On Central Banks’ Determination to Inflate

Gold and silver moved further up the price chart last week, with the most-actively traded Comex gold contract (February) gaining $26.60 (1.6%) to settle at $1,726.70 per troy ounce. Silver for March delivery gained 62 cents (1.9%), settling at $33.74 per troy ounce. The HUI Index of gold and silver mining stocks put in a good showing following the FOMC news on Wednesday and continued higher early in the session Thursday. However, later on in the day the shares faltered, which as some analysts have pointed out could be a sign that hedge funds lack confidence on the sustainability of this latest risk rally.

Certainly there have been times over the last few months when nascent stock market and commodity rallies have been snuffed out early following a burst of initial optimism – notably in late October last year, following signs that Europe’s leaders had arrived at a plan for restructuring Greece's debts. The situation is different this time, however, in that the markets are stating to adjust to the fact that the world’s monetary authorities are not going to “deflate the bubble” (to coin a technical term).

Evidence in favour of this point has been steadily accumulating over the last few months – whether in the form of the European Central Bank’s rapidly expanding balance sheet, the Fed-ECB swap lines announced last November, and the €489bn’s worth of three-year loans the ECB made to European banks in December as part of its “long-term refinancing operation”. A second LTRO is scheduled for next month.

In addition, the International Monetary Fund is also looking to bolster its bailout options, a move sure to generate political controversy in countries that are expected to contribute more of their taxpayers’ money to the organisation. Already US Republicans are speaking out against American involvement in any eurozone rescue, though they’ve missed the boat slightly on this, as the increase in Fed-ECB swap lines was clear assistance for the eurozone (which avoided the obvious political risks the Fed would have run if it had engaged in direct purchases of European securities).

Similarly, the significance of any new IMF deal may initially slip under the radar screen of most politicians and a good chunk of the media, as it will be presented in the language of international bureaucracy rather than plain English. Nevertheless, the IMF has been steadily laying the groundwork for greater involvement on its part in bailouts since the 2008 crisis, and increasing its issuance of “Special Drawing Rights” (SDRs) – a kind of central bank currency.

The world’s monetary authorities will not go down without a fight, and it’s foolhardy to question their determination to inflate.