*****Cracks Appearing In US Financial System*****

Fewer Buyers Showing up at Treasury Auctions

The Associated Press reports that rates rise for 3-month and 6-month bills.

(emphasis mine) [my comment]

Rates rise for 3-month and 6-month bills
(AP) — Tuesday, April 6, 2010

WASHINGTON — Interest rates on short-term Treasury bills rose in Monday's auction to the highest levels since last August.

The Treasury Department auctioned $28 billion in three-month bills at a discount rate of 0.175 percent, up from 0.145 percent last week. Another $29 billion in six-month bills was auctioned at a discount rate of 0.265 percent, up from 0.240 percent last week.

The three-month rate was the highest since three-month bills averaged 0.180 percent on Aug. 17. The six-month rate was the highest since 0.270 percent, also on Aug. 17.

...
Separately, the Federal Reserve said Monday that the average yield for one-year Treasury bills, a popular index for making changes in adjustable rate mortgages, rose to 0.43 percent last week from 0.42 percent the previous week.

The Washington Post reports about long-term interest rates rising.

During the past month, the rate that the federal government must pay to borrow money for 10 years has risen steeply -- to nearly 4 percent on Monday, from 3.6 percent on March 4. That higher number is likely to drive up a wide range of other commonly used interest rates, boosting what home buyers must pay to take out a mortgage, and raising borrowing costs for companies looking to expand.

... With public debt levels soaring around the world, the supply of bonds has begun to outstrip investors' appetite for them. Some investors may be questioning whether the United States will ever get its fiscal house in order and are demanding higher rates because the federal government seems to be a riskier borrower than in the recent past. Meanwhile, investors' expectations about inflation may edge up, leading them to require higher interest rates.

... there are some reasons for angst in the recent run-up in rates.

The government auctioned $118 billion in debt last week, part of its ongoing effort to fund current budget deficits and roll over old debt that has matured. Fewer buyers than expected showed up, contributing to a steep rise in rates last week.

That suggests bond investors are coming to terms with the large needs for funding coming from the U.S. government -- and other sovereign entities -- in the near future, and are insisting on higher rates given the flood of new federal debt to be issued.

The Federal Reserve last week ended a program to buy $1.25 trillion in mortgage-backed securities, and foreign buyers have shown less interest in U.S. government debt, factors that reduce the pool of buyers for those assets and drive up interest rates.

A related but more long-term risk is that bond buyers could come to think that the government will not be able to rein in its budget deficit to a sustainable level, making investors demand more compensation because of this risk.

"You're losing some very price-inelastic demanders . . . and that's probably a little bit of what is going on with higher rates," Harris said. "Once the economy gets into full recovery, you have to figure the equilibrium rates should be higher given the structural deficit the U.S. has."

Another factor that can drive rates up is a rise in inflation expectations. After all, if investors think that a dollar in the future will be worth much less than it is now, they'll require a higher rate of return to invest their money.

Treasury Yields breaking upwards

The Fed's Emergency Meeting

While Americans enjoyed a long Easter weekend, the Fed heads were called in for an emergency meeting announced on Friday. This meeting suggests there might be angst at the Fed about the recent run-up in treasury rates.

Rebel Trades comments on the Federal Reserve Emergency Meeting.

Federal Reserve Emergency Meeting
by Chuck on April 1, 2010 at 11:11 pm

Ok, this is a bit out of the ordinary...


.

The Wall Street Pit also reports about the Fed's Emergency Meeting.

The Fed's Emergency Meeting
By Duncan DavidsonApr 4, 2010, 11:49 PM

The Fed called for an emergency meeting Monday morning, which likely means they will raise the Discount Rate a second time. They raised it on Feb 18, and the USD strengthened. Monday is a bank holiday in Europe. so reaction may be muted until they Euro banks wake up Tuesday am. (Also, the recent pattern of a Monday Pump up may be delayed to Tuesday, due to this holiday.)
...
Or is something else going on? After ObamaCare passed, the Fed had a hard time with auctioning off Treasuries, and has more to offload this week. Perhaps this emergency meeting will reconsider ending QE so the Fed can prop up the auctions.

