Hillary Clinton’s platform. She promises to finesse the gains of Mr Obama’s first two terms. Mr Trump vows to change the rules of the game entirely.

The final echo from the 1930s is in the declining global order. In a widely cited interview with the Atlantic last week, Mr Obama complained about “free riders” among America’s allies, including David Cameron’s Britain. He also expressed disdain for the US establishment’s obsession with “credibility” as the measure of American power, and force as their perennial solution.
Mr Obama’s words have elicited outrage in both London and Washington. Yet he gave a good summary of US public opinion. Indeed, what Mr Obama said is not wildly different from what Mr Trump has been arguing. Americans are tired of paying for Pax Americana.

Unlike Britain in the 1930s, the US can still bear the burden. But it does not want to.

Neville Chamberlain, the proponent of Nazi appeasement, said Czechoslovakia was not worth the bones of a single British grenadier. Mr Obama believes much the same about the people of Syria. He expressed no concern about Syria’s impact on Europe. The flood of refugees is Europe’s problem.

Ukraine is in Russia’s neighbourhood. The Middle East must fend for itself. Such were the valedictory thoughts of a world-weary president. They were not a million miles from Mr Trump’s.

The coming months provide a test. In June, the UK votes on whether to leave the EU. If Brexit takes place, the European project could start to go backwards. Will America care?

By then, we will also know the battle lines for the US presidential election. In all probability it will be Mrs Clinton against Mr Trump. Western democracy is on trial. Autocrats in Russia and China will be watching keenly.

Weekend Edition: Doug Casey on Gold Stocks

(Interviewed by Louis James, Editor, International Speculator)

This interview was first published on September 30, 2009.

Editor’s Note: If you’ve been reading the Dispatch, you know we’re extremely bullish on gold stocks right now. In short, we believe gold stocks have the potential to rise 500% or more in the near future.

In today’s Weekend Edition, we’re sharing a classic interview between Doug Casey and Louis James

Louis James: Doug, we were talking about gold last week, so we should follow up with a look at gold stocks. If one of the reasons to own gold is that it’s real – it’s not paper, it’s not simultaneously someone else’s liability – why own gold stocks?

Doug: Leverage. Gold stocks are problematical as investments. That’s true of all resource stocks, especially stocks in exploration companies, as opposed to producers. If you want to make a proper investment, the way to do that is to follow the dictates of Graham and Dodd or use the method Warren Buffett has proven to be so successful over many years. Unfortunately, resource stocks in general, and metals exploration stocks in particular, just don’t lend themselves to such methodologies. They are another class of security entirely.

L: “Security” may not be the right word. As I was reading the latest edition of Graham & Dodd’s classic book on securities analysis, I realized that their minimum criteria for investment wouldn’t even apply to the gold majors. The business is just too volatile. You can’t apply standard metrics.

Doug: It’s just impossible. For one thing, they cannot grow consistently because their assets are always depleting. Nor can they predict what their rate of exploration success is going to be.

L: Right. As an asset, a mine is something that gets used up as you dig it up and sell it off.

Doug: Exactly. And the underlying commodity prices can fluctuate wildly for all sorts of reasons. Mining stocks, and resource stocks in general, have to be viewed as speculations, as opposed to investments.

But that can be a good thing. For example, many of the best speculations have a political element to them. Governments are constantly creating distortions in the market, causing misallocations of capital. Whenever possible, the speculator tries to find out what these distortions are because their consequences are predictable. They result in trends you can bet on. It’s like the government is guaranteeing your success because you can almost always count on the government to do the wrong thing.

The classic example, not just coincidentally, concerns gold. The U.S. government suppressed its price for decades while creating huge numbers of dollars before it exploded upward in 1971.

Speculators who understood some basic economics positioned themselves accordingly.

As applied to metals stocks, governments are constantly distorting the monetary situation, and gold in particular, being the market’s alternative to government money, is always affected by that. So gold stocks are really a way to short the government – or go long on government stupidity, as it were.

