Under convertibility, central banks forfeit the right to act as lenders of last resort…Would the Fed and the ECB give up their powers in the name of stability? It seems too far fetched to me. If these banks wanted to keep their powers, they would need a supra-national bank to back them. Can you imagine the IMF playing out this role? I can’t.
A rare congruence of factors has taken place in the last 24 hours, allowing Treasuries to gain (flatter yield curve) the USD to weaken, and US stocks to gain a bit of what was lost last week. As I mentioned yesterday, there is a lot happening these days, a lot of moving parts at a very fast pace, which is shifting the tectonic plates rather swiftly.
To begin with, I have to side with the notion that the waves touching North America yesterday were generated out of Japan and Germany (i.e. Menkel’s victory) during the weekend, and augmented by the winds of the European Central Bank on Monday.
It’s true, the announcement of Xerox Corp. reaching an agreement to buy Affiliated Computer Services for $6.4BN and Abbott Laboratories’ plan to purchase Solvay SA did also add to the winds. From Japan, we seem to have had a short-cover move in the JPY/USD carry trade. I like this explanation. It makes sense in my view. It was suggested yesterday by UBS’ Rates Team.
The short-covering is a bullish trade on the Yen, positively affecting Treasuries. It might look like a flight-to-safety trade, but the fact that both Europe’s and North American indexes finished higher rejects this thesis. We should get confirmation of this if we see the yesterday’s rally extending to Asia in overnight trading.
Yesterday too, M. Trichet went public with Euro-bearish comments, in support of the USD. Among those, he said that “now is not the time to exit”, that “rates are appropriate” but above all, that “ a strong dollar is extremely important”. One has the sense that there is a lot of propaganda going on lately, as Bank of Canada’s Governor Carney also addressed the public (in Ottawa) to show once more his unease with a strong Canadian dollar.
These comments bring uncertainty and over the weekend, I could read a few different theories on the potential next moves in interest rates. This brings me to my point today. Yesterday, I briefly mentioned that Robert Mundell had suggested before a crowd in Hong Kong that the USD/EUR exchange rate should be fixed (http://www.bloomberg.com/apps/news?pid=20601083&sid=aczBO8TH0OpA).
The move towards a convertible Euro would certainly evaporate the uncertainty we suffer these days. As soon as these comments hit the news, gold sold off last Thursday. I show the chart for the price of gold (in USD/oz, source: Bloomberg) for the last five trading sessions.
Can we say that Mr. Mundell’s comments triggered the big move to the downside on Thursday? I am never too sure but the timing is perfect. The sell off started between 8:48 and 8:57am, exactly coincident with the release of Mr. Mundell’s comments, at 8:53am. You decide. But the sell off would be consistent with a thesis held at “A View from the Trenches”, first proposed on April 21st: “…when there is global coordination of inflationary monetary policies, gold cannot be a safe and lucrative asset. When inflationary monetary policies are not globally coordinated, gold is a safe and lucrative asset…” (www.sibileau.com/martin/2009/04/21 )
There is a lot to opine on this suggestion. But I can remember my days at the Universidad de Buenos Aires, when students and professors endlessly debated the wisdom of the USD/Argentine Peso convertibility. The main lesson was that under convertibility, central banks forfeit the right to act as lenders of last resort. This is the reason behind the Austrian School of Economics’ support of the gold standard. If central banks cannot provide liquidity in a crisis, the banking system will be conservative, because Banks will be on their own.
Thus, what is the conclusion one can make here? Would the Fed and the ECB give up their powers in the name of stability? It seems too far fetched to me. If these banks wanted to keep their powers, they would need a supra-national bank to back them. Can you imagine the IMF playing out this role? I can’t.
What is one to make out of this? If the idea is good but doesn’t seem feasible, the late sell off in gold should be seen as an opportunity…