Also,
last week the Fed revealed that its Maiden Lane program (where it bought mortgage backed securities — the toxic waste of the housing bubble) has left it holding $2.4T of assets of questionable value. The Maiden Lane III portfolio is only worth 39c on the Dollar. This means the Fed has assumed an impaired balance sheet, and needs to fix it. One way to do this is to sell off or swap out the toxic debt, and buy Treasuries to slowly return to its historical quality of reserve assets. Thus rather than explicitly continue QE, it may begin a swap program.

Whichever, the Fed is in a bit of a pickle: it needs to successfully fund the huge deficits, and at the same time exit from extraordinary measures. More after the Fed's meeting.

Reasons for panic at the Fed

The Fed had a hard time with auctioning off Treasuries, and has more to offload this week. Treasury Yields are breaking up. Worse, the Fed is out of room out on its balance sheet, as can be seen in graphic below.

(The Fed also has outstanding commitments to buy 104 billion mortgage-backed securities not shown in the chart below)

The Fed faces the envious choice of allowing the treasury market to slowly breakdown or resuming its quantitative easing (money printing) to prop up auctions (which would fan inflation fears and scare investors out of the dollar, causing either the breakdown of the treasury market or even more quantitative easing).

In any case, the last thing the Treasury and Federal Reserve need at this point is anything else that would put pressure on treasury prices, which explains why Secretary Geithner is rushing off to China.

Geithner's Last-Minute Trip To China

247wallst reports that Geithner's Last-Minute Trip To China.

Geithner: A Last-Minute Trip To China
Posted: April 7, 2010 at 4:54 am

Treasury chief Tim Geithner made an unannounced trip to China today to meet with the Chinese Vice Premier, Wang Qishan, the official most involved with monetary policy. This may lead to speculation that the People's Republic will re-value the yuan will come sooner than expected.

Why would US Treasury Secretary Tim Geithner make an unannounced, lightning visit to Beijing against a background of fresh signals from Chinese policymakers, including the central bank, that they might be paving the way to let the yuan resume its rise? To try to stop or delay the revaluation.

The US treasury market is already in trouble, as seen above. If China starts appreciating the yuan, not only will one of the biggest buy of treasuries disappear, but inflation will also explode in the US as the cost of Chinese imports (everything at Wal-Mart) rises, further undermining dollar denominated debt.

A shift in Beijing's exchange rate policy appears imminent

The Standard reports that a shift in Beijing's exchange rate policy may be imminent.

Hint of yuan rate change as Geithner visits Beijing
Katherine NgandSophie He
Thursday, April 08, 2010


A shift in Beijing's exchange rate policy may be imminent as US Treasury Secretary Timothy Geithner makes a lightning visit to Beijing today to meet Vice President Wang Qishan.

The talks are taking place amid fresh signals from policymakers that they
are prepared to allow the value of the yuan to rise.
...

... mainland officials said Beijing could widen the daily trading band for the yuan and allow it to resume the gradual appreciation that was halted in July 2008.

Ba Shusong, deputy director-general of the Financial Research Institute at the Development Research Center, a Cabinet think-tank,
said on Tuesday that China is preparing for a shift in exchange rate policy.

The timing depends on the pace of economic recovery in both the United States and China, Ba said, adding that the current peg is a temporary measure that will be abolished at some point.

The National Development and Reform Commission also hinted that Beijing is ready to let the yuan rise, with its posting on the government website yesterday warning exporters should be "alert to potential risks and minimize their losses".

The yuan yesterday rose to a one-month high with its 12-month non-
deliverable forward trading at 6.6355, up 0.17 percent, after the People's Bank of China set its mid-point at 6.8259 per dollar - a 10-month high.

The central bank yesterday said it would sell three-year bills for the first time since June 2008, adding to speculation it is preparing to raise interest rates and allow gains in the yuan to help curb inflation.

The Economic Times reports that China paving the way for yuan's rise, to sell 3-year bills.

