Vivek Kaul
The American government has filed a suit against the rating agency Standard And Poor’s (S&P) seeking $5 billion in damages. The suit filed by the Department of Justice alleges that the rating agency gave good ratings to bad mortgage securities to earn a handsome income.
In the United States a home loan is referred to as a mortgage.
Lets try and understand this in a little more detail. Starting in around 2002 American banks and other financial firms started giving out what came to be known as subprime home loans. The term ‘prime’ was used in reference to the best customers of the bank. And loans to such customers were prime loans.
In its strictest sense a subprime loan was defined as a loan given to an individual with a credit score below 620, who had no assets and was thus unlikely to qualify for a traditional home loan. A credit score was a number calculated on the basis of the borrower’s past record at paying bills and loans of all kinds, the length of his credit history, the kind of loans taken etc.
On the basis of the number the lender could get some sort of an idea of what sort of a risk he would enter into by lending to the borrower. That was the purported idea behind the credit score. In the normal scheme of things, a borrower categorised as “sub-prime” would not have got a loan.
But those were days when anybody and everyone got a loan. Banks did not keep subprime loans on their books. What they did was that they pooled these loans together and sold bonds against them. The interest paid on these bonds was lower than the interest the bank was charging on the home loan. The difference in interest was the money made by the bank. This process was referred to as securitisation.
The bonds were bought by investors of various kinds. When the borrowers of home loans paid interest on their loans that interest was pooled together and was used to pay interest to those investors who had bought these bonds. The same thing happened with the principal on the home loan that was repaid by the borrowers. It was pooled together and used to pay off the investors who had bought these bonds.
By doing this the bank did not maintain the risk of the home loan defaulting on its books. Also by securitising the subprime home loans the banks got back the money they had lent out as home loans immediately. This allowed them to give out fresh subprime home loans which they again securitised by issuing bonds and so the system worked. The difference in interest was the money made by the bank. The bank also charged a fee from investors for securitising bonds.
If the bank had kept the loan on their books for the entire duration of the home loan, as used to be the case earlier, they wouldn’t have been able to make fresh loans immediately. Also, they would have to carry the risk of default by the borrowers on the home loan on their books.
As far as investors were concerned they got to invest in a financial security which gave a better rate of return than government and most corporate bonds. But what made them really invest in the subprime bonds was the fact that they got very good ratings from rating agencies like S&P, Moody and Fitch. So here was a financial security which had a rating which was as good as the government bond or a corporate bond, but gave a higher rate of return.
What was ironical was that the subprime home loans bonds were given the best rating of AAA. Subprime loans were basically being given to people who would have not got loans in the normal scheme of things. The lending terms had become so easy that home loans could be made to someone with No Income, No Jobs, or assets for that matter (or NINJA loans for short).
The lenders also introduced a loan where the borrower could simply get a loan by stating his or her income. The lenders wouldn’t make any effort to verify it. These loans came to be referred to as liar loans. In 2006, 40% of all subprime loans were liar loans.
Given this, the risk of default on subprime home loans was very very high. And loans with a very high chance of default couldn’t be rated AAA, which is what was happening.
But why were the rating agencies rating subprime bonds which were backed by subprime loans most likely to be defaulted on handing out AAA ratings? For this we have to go back in history.
In fact, a major reason why subprime bonds were able to get AAA rating was because of something that happened way back in 1970. This was the year when Penn Central, the biggest railway company (or what Americans call a railroad) in the United States, went bankrupt due to sustained losses in its passenger as well as freight operations. This was an event that credit rating agencies were not able to foresee.
Till this point of time the rating agencies ran a subscription based service. Hence what the rating agency thought about a particular new bond was not known to the world at large but only to those who had the subscription service of the rating agency.
In response to the crisis the Securities and Exchange Commission (SEC) mandated that brokers holding onto bonds which were less than investment grade would be penalised. But this immediately raised the question that who would decide what ‘investment-grade’ was? So SEC created a new category of officially designated rating agencies. The rating firms Standard & Poor’s, Moody’s and Fitch, were designated to be the three officially designated rating agencies.
What the SEC was effectively saying was that what the rating agencies thought about a bond was too important to be restricted only to those who were willing to pay for their subscription service. Hence, every rating from then on was publicly available.
