There is by now almost universal expectation that when the FOMC meets on May 16, they will raise the Fed Funds rate by 0.50% to 6.50%. So far, some "benign" economic numbers, including a PPI drop of 0.3% ("core" PPI was up 0.1%), has done nothing to shake that conviction. Well, if the Fed DOES raise by 0.5% on May 16, they will be breaking a quite long-standing habit.
The last time that the Fed moved interest rates (up or down) by any increment other than 0.25% was on February 1, 1995, more than five years ago. That rise was from 5.50% to 6.00% (the Fed Fund Rate's present level) and was the culmination of a period of exactly one year during which the Fed Funds rate was doubled. It was also about a month before the start of the great U.S. bull market of the last half of the 1990s.
The main feature of early 1995, besides a flat stock market and a horrible blood bath in the bond market, was a plummeting U.S. Dollar. Partially because of this Dollar weakness, the Fed had been very aggressive in raising rates. How aggressive? Well, in two stages between November 1994 and the beginning of February 1995, the Fed raised by 1.25% (a 0.75% rise on Nov. 15 1994 followed by the 0.50% rise on Feb. 1 1995). The rate rises didn't help
On December 22, 1994, the $US Index stood at 89.97. By April 18, 1995, the index had plunged more than 10% to bottom out at 80.43. The rate rises, demonstrably, didn't help. What did help was co-ordinated currency intervention, led by the Fed and the Bank of Japan, with even the Europeans getting involved. From that low in April 1995, the Dollar has been rising ever since. Again, interest rates have not been the impetus. Official Fed rates now are at exactly the same level as they were in February 1995. But on May 16, that is expected to change.
What did Gold do in 1995, despite all these Dollar gyrations? Essentially nothing at all
In 1994-early 1995, Mr Greenspan's public reason for raising rates was to head off unsustainable rates of economic growth (in late 1993). The reason that was hinted at but never stated was to damp down an overheated stock market. The economic reason which made perfect sense at the time was to support a badly ailing Dollar.
OK, so here we are, five years later. Again, the public reason for raising rates is to head off unsustainable rates of economic growth. And again, the reason hinted at but not stated is to damp down an overheated stock market - although judging by the NASDAQ, that goal is well on the way to having been realised. The only distinction between now and early 1995, and it is a BIG distinction, is the recent history of the Dollar. Then, it was weak. Now, it is strong.
If you who are reading this do not live in the U.S., ask yourself this. When was the last time that your Central Bank raised interest rates in the face of a currency that was not merely strong, but climbing rapidly against every other currency in the world? If you do live in the U.S., ask yourself this. When was the last time that the Fed did it?
Nope, we can't think of a time either.
In fact, the Fed IS protecting the Dollar, although up until Friday, May 12, it certainly did not appear as if the Dollar needed any protection. It is a fact known to all financial policy makers both inside and outside the U.S. that America is completely dependent on an ongoing tidal wave of foreign liquidity to maintain their economic nirvana. The trade deficit numbers are all one needs to recognize this.
Over the past six weeks, since the Nasdaq turned turtle and U.S. markets in general moved onto very shaky ground, one potential magnet for foreign capital has been severely injured. Over the past two weeks, as the inverted curve on U.S. Treasury debt paper worsened and as yields all along the curve began to rise, a second magnet for foreign capital has begun to flag. That leaves just one left. The up until now all conquering U.S. Dollar itself. Ominously, we now have the first sign that the Dollar might be coming off too.
The U.S. MUST continue to attract foreign capital. It has no savings. Its people continue to live beyond their immediate means, trusting the stock market to provide. Thus, the U.S. MUST continue to be a magnet for foreign capital. With prospects for capital gains dwindling - see the recent performance of the U.S. stock and bond markets - the prospect for at least a solid rate of return in a SAFE investment must be maintained. That means HIGHER interest rates.
"The final "battle" was always going to be against Gold and Gold's usurper, the U.S. Dollar. If the U.S. can manage to keep all the financial balls currently in the air until the Presidential elections are over, it will be an awesome feat. One cannot rule it out, but we wouldn't want to bet the farm on it."
(Posted on this page on April 28)
Two weeks after that was written, the situation has worsened. The prospect of the re-emergence of another Asian Crisis is looming, with most Asian stock markets (including the Japanese market) showing big year 2000 losses. Europe's stock markets are holding up, though their currencies are not. In the U.S., the immediate prospect of swallowing a 0.50% rate rise must threaten further deterioration in both the stock and bond market.
That leaves the Dollar, and waiting in the wings (where it has been for a LONG time) is Gold. There comes a point where an investment which has been looked upon as "guaranteed safe" for decades loses its reputation. There comes a point where a rate of return, no matter how badly needed, becomes secondary to capital preservation. That point is not yet here. It will be signalled by a turnaround of recent U.S. Dollar strength. We may have seen the first signs of that on May 12.
A 0.50% rate rise on May 16, if it happens, "should" be very positive indeed for Gold. So should any further weakness in the Dollar, especially in the aftermath of such a rate rise. We say "should" for clear and obvious reasons. There is the Dollar, and there is Gold. They cannot co-exist in a monetary role. As long as there is no official link between them, it must be one or the other. We do not know if GATA explained that to the politicians they visited in Washington. We do know that the Gold machinations which GATA is (properly) protesting against are not new. We also know that they are going to be sorely tested in coming weeks.