China paving the way for yuan's rise, to sell 3-year bills
8 Apr 2010, 0231 hrs IST,AGENCIES

BEIJING: US Treasury Secretary Timothy Geithner will hold talks in Beijing on Thursday against a background of fresh signals from Chinese policymakers, including the central bank, that they might be paving the way to let the yuan resume its rise.

The National Development and Reform Commission (NDRC), the nation's top economic planner, said China would monitor exchange rate risks facing exporters, while an economist from the agency said Beijing should edge toward a more flexible yuan.

The statement suggested policymakers are weighing what may happen if they let the yuan recommence its climb after keeping it yoked to the dollar since mid-2008.

On Wednesday China's central bank set the yuan's mid-point at 6.8259 per dollar, the strongest for the yuan in 10 months.


Rates to rise soon?

Adding to the speculation that Beijing is preparing to raise interest rates and allow gains in the yuan to help curb inflation, China'central bank said it will sell three-year bills for the first time since June 2008.
The sale of 15 billion yuan ($2.2 billion) in the securities on Thursday will be followed by issuance every two weeks, the People's Bank of China said in statement. The bills may yield 2.75% at the sale, compared with 1.93% on one-year bills sold on Tuesday, according to the median estimate in a survey of nine finance companies.

Selling higher-yielding bills may be a precursor to the first increase in benchmark lending rates in more than two years and allowing yuan gains, said Jiang Chao, an analyst at Guotai Junan Securities Co, the nation's largest brokerage by revenue.
Policy makers from China to India have begun withdrawing economic stimulus this year, seeking to prevent asset-price bubbles as Asia leads the recovery from a global recession. "This is meant to pave the way for the central bank to raise interest rates or resume yuan appreciation," said Jiang. "The PBOC can drain liquidity by issuing bills if the interest- rate hike or appreciation attracts more hot money."

Central bank adviser Li Daokui said the nation may raise rates this quarter should the inflation rate breach 3%, the China Securities Journal reported on Wednesday. Consumer prices rose 2.7% in February from a year earlier.

The bills will drain cash from the economy by providing an alternative to lending, according to Xu Xiaoqing, a bond analyst at China International Capital Corp, the nation's first Sino- foreign investment bank in Beijing.

"The central bank needs to use higher-yielding bills to attract banks so that they won't make too many loans," said Xu, who sees a rate increase this quarter. "Three-year bills can lock up banks' cash for longer periods, which will push up money-market rates and bond yields."

The yuan will presumably be at the top of Geithner's agenda when he meets Chinese vice-premier Wang Qishan on Thursday on his way home from financial partnership talks in India. A US Treasury spokesperson, accompanying Geithner in Mumbai, declined to talk about the subject matter of the meeting and said there would be no further statements about it.

The Washington Post reports that NDRC stress tests.

China hints at readiness to let yuan rise
By Aileen Wang and Simon Rabinovitch
Wednesday, April 7, 2010; 6:50 AM

...
STRESS TESTS


NDRC is a sprawling agency in charge of industrial policy which has a stronger voice than almost any other government agency, including the central bank, in China's decision-making process about the currency.

Following "stress tests" to examine how exporters would cope with appreciation, the NDRC's comments were possibly a sign the government wants to warn export firms to be ready for a stronger currency that could threaten already thin profit margins.


...
The yuan rose slightly in the spot market on Wednesday, reaching 6.825 to the dollar, its highest rate this year.

Marketwatch reports that China's looming trade deficit shadows yuan debate.

April 4, 2010, 11:28 p.m. EDT
China's looming trade deficit shadows yuan debate
First deficit in six years expected, adding twist to argument over yuan value
By Yu Hairong, Caixin Online

BEIJING (Caixin Online) -- Expressions of surprise, but not quite shock, recently greeted Minister of Commerce Chen Deming when he informed an audience of high-ranking officials that China would likely report a trade deficit for March.

"I personally expect that in March of this year, China will run a trade deficit," Chen told the gathering of government officials, scholars and multinational executives at the China Development Forum in Shanghai.

If the prediction proves accurate,
the giant exporting nation would post its first monthly trade deficit since May 2004.