The bad news is that governments act chaotically, spastically. The beast jerks to tug on its strings held by its various puppeteers. So, it’s hard to predict price movements in the short term. You can only bet on the end results of chronic government monetary stupidity.

The good news is that, for that very same reason, these stocks are extremely volatile. That makes it possible, from time to time, to get not just doubles or triples but ten baggers, twenty baggers, and even a hundred-to-one shots in these mining stocks. That kind of upside makes up for the fact that these stocks are lousy investments and that you will lose money on some of them.

L: One of our mantras: Volatility can be your best friend.

Doug: Yes, volatility can be your best friend, as long as your timing is reasonable. I don’t mean timing tops and bottoms – no one can do that. I mean spotting the trend and betting on it when others are not so you can buy low to later sell high. If you chase momentum and excitement, if you run with the crowd, buying when others are buying, you’re guaranteed to lose. You have to be a contrarian. In this business, you’re either a contrarian or road kill. When everyone is talking about these stocks on TV, you know the masses are interested, and that means they’ve gone to a level at which you should be a seller and not a buyer.

That makes it more a game of playing the psychology of the market, rather than doing securities analysis.

I’m not sure how many thousands of gold mining stocks there are in the world today – I’ll guess about 3,000 – but most of them are junk. If they have any gold, it’s mainly in the words written on the stock certificates. So, in addition to knowing when to buy and when to sell, your choice of individual stocks has to be intelligent, too. Remember, most mining companies are burning matches.

L: All they do is spend money.

Doug: Exactly. That’s because most mining companies are really exploration companies. They are looking for viable deposits, which is quite literally like looking for a needle in a haystack.

Finding gold is one thing. Finding an economical deposit of gold is something else entirely. And even if you do find an economical deposit of gold, it’s exceptionally difficult to make money mining it. Most of your capital costs are upfront. The regulatory environment today is onerous in the extreme. Labor costs are far above what they used to be. It’s a really tough business.

L: If someone describes a new business venture to you, saying, “Oh, it’ll be a gold mine!” Do you run away?

Doug: Almost. And it’s odd because historically, gold mining used to be an excellent business to be in. For example, take the Homestake Mine in Deadwood, South Dakota, which was discovered in 1876 – at just about the time of Custer’s last stand, actually. When they first raised capital for that, their dividend structure was something like 100% of the initial share price, paid per month. That was driven by the extraordinary discovery. Even though the technology was very primitive and inefficient in those days, labor costs were low, you didn’t have to worry about environmental problems, there were no taxes on whatever you earned, you didn’t have to pay mountains of money to lawyers.

Today, you probably pay your lawyers more than you pay your geologists and engineers.

So, the business has changed immensely over time. It’s perverse because with the improvements in technology, gold mining should have become more economical, not less. The further back you go in history, the higher the grade you’d have to mine in order to make it worthwhile. If we go back to ancient history, a mineable deposit probably had to be at least an ounce of gold per ton to be viable.

Today, you can mine deposits that run as low as a hundredth of an ounce (0.3 g/t). It’s possible to go even lower, but you need very cooperative ore. And that trend toward lower grades becoming economical is going to continue.

For thousands of years, people have been looking for gold in the most obscure and bizarre places all over the world. That’s because of the 92 naturally occurring elements in the periodic table, gold was probably the first metal that man discovered and made use of. The reason for that is simple: Gold is the most inert of the metals.

L: Because it doesn’t react easily and form compounds, you can find the pure metal in nature.

Doug: Right. You can find it in its pure form, and it doesn’t degrade, and it doesn’t rust. In fact, of all the elements, gold is not only the most inert, it’s also the most ductile and the most malleable. And, after silver, it’s the best conductor of both heat and electricity, and the most reflective. In today’s world, that makes it a high-tech metal. New uses are found for it weekly. It has many uses besides its primary one as money and its secondary use as jewelry. But it was probably also man’s first metal.