But the ratings agency was a business at the end of the day, they had to also make money. The question was who would pay them if their ratings were publicly available? So the SEC deemed that the company which was in the process of issuing a bond, should get itself rated from the rating agencies and pay them for it as well.
This created a clear conflict of interest. The rating agencies could be easily played off against one another. And this is what happened during the entire subprime boom.
Banks and other financial institutions looking to rate their subprime bonds played off one rating agency against the other. If they did not get the AAA rating they were looking for their bonds they threatened to take their business elsewhere.
What did not help was the fact that the money the rating agencies made on rating subprime bonds was three times the money they made on rating other standard corporate bonds. This resulted in a lot of subprime bonds being rated AAA.
While the bonds may have been rated AAA, the basic point was forgotten. No bonds could be better than the home loans that were outstanding against them. And the fact of the matter was that the subprime home loans were the worst of the lot.
Given this, it doesn’t make any sense on part of the American government to blame only Standard & Poor’s for what happened. The other two officially designated rating agencies Moody’s and Fitch are equally to be blamed. And so is the American government (through SEC) for persisting with a regulation which allowed issuers of bonds i.e. banks and other financial firms to shop for a rating.
The article originally appeared on www.firstpost.com on February 7, 2013.
(Vivek Kaul is a writer. He can be reached at [email protected])
Financial Crisis
Why Mrs Watanabe can now drive the Sensex higher
Vivek Kaul
Shinzo Abe, the new prime minister of Japan, has promised to end Japan’s more than two decade old recession, through some old fashioned economics which is being now referred to as Abenomics by the experts.
For the lesser mortals Abenomics is nothing but money printing. Abe plans to go in for an ‘unlimited’ money of money printing and use the newly created ‘yen’ to increase government spending on public works.
So far so good. But what’s the idea here? In the process of printing and stuffing the financial system with an unlimited amount of yen, Abe hopes to increase money supply. As an increased amount of money chases the same amount of goods and services, he hopes to create some inflation.
The target is to create an inflation of 2%. And how does that help? In December 2012, Japan had an inflation rate of -0.1%. For 2012 as a whole inflation was at 0%, which meant that prices did not rise at all. In fact for each of the years in the period 2009-2011, prices have fallen in Japan on the whole.
In a scenario where prices are flat or are falling or are expected to fall, consumers generally tend to postpone consumption(i.e. buying goods and services) in the hope that they will get a better deal in the future. This impacts businesses as their earnings either remain flat or fall. This in turn slows down economic growth.
On the flip side, if people see prices going up or expect prices to go up, they generally tend to start purchasing things. Hence, Abe’s idea is to flood yen into the financial system and in the hope create some inflation or at least get consumers to start thinking that inflation is coming and ensure that they go out and make some purchases.
In case of a scenario where prices are falling people tend to wait to buy stuff at lower prices. In case of a scenario where prices are rising or expected to rise people tend to start buying stuff because otherwise they will have to pay a higher price for it. Either ways, human beings like a good deal.
When people buy stuff businesses see an increase in incomes and profits, which in turn spurs up economic growth. So that is the theory behind Abenomics.
Now whether this economic theory translates into practice as well with prices rising and the Japanese buying and thus helping create economic growth remains to be seen.
But there is another angle to this. As explained earlier in the article, Abe’s plan is to flood the financial system with an unlimited amount of yen. As and when this starts to happen, there will be more yen in the market than before. And this will lead to a fall in the value of the yen against other currencies.
But the market does not wait for things to happen, it starts to react to things it expects to happen. Given this, the Japanese yen has been losing value against the dollar. Three months back one dollar was worth around 80 yen. Now its worth around 94 yen. What is interesting is that between January 29, 2012 and today, the exchange rate has fallen from 90 yen to a dollar to 94 yen to a dollar.
The depreciating Japanese yen makes the situation just right for the comeback of the yen carry trade. So what is the yen carry trade?
Lets go back more than twenty years to understand where it all started. In the late 1980s Japan was in the midst of both a real estate and a stock market bubble. The Bank of Japan managed to burst the stock market bubble very rapidly and the real estate bubble very slowly, by raising interest rates.