A day after Chen spoke, Premier Wen Jiabao confirmed that
China had run a trade deficit through the first 10 days of March. He carefully added that government policy makers do not promote trade surpluses but, in fact, are trying every means to expand imports.

...
Yuan factor

Chen said at the forum that,
in theory and practice, allowing a nation's currency to appreciate can have only a limited impact on current-account balances.

China's craving for raw materials and intermediate goods
helps other countries develop their industrial sectors. And China's demand for luxury goods and services from countries with which it runs trade deficits helps support large numbers of jobs in those countries.

A look at a few statistics sheds light on China's position.
Between 2005 and 2008, the yuan rose 20% against the U.S. dollar. But at the same time, China's trade surplus rose to more than $295 billion.

During the first two months of this year, China's imports rose sharply -- by 63.6%
-- while exports increased by only 31.4%. As a result, China's trade surplus fell 50% to $21.76 billion at the end of February.

...
Song Hong, director of the International Trade Research Office at the Chinese Academy of Social Sciences' Institute of World Economics and Politics, said
the impending deficit would continue a trend that started last year in which China's importsgrew faster than its exports. He also noted that China recently sent several trade delegations overseas, generating many orders.

Researchers at China International Capital Corp. say
appreciating the yuan would be justified if a March deficit surfaced because prices for imported products are rising faster than prices for exports. Such an appreciation would improve China's trading position, they said.

Customs statistics for January and February show increases in import quantities and prices. For example, iron ore and soybean prices rose 16.6%.

My reaction: A shift in Beijing's exchange rate policy appears imminent

1) mainland officials said Beijing could widen the daily trading band for the yuan and allow it to resume the gradual appreciation that was halted in July 2008.

2) Ba Shusong, deputy director-general of the Financial Research Institute at the Development Research Center, a Cabinet think-tank, said on Tuesday that China is preparing for a shift in exchange rate policy.

3) The National Development and Reform Commission (NDRC) also hinted that Beijing is ready to let the yuan rise, with its posting on the government website yesterday warning exporters should be "alert to potential risks and minimize their losses".

4) NDRC has just recently finished "stress tests" to examine how exporters would cope with appreciation. NDRC has a stronger voice than almost any other government agency, including the central bank, in China's decision-making process about the currency.

5) The central bank Tuesday said it would sell three-year bills for the first time since June 2008. Selling higher-yielding bills may be a precursor to the first increase in benchmark lending rates in more than two years and allowing yuan gains.

6) On Wednesday China's central bank set the yuan's mid-point at 6.8259 per dollar, the strongest for the yuan in 10 months. The yuan also rose slightly in the spot market on Wednesday, reaching 6.825 to the dollar, its highest rate this year.

7) China will likely report a trade deficit for March, which would justify appreciating the yuan because prices for imported products (iron ore, soybean, etc) are rising faster than prices for exports.

Conclusion: Expect the yuan to resume appreciating, probably in the next three months.




Gold prices soar after CFTC Hearings confirm manipulation


Gold manipulation was been officially confirmed at the CFTC hearings held on March 25. Since then, gold prices have skyrocketed.





If you haven't read my entry, *******Gold Manipulation OFFICIALLY CONFIRMED*******, please do so. Basically, the lack of physical holdings by all who claim to have gold in storage is pervasive throughout the gold world.

Amazing set of revelations

1) For the first time ever, a whistleblower, Andrew Maguire, has stepped forward citing specifics of a gold market rigging as it was occurring in real time.

2) There is no gold corresponding to the vast "gold deposits" at the major LBMA banks. During the CFTC hearings, Jeffrey Christian of CPM Group (one of the most respected precious metals consultancies) stated that "precious metals...trade in the multiples of a hundred times the underlying physical..."

3) Almost all of the trading activities on the London exchange were merely settled by paper for paper, not for physical metals as the exchange supposedly requires.

4) There are thousands of clients (Asian and Middle Eastern governments, sovereign wealth funds, GLD, etc) who think they own hundreds of billions and perhaps trillions of dollars of gold bullion, and are being charged storage fees on that fantasy bullion, but what they really own unsecured gold loans to the banks at a negative interest rate.