But for that same reason, all the high-grade, easy-to-find gold deposits have already been found.

There’s got to be a few left to be discovered, but by and large, we’re going to larger-volume, lower-grade, “no-see-um” type deposits at this point. Gold mining is no longer a business in which, like in the movie The Treasure of the Sierra Madre, you can get a couple of guys, some picks and mules, and go out and find the mother lode.

Unfortunately. Now, it’s usually a large-scale, industrial earth-moving operation next to a chemical plant.

L: They operate on very slender margins – and they can be rendered unprofitable by a slight shift in government regulations or taxes. So, we want to own these companies... Why?

Doug: You want them strictly as speculative vehicles that offer the potential for ten, a hundred, or even a thousand times returns on your money. Getting a thousand times on your money is extraordinary, of course – you have to buy at the bottom and sell at the top – but people have done it.

It’s happened not just once or twice but quite a number of times that individual stocks have moved by that much.

That’s the good news. The bad news is that these things fluctuate down even more dramatically than they fluctuate up. Don’t forget that they are burning matches that can actually go to zero. And when they go down, they usually drop at least twice as fast as they went up.

L: That’s true, but as bad as a total loss is, you can only lose 100% – but there’s no such limit to the upside. A 100% gain is only a double, and we do much better than that for subscribers numerous times per year.

Doug: Exactly. And as shareholders in everything from Fannie Mae to AIG to Lehman Brothers and many more have found out, even the biggest, most solid companies can go to zero.

L: So, what you’re telling me is that the answer to “Why gold?” is really quite different to the answer to “Why gold stocks?” These are in completely different classes, bought for completely different reasons.

Doug: Yes. You buy gold, the metal, because you’re prudent. It’s for safety, liquidity, insurance. The gold stocks, even though they explore for or mine gold, are at the polar opposite of the investment spectrum; you buy those for extreme volatility and the chance it creates for spectacular gains. It’s rather paradoxical, actually.

L: You buy gold for safety and gold stocks specifically to profit from their “un-safety”…

Doug: Exactly. They really are total opposites, even though it’s the same commodity in question. It’s odd, but then, life is often stranger than fiction.

L: It’s being a contrarian – “timing” in the sense of making a rational decision about a trend in evident motion – that helps stack the odds in your favor. It allows you to guess when market volatility will, on average, head upward, making it possible for you to buy low and sell high.

Why Negative Rates Can’t Stop the Coming Depression

by Bill Bonner

Are you ready to pay to save?

Agora founder Bill Bonner explains why “negative interest rates” are spreading around the world…and could soon come to the U.S.

Bill founded Agora Inc. in 1978. Since then, it has grown into one of the largest independent newsletter publishing companies in the world.

He also co-wrote two New York Times bestselling books: Financial Reckoning Day and Empire of Debt. In his latest book, Hormegeddon, Bill describes what happens when you get too much of a good thing in the sphere of public policy, economics, and business.

Like Doug Casey, Bill believes the worst is yet to come.

Bill says the coming financial collapse will be worse than the market crashes in 1987, 2000, and 2008. But this time, he says, it will affect everything from your your bank the cash in your wallet.

You’ll find the important details in his article below.

Until next time,

Nick Giambruno
Senior Editor
International Man

by Bill Bonner

A bird in the hand is worth two in the bush.

                                                                         – Anonymous.

In our upcoming issue of The Bill Bonner Letter, we explore the strange territory of “NIRP” – negative-interest-rate policy.

About $7 trillion of sovereign bonds now yield less than nothing. Lenders give their money to governments…who swear up and down, no fingers crossed, that they’ll give them back less money sometime in the future.

Is that weird or what?

Into the Unknown

At least one reader didn’t think it was so odd.

“You pay someone to store your boat or even to park your car,” he declared.

“Why not pay someone to look out for your money?”