After bursting the bubble by raising interest rates the Bank of Japan started cutting interest rates and soon the rates were close to 0%. This meant that anyone looking to save money by investing in fixed income investments(i.e. bonds or bank deposits) in Japan would have made next to nothing. This led to the Japanese money looking for returns outside Japan.
Some housewife traders started staying up at night to trade in the European and the North American markets. They borrowed money in yen at very low interest rates, converted it into foreign currencies and invested in bonds and other fixed income instruments giving higher rates of returns than what was available in Japan. Over a period of time these housewives came to be known as Mrs Watanabes and at their peak accounted for around 30% of the foreign exchange market in Tokyo.
The trading strategy of Mrs Watanabes came to be known as the yen-carry trade and was soon being adopted by some of the biggest financial institutions in the world. A lot of the money that came into America during the dotcom bubble came through the yen-carry trade. It was called the carry trade because investors made the carry i.e. the difference between the returns they made on their investment (in bonds or even in stocks for that matter) and the interest they paid on their borrowings in yen.
The strategy worked as long as the yen did not rise in value against other currencies, primarily the US dollar. Let us try and understand this in some detail. In January 1995, one dollar was worth around 100 yen. At this point of time one Mrs Watanabe decided to invest one million yen in a dollar denominated asset paying a fixed interest rate of 5% per year.
She borrowed this money in yen at the rate of 1% per year. The first thing she needed to do was to convert her yen into dollars. At $1=100 yen, she got $10,000 for her million yen, assuming there were no costs of conversion.
This was invested at the rate of 5% interest. At the end of one year in January 1996, $10,000 had grown to $10,500. Mrs Watanabe decided to convert this money back into yen. At that point, one dollar was worth 106 yen. She got around 1.11 million yen ($10,500 x 106) or a return of 11%. She also needed to pay the interest of 1% on the borrowed money. Hence her overall return was 10%.
Her 5% return in dollar terms had been converted into a 10% return in yen terms because the yen had lost value against the dollar. So this was a double gain for her. The depreciating yen added to the overall return.
But let us say instead of depreciating against the dollar, as the yen actually did, it had appreciated. And let us further assume that in January 1996, one dollar was worth 95.5 yen. At this rate $10,500 that Mrs Watanabe got at the end of the year would be worth 1 million yen ($10,500 x 95.5) when converted back to yen. Hence Mrs Watanabe would end up with a loss, given that she had to pay an interest of 1% on the money she had borrowed in yen.
The point is that for the yen carry trade to be profitable the yen would have to be either stagnant against the dollar or lose value. The moment it started to appreciate against the dollar, the returns in yen terms started to come down.
The yen carry trade worked in most years up since it started in the mid 1990s, to mid 2007. In June 2007, one dollar was worth 122.6 yen on an average. After this the value of the yen against the dollar started to go up, and fell to around 80 yen to a dollar. This had meant the death of the yen carry trade.
But with the yen losing value against the dollar again it makes the idea of the yen carry trade viable again. Between 2004 and 2008, stock markets across the emerging market rose as money through the yen carry trade route came in. This included India as well.
Things as they are now look ideal for the yen carry trade to start again. What helps is the fact that interest rates in Japan are very low almost close to 0%. Hence, money can be borrowed very cheaply.
As the yen carry trade picks up, investors borrow in yen, and sell those yen to buy dollars. This ensures that there is a surfeit of yen in the market leading to a further fall in its value against the dollar. This in turn makes the yen carry trade even more attractive.
Reports in the international media seem to suggest that it has already started happening. India now remains an ideal candidate for money to come through the yen carry trade route given that the Indian rupee has been gaining value against the dollar, which would make the yen carry trade even more profitable.
While the Indian economy falters, BSE Sensex, India’s premier stock market index might be getting ready for another rally. This time due to the blessings of Mrs Watanabe(s) from Japan. In fact when I had asked Professor Aswath Damodaran, how strong is the link between economic growth and stock markets, in a recent interview, he replied “It’s getting weaker and weaker every year.”