5)
It is impossible for the London exchange to ever deliver all the gold and silver owed to the owners of contracts.


Unbelievable "coincidences" surrounding CFTC hearings

1) The live television broadcast of the CFTC hearing suffered a technical failure right as Murphy was set to begin his testimony. This was corrected right after Murphy was finished.

2) At least one live voice broadcast (radio) failed during Murphy's presentation.

3) After the hearing, Murphy was contacted by several major media outlets for more interviews. Within 24 hours, all the interviews were canceled. All of them.


4) The day after Maguire gave his radio interview, he was the victim of a hit and runcollision. Somebody sped out of a side alley at top speed, smashed into Maguire's car, and then tried to escape. A high-speed chase ensued, and the perpetrator was caught by police. Although the British press has reported that this might have been an assassination attempt or a threat, there has been no word from the police.

5) Shortly before somebody crashed into Maguire's car, the CFTC caught on fire. This fire happened to be located in the one small basement room where gold and silver trading data and other pertinent documents were kept.

6) A few days after the CFTC caught on fire, there was an DOS (denial of service) attack on the King World website which contains the radio interview of Maguire and his emails to the CFTC.


Virtual blackout by the mainstream news media

1) Only the blogs, and almost no one in the mainstream media, are covering the relevations of the CFTC hearings.

2) At the Wall Street Journal, a search on "Gensler" (CFTC Chairman Gary Gensler would surely be included in any report) produces only one item from before the hearing. Readers of the Wall Street Journal will never hear what happened at the hearing and whether the CFTC paid any attention to them.

3) The few mainstream stories that do cover the CFTC hearings are unnaturally one sided, failing to mention anything other than opposition to any idea of position limits in metal markets

4) A Google News search on "Gensler" confirms the virtual blackout by the mainstream news media.

5) The media's strategy seems to be to stonewall and hope scandal goes away.


Implications

1) This is a scandal of monumentous proportions. As the articles above put it:

"Sub-prime crisis was peanuts before this scam."

"This is a potential multi-trillion dollar fraud that could bring down the world's financial system."

'FRAUD', that is the one word which comes to any investor's mind when s/he reads about the Commodity Futures Trading Commission (CFTC) hearing on manipulations in bullion market by gold cartels

"It is a bombshell. This has to be dealt with, one way or the other. Bring it out into the light of day, and let the facts be known. This is either the equivalent of the fictionalized testimony on the order of the Salem Witch trials, or one of the most damning accusations of malfeasance in office against quasi-governmental agencies, and probably US officials, since Teapot Dome. "

2) As the significance of the CFTC hearings' revelations sink in, it will create a gold rush and dollar panic, resulting in the biggest short squeeze in the history of all commodities. (See *****Preview of 2010's Gold Rush And Dollar Panic*****)

3) The upward explosion in gold prices, it will result in a complete loss of confidence in the U.S. dollar.


Conclusion: Last October, I wrote about the Gold Market Reaching The Breaking Point. Well now we are there.

The scandal in the gold market continues to grow.

Canada's Only Bullion Bank Gold Vault Nearly Empty

Zerohedge reports about The Latest Gold Fraud Bombshell.

The Latest Gold Fraud Bombshell: Canada's Only Bullion Bank Gold Vault Is Practically Empty
Submitted by Tyler Durden on 04/07/2010 10:30 -0500