Ah…we thought he had a point. But then, we realized that the borrower isn’t looking out for your money; he’s taking it…and using it as he sees fit.

It is as though you gave a valet the keys to your car. Then he drove it to Vegas or sold it on eBay.

A borrower takes your money and uses it. He doesn’t just store it for you; that is what safe deposit boxes are for.

When you deposit your money in a bank, it’s the same thing. You are making a loan to the bank. The bank doesn’t store your money in a safe on your behalf; it uses it to balance its books.

If something goes wrong and you want your money back, you can just get in line behind the other creditors.

The future is always unknown. The bird in the bush could fly away. Or someone else could get him.

So, when you lend money, you need a little something to compensate you for the risk that the bird might get away.

A New Level of Absurdity

That’s why bonds pay income – to compensate you for that uncertainty.

Inflation, defaults, depression, war, and revolution all raise bond yields because all increase the odds that you won’t get your money back.

That’s why countries with much uncertainty – such as Venezuela – have higher interest rates than countries, such as Switzerland, where the future is probably going to be a lot like the past.

Venezuelan 10-year government bonds yield 11%. The Swiss 10-year government bond yields negative 0.3%.

The interest you earn on a bond is there to compensate you for the risk that you won’t get your money back. Or that the money you do get back when the bond matures will have less purchasing power than the money you used to buy the bond in the first place.

You never know. Maybe the company or government that issued the bond will go broke. Or maybe the Fed will cause hyperinflation. In that case, even if you get your money back, it won’t buy much.

With interest rates at zero, lenders must believe that the future carries neither risk. The bird in the bush isn’t going anywhere; they’re sure of it.

As unlikely as that is, negative interest rates take the absurdity to a new level.

A person who lends at a negative rate must believe that the future is more certain than the present.

In other words, he believes there will always be MORE birds in the Bush.

Boneheaded Logic

The logic of lowering rates below zero is so boneheaded that only a PhD could believe it.

Economic growth rates are falling toward zero. And at zero, it normally doesn’t make sense for the business community – as a whole – to borrow. The growth it expects will be less than the interest it will have to pay.

That’s a big problem…

Because the Fed only has direct control over the roughly 20% of the overall money supply. This takes the form of cash in circulation and bank reserves. The other roughly 80% of the money supply comes from bank lending.

If people don’t borrow, money doesn’t appear. And if money doesn’t appear – or worse, if it disappears – people have less of it. They stop spending…the slowdown gets worse…prices fall…and pretty soon, you have a depression on your hands.

How to prevent it?

If you believe the myth that the feds can create real demand for bank lending by dropping interest below economic growth rates, then you, too, might believe in NIRP.

It’s all relative, you see. It’s like standing on a train platform. The train next to you backs up…and you feel you’re moving ahead.

Negative interest rates are like backing up. They give borrowers the illusion of forward motion…even if the economy is standing still.

Or something like that.



Editor’s Note: Negative interest rates are a disaster story in the making. And they will only speed up the major monetary collapse we believe is coming.

Bill believes the fallout from his catastrophe will be far worse than 2008. When it hits, every service you’ve come to depend on – your bank…your grocery store…your Social Security checks – will shut down.

London Gold Fix Rigging - Fact or Myth?

By: Arkadiusz Sieron

The London Gold Market is a part of the London Bullion Market, which is a wholesale over-the-counter market for the trading gold and silver, coordinated by the London Bullion Market Association. It is the wholesale market - the usual minimum size of transaction is 2,000 ounces of gold (while the standard size is 5,000 ounces) - individual investors are practically excluded from the market. The London Gold Market was the most important gold market until the 1970s, when the American Commodity Exchange Inc. (Comex) started to trade gold futures and soon gained prominence. Currently, the gold market is dominated by these two centers of gold trading. The Comex dominates the market in gold futures, while the London Gold Market is by far the largest global center for over-the-counter (OTC) transactions. It is also the biggest marketplace for gold in the world by the volume of trade (the London OTC spot market is about ten times higher that of the U.S. futures market), which clears the annual mining production of gold every few days.

