‘Currency Wars’ Hotting up

Gold and silver prices paused for breath yesterday following their price breakouts last week. Gold for April delivery at the New York Comex settled down 0.1% at $1,734.40 per troy ounce, while silver for March delivery lost 26 cents (0.8%), settling at $33.53 per troy ounce. Both metals have however put in good showings in trading today, with the gold price hitting $1,740 and silver just a whisker away from $34.

Gains in the US dollar yesterday hurt commodities generally, though this morning the Dollar Index has fallen back below 79. This is largely because of growing optimism among traders that eurozone officials and Greece’s private creditors are close to some sort of deal to “restructure” that nation’s debt.

This “restructuring” is de facto default (in what other walk of life would a debtor’s failure to repay 70% of the principal be talked of as anything other than a default?) but as discussed by Jim Sinclair in an interview on the Ellis Martin Report, a de jure declaration of default by the International Swaps & Derivatives Association (ISDA) carries potentially serious implications for the banks that have written the vast bulk of the credit default swaps on Greek debt. Credit default swaps are insurance on default – the “writer” of the swap agreeing to pay insurance on a default in return for payments from those who have bought the insurance.

Meanwhile in China, increased gold sales are being interpreted by many analysts as a harbinger of serious problems for the Chinese economy. Forbes contributor Gordon Chang notes “the growing sense of pessimism inside the country”, with US$34 billion of capital flight in the third quarter 2011 increasing to $100bn in Q4. Many Chinese are buying gold as a means of divesting themselves from country’s property and stock markets – all of which serves to create a “vicious circle” whereby capital flight leads to falling economic indicators, and thus more pessimism about the economy and even more selling.

Thus, says Michael Pettis of Peking University, “many are going to argue that the rapid decline in the trade surplus, coupled with unmistakable evidence of flight capital, means that the PBOC (People’s Bank of China) should devalue the RMB.”

A devaluation of the RMB looks increasingly inevitable, given both China’s long-standing preference for mercantilist trade policies, the fact that received economic wisdom has it that cheapening your currency is the best way to fight recession, and the truism that most politicians everywhere are loathe to countenance even the merest hint of deflation.

So the Chinese will print money in an effort to regain export advantage – just as the Americans have been doing over the last three years, and just as Europeans have also been doing. But as commented before on this site, in these “Currency Wars” countries cannot all devalue their currencies against other currencies – but they certainly can all devalue against gold.