Continuing on the trail of exposing what is rapidly becoming one of the largest frauds in commodity markets history is the most recent interview by Eric King with GATA's Adrian Douglas, Harvey Orgen (who recently testified before the CFTC hearing) and his son, Lenny, in which the two discuss their visit to the only bullion bank vault in Canada, that of ScotiaMocatta, located at 40 King Street West in Toronto, and find the vault is practically empty. This is a relevant segue to a class action lawsuit filed against Morgan Stanley, which was settled out of court, in which it was alleged that Morgan Stanley told clients it was selling them precious metals that they would own in full and that the company would store, yet even despite charging storage fees was not in actual possession of the bullion. It appears that this kind of lack of physical holdings by all who claim to have gold in storage, is pervasive as the actual gold globally is held primarily in paper or electronic form. Lenny Organ who was the person to enter the vault of ScotiaMocatta, says "What shocked me was how little gold and silver they actually had." Lenny describes exactly how much (or little as the case may be) silver was available - roughly 60,000 ounces. As for gold - 210 400 oz bars, 4,000 maples, 500 eagles, 10 kilo bars, 10 one kilogram pieces of gold nugget form, which Adrian Douglas calculates as being $100 million worth, which is just one tenth of what the Royal Mint of Canada sold in 2008, or over $1 billion worth of gold. As Orgen concludes: "The game ends when the people who own all these paper obligations say enough and take physical delivery, and that's when the mess will occur."

Also note the interesting detour into what Stephan Spicer of the Central Fund Of Canada, said regarding his friend at a major bank, who wanted access to his 15,000 oz of silver, and had to wait 6-8 weeks for its to be flown in from Hong Kong.

It is funny that central bankers thought they could take
the ponzi mentality of infinite dilution of all assets coupled with infinite debt issuance, as they have done to fiat money, and apply it to gold, in essence piling leverage upon leverage. They underestimated gold holders' willingness to be diluted into perpetuity - when the realization that gold owned is just 1% of what is physically deliverable, you will see the biggest bank run in history.

According to Lenny Organ, ScotiaMocatta (Canada's only bullion bank vault) only has 89,000 ounces of physical gold (worth about $100,000,000).

ScotiaMocatta gold holdings

ounces

210 400 oz bars

84,000

4,000 maples

4,000

500 eagles

500

10 kilo bars

353

10 one kilogram pieces of gold nugget

353

Total

89,206


For comparison, go to NYMEX Daily Reports and download Gold Stocks data. There you will find information about iShares COMEX Gold Trust's "physical" gold holding:

iShares COMEX Gold Trust

Gold

Gross Troy

Sub Custodians

Deposited

Ounces

Brink's, Inc.

100 oz.

0.000

Kilo

0.000

Total*

0.000

Scotia Mocatta

100 oz.

457,172.596

Kilo

0.000

Total*

457,172.596

London

400 oz.

485,088.675

New York

400 oz.

125,847.919

Toronto

400 oz.

1,408,112.833

Grand Totals

2,476,222.023



iShares COMEX Gold Trust claims to have 1,408,112 ounces of gold stored in Toronto, yet ScotiaMocatta (Canada's only bullion bank vault, located in Toronto) reportedly only has 89,000 ounces of gold. Needless to say, iShares COMEX Gold Trust is NOT a safe way to own gold.


--------------------------------


Regia Fund Blog

As I have written before, I've moved to Russia and have launched a fund to Invest in Russian Black Earth farmland. (Please email me if you're interested). Well we have now launched a Regia Fund Blog:

http://regiafund.blogspot.com/


Regia Fund Blog will focus on news relating to agriculture or Regia Fund. It will be mostly updated by Charles Bausman and Rich Selby, but I will also contribute whenever I write something relevant for Market Skeptics (I will also have to work on the blog's layout when I get the chance).

This entry was posted in China, Currency_Collapse, Federal_Reserve, Gold, News_Developments, Treasury, Wall_Street_Meltdown. Bookmark the permalink.

7 Responses to *****Cracks Appearing In US Financial System*****

  1. me says:

    Thanks, Eric for your insight upon T, Gold 'n Chinese Y., I was wondering if you have any idea upon how the gold price will be affected if Chinese Yuan being valuated in July, 2010? Will it bring G price down or up?

  2. Jimmy says:

    Hello Eric,

    There is a miscalculation:

    ScotiaMocatta gold holdings ounces

    210 400 oz bars 84,000
    How do you calculate it to 84,000 ounces?