How does the London Gold Market really operate and how does it influence the price of gold?

London has always been an important center for precious metals. The first records of bullion transactions date back to the 17th century, when the firm of Mocatta and Goldsmid (now ScotiaMocatta), the oldest member of the London Gold Market, was established. However, it truly originated in the 19th century, when London became the global financial center. London dominated global commerce and finance and the British pound was under the gold standard. 

Soon the large gold reserves of Australia and South Africa were discovered (they were British colonies at the time), hence London quickly became the hub of bullion trading. The gold confiscation implemented by Roosevelt in 1933helped London to keep its position. Nowadays, London is still considered as one of the most important markets, offering many useful services for gold investors.

First, most transactions are cleared through London, even though the physical market for gold is global. Due to the strong position of the London gold market, clients from all over the world have open bullion accounts, called Loco London accounts, with London bullion dealing houses. This is why most transactions are settled by transfers of bullion in London through its clearing system.

Second, the London market maintains the global standard for the quality of gold bars. Only bars produced by refiners meeting the required conditions specified in the Good Delivery Lists can be traded in the London market. The Lists assure the common standard in the market, improving the quality and increasing the confidence among its participants.

Third, the London market offers vaulting services. Seven commercial custodians and the Bank of England provide secure locations for bullion traded on the market. These custodians act also as gatekeepers, checking the weight and quality of the gold bars.

Finally, the London market sets the gold fix - the so-called LBMA Gold Price - twice a day: at 10:30 GMT, and 15:00 GMT in the U.S. dollar, serving as a benchmark for pricing the gold widely used by producers, consumers, investors and central banks. Gold fixing was introduced in 1919 with the London Gold Fixing system. Initially, the fix was established by five banks in an elegant private auction at the London offices of Nathan Mayer Rothschild & Sons. Until 1968 there was only one fixing in the morning and the price was set in British pounds. In that year, the second fixing at 3 P.M. was added to cover the opening of the American market, while the price of gold started to be fixed in the U.S. dollar. Some analysts claim that the price of gold is manipulated during London hours, or that the London P.M. fixing is rigged. However, the chart below does not show any systemic deviations between those two prices.

Chart 1: London Gold A.M. Fixing (green line) and London Gold P.M. Fixing (red line) from February 2015 to February 2016.

Gold Fixings

From May 5, 2004 to March 19, 2015 the fixing has was conducted via a dedicated conference line. On March 20, 2015 the LBMA Gold Price replaced the London Gold Fixing price. The fix is now conducted via an electronic platform managed by the ICE Benchmark Administration, not through a private arrangement, with conference calls twice a day. The aim of that change was to bring more transparency to the price discovery process and to increase the number of participants involved in setting the benchmark price of gold (now, there are twelve price participants instead of five or even four as it used to be.)

How is the LBMA Gold Price set? At the start of each fixing, the chairperson sets the starting price at the level thought to best match the demand with the supply. Then, participants enter their buy and sell orders by volume. If the market is out of balance, business cannot be done and the new round of entering volumes is required. For example, if more gold is offered than demanded, then the price will be adjusted downwards (and vice versa), until equilibrium is reached. The process iterates until the net volume of all participants fall within the pre-determined tolerance at the end of a round (i.e. the imbalance is set at 10,000 oz.). The auction is complete when all volume is traded at that fix price. What is important is that the participants buy/sell gold not only on their own behalf, but also on that of their clients.

Summing up, the London Gold Market is the crucial market for gold. It is the biggest marketplace for gold in the world by the volume of trade. However the U.S. futures markets may play a slightly more important role in the price discovery. As an over-the-counter market, the London market is less transparent. However, this does not mean that London gold prices are manipulated. The London market is simply structurally different from centralized exchanges. Still, it provides many useful services for the gold investing community.

Thank you.