    4,000 maples 4,000

    500 eagles 500

    10 kilo bars 353
    353 ounces must be 321.5 ounces (10,000 gram / 31.1034768 grams per ounce)

    10 one kilogram pieces of gold nugget 353
    idem 321.5 ounces

    Total 89,206 not right total...

    and this is also a must-read:

    http://www.businessinsider.com/hsbc-tells-gold-bugs-to-take-their-bullion-and-gold-coins-somewhere-else-2009-11

  3. Jimmy says:

    Or maybe warn Lenny Organ to buy a new calculator or new batteries for his calculator... ;-)

  4. Eric,

    Your recent articles have helped clear up the common misconception that the US now has a long term preference for a weak dollar. A significant reason for this misconception is the heavy media coverage of US requests for China to allow its exchange rate to rise. However, even though the US sometimes wants a low dollar exchange rate for trade related reasons and to force other countries to accumulate more dollars to purchase oil, for the long term the US clearly needs a strong dollar. The less the dollar needs to be weakened to harm other economies and to maintain dollar hegemony, the better for the US economy.

    When the US weakens the dollar, it needs to maintain a high total value of dollar liquidity that is held in a larger number of weaker dollars. The US clearly needs to maintain a strong monetary base even with a weak dollar. US dollar strength for the longer term depends on being able to sell valuable good and services, gold, and valuable investments. In recent years the valuable goods and services exported have been in the form of such services as financial advice on what is the best combination of mortgage backed securities, the gold has been paper gold, and the valuable investments have been toxic debt. At the same time, the US imports valuable goods and the resources and labor of other countries. Valuable exports effectively include printed dollars needed to purchase oil. Such a situation is only sustainable to the extent that dollars are needed to purchase oil.

    It is likely that a substantial part of the strength in the dollar that is gained from settlement of gold delivery contracts in dollars is related to a situation that is somewhat similar to that which you explained in your discussion of securities trade settlement in Europe. This adds to the tendency toward dollar strength that results from downward pressure on the price of gold, but could also be expected to add to the tendency toward downward pressure on the dollar during a dollar collapse.

    When dollars that are received from settlement of gold futures contracts in dollars are returned to foreign investors and deposited in overseas banks, the tendency toward dollar strength that results from purchases of dollars to buy paper gold rather than physical gold is at least somewhat offset by downward pressure on the dollar as dollars flow back overseas. However, upward pressure on the dollar occurs to the extent that IOU’s for dollars are credited to foreign owned gold fund accounts in settlement of contracts to deliver gold. The dollar strength that results would tend to be strongly related to the extent to which overseas dollars held in gold funds are used to invest in the US. In this case, the dollars effectively become free loans backed only by IOU’s.

    Upward pressure on the dollar increases as an increasing amount of foreign currency held in gold accounts is sold. Massive amounts of foreign currency can be sold with IOU's as collateral while foreign investors believe that that are holding gold and are often charged storage fees. Considering the recent testimony that there is at least a hundred times as much paper gold as there is physical gold, selling of increasing amounts foreign currency held by gold funds could have a significant impact on the value of the dollar. The 85% increase in the gold ETF market that was mentioned in your article is a clear indication of this. However, during a collapse of the paper gold market, previous borrowing of foreign currency from accounts to use for financing would create the need to purchase foreign currency to cover short positions which would add to the downward pressure on the dollar.

    Continued below

  5. Continued from above:

    A substantial amount of dollar strength is likely added through naked short selling in the commodity futures markets. In addition, with the resulting low commodity prices and low and stable food prices, US consumers have the confidence to make large purchases and the demand for discretionary purchases of goods with high profit margins becomes more inelastic. Farm subsidies help make food prices even lower and more stable.

    Increased demand for discretionary purchases and rising home prices and increased home equity lending allow for willingness to produce goods for US consumers in exchange for dollars to purchase oil to be matched by increased US demand. This allows for the US to take advantage of low prices of resources and labor overseas. To some extent, US consumption becomes effectively free of charge, especially with a strong dollar.

    During the 2008 financial crisis when treasury rates were briefly negative, it appeared that it might soon not have been possible to absorb potential inflows to the US through sales of treasuries. Sales of treasury IOU’s would have allowed for interest rates to have remained far enough above zero to absorb the high demand for treasuries and prevent the loss of confidence that would have soon occurred when negative rates combined with lack of upside potential to cause a selloff. The reduced need for liquidity after the worst part of the crisis would have a made a selloff likely with interest rates below zero. In addition, treasury IOU’s probably were related to a significant part of the demand for treasuries after the demand for treasuries fell in recent months. Even during times when markets are generally stable, naked short selling can add to market stability and strengthen the dollar by helping to maximize potential dollar inflows.

    Even though naked short selling creates downward pressure on the stocks prices, any harm to the US economy that has been caused by this has likely until recently been far more than offset. If stock prices were to rise in proportion to dollar inflows, periods of strong dollar inflows would created stock price bubbles that grew rapidly and were large enough to very soon cause substantial harm to the economy. Naked short selling of stocks and use of IOU’s to absorb inflows has probably created a strong net tendency toward dollar strength.

    The derivatives market likely supports dollar strength through an extremely large amount of naked short selling and use of IOU’s to put downward pressure on other currencies. This adds to the dollar strength that is caused by the lower interest rates that derivatives allow for.

    It appears that all that is now preventing a dollar collapse is the increased need to for dollars to purchase oil as oil prices rise.However,the need for a weaker dollar to cause oil prices to rise to increase demand for dollars will also harm the US economy as oil and commodity prices rise, and weakening of the dollar increases the chance of a collapse of the gold, commodity and treasury markets. It appears that right now the US is caught between a rock and a hard place.

  6. To clarify what I said in my comments above about selling gold to strengthen the dollar, when the US actually had a large supply of gold, selling that gold would strengthen the dollar by making it available for dollars to purchase just as selling valuable goods and services and valuable investments makes the dollar stronger. If there is value that can be consumed with dollars the dollar becomes more valuable. This occurs whether that value is in US goods and services exports, dollar denominated investments, or gold. When less gold is sold by the US and less gold is available to those who hold dollars, the dollar price of gold rises and the value of the dollar tends to fall. However, there is a limit to the value that can be added to the dollar by selling gold when it is seen that the supply of gold is about to run out.

    Since oil is traded in dollars, oil becomes available only to those who hold dollars. Because of this, dollars remain valuable even if the US doesn’t sell valuable exports to add to value that is available for dollars to consume.

    As dollars pass through OPEC countries and back to the US through petrodollar recycling, more dollars are constantly needed by other countries to purchase oil. Whereas the US can print dollars to purchase oil, other countries have to sell goods to the US to get dollars to purchase oil. As goods produced by other countries become availabe for US consumers at low prices along with goods that are produced in the US, inflationary pressures are reduced and the dollar tends to rise because of the additional goods available for dollars in the US to consume. The US reports a higher GDP as the real value of spending increases and the real value of corporate profits rises. Real value is added to equity, debt, and the US monetary base. The productive efforts of other countries are reflected as retailing. Manufacturing inputs produced in other countries tend to add to manufacturing related GDP. US banks gain additional benefit by lending petrodollars at high interest rates often to third world countries.

    For the Euro, things are different. Because EU gold is regularly market to market, as the price of gold rises there is upward pressure on the Euro because with the gold becoming more valuable there is a potential to sell more gold. However, because of gold being traded in dollars and because of IMF transactions European Union gold sales at times may have a net strengthening effect on the dollar by making more gold available to those who hold dollars as gold is traded in dollars. Since there is also upward pressure on the Euro as gold is made available to those who hold Euros but gold is usually traded in dollars, this adds to the uncertainty of the long term impact on exchange rates that is caused by European Union gold sales.

    I also mentioned that because derivatives increase the ability for the US to have low interest rates, dollar strength is increased. Although high interest rates generally strengthen a currency, the US economy is not currently able to withstand high interest rates. Low interest rates are now needed for dollar strength in that they allow debt to be repaid. In addition, as interest rates fall, equity valuations tend to rise so capital inflows increase and increase even more if IOU’s for assets are sold which strengthens the dollar.

  7. Guava says:

    Your views on this topic are really interesting and give a clear cut view. Thanks for sharing the knowledge.

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