Reference: Extreme Money: Masters of Universe and the Cult of Risk by Satyajit Das
The article originally appeared on www.firstpost.com on February 6, 2013
(Vivek Kaul is a writer. He can be reached at [email protected])
The $1 trillion coin: Krugman’s loony idea to save US
Vivek Kaul
When the going gets tough, the ideas get absurd and bizarre. No one said that. I just happened to ‘coin’ it after coming across one of the craziest things I have heard in recent times. It all about ‘coining’ a trillion dollar platinum coin that could ‘supposedly’ solve one of the biggest financial problems of our times. But before we get to that some background information is required here.
The American government cannot print money
The budget deficit of the American government has been greater than trillion dollars for the last four years. Budget deficit is the difference between what a government earns and what it spends.
In order to finance this deficit the American treasury department (or what we call the ministry of finance in India) borrows money. But there is only so much money going around to be borrowed. And with trillion dollar deficits borrowing beyond a point is not possible.
So what does the government do? Common sense tells us that it can print dollars and finance the deficit. But the American government is not allowed to print money. Instead it borrows from the Federal Reserve of the United States (the American Central bank or what we call the Reserve Bank of India).
Now where does the Federal Reserve get money to lend to the government? It simply prints it. The Federal Reserve as the central bank is allowed to print money. As John Truman Wolfe author of Crisis by Design: The Untold Story of the Global Financial Coup puts it “How bizarre is it that instead of simply printing the money themselves, governments “chose” to borrow it from their respective central bank. The US is currently $16 trillion in debt – and the debt is growing at the rate of $49,000 a second! Last year’s interest on the debt here was $454,000,000,000 – Why borrow money from the Fed (who simply creates it out of thin air by making a book entry and clicking a mouse ) when the government could simply print its own without borrowing it and paying interest on it.”
The debt ceiling
There is a ceiling to how much the American government can borrow and it is $16.4trillion. This was breached on December 31, 2012. After this the treasury secretary Timothy Geithner put in place some “extraordinary measures” that will give a headroom of round $200 billion and help the American government avoid a default on its maturing debt as well as continue meeting its various expenditures. The American government has reached a stage where it has to take on more debt to pay off previous debt. But with the debt ceiling being hit more debt cannot be taken on. The American politicians have been unable to find a solution to this till date.
The loophole
The US Code Section 5112 states this:
“The (Treasury) Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.”
The above section basically allows the American Treasury Secretary to mint absolutely any kind of platinum coin. When it comes to gold and silver coins, he is not allowed such a leeway. The Code prescribes the exact dimensions as well as weights of gold and silver coins that can be minted. In case of platinum coins no such prescriptions are made.
So what is the idea?
This loophole allows the Treasury Secretary of the United States to get the US Mint to mint a platinum coin and deem it be worth $1trillion (or any big amount for that matter). The amount of platinum in the coin doesn’t really matter. It could be one gram or one troy ounce (28.31 grams). Hence the face value of the coin (i.e. $1trillion) would have no link with the amount of platinum in it.
Having minted such a platinum coin, the Treasury Secretary can then use the coin to repay the money that it has borrowed from the Federal Reserve. The Federal Reserve would have to accept the coin simply because any creditor cannot refuse what is legally deemed to be money, when it comes to the settlement of a debt. And the $1trillion coin would be a legal tender.
Once the $1 trillion coin is presented to the Federal Reserve, the total debt outstanding of the American government would come down below the debt ceiling of $16.4trillion. As on January 2, 2013, the American government had borrowed around $1.67trillion from the Federal Reserve. And that way the American government could continue to borrow more.
The Krugman push
The Nobel prize winning economist Paul Krugman gave a push to the idea by recommending it on his blog a couple of days back. Krugman feels that even though the idea is silly it makes sense simply because the US Congress has the right to approve the spending bills but then it won’t let the President to borrow money required to implement those bills.
As Krugman wrote “we have the weird and destructive institution of the debt ceiling; this lets Congress approve tax and spending bills that imply a large budget deficit — tax and spending bills the president is legally required to implement — and then lets Congress refuse to grant the president authority to borrow, preventing him from carrying out his legal duties and provoking a possibly catastrophic default.”
There are others who do not buy the idea at all. As Kevin Drum, a famous blogger, wrote recently “Is this really the road liberals want to go down? Do we really want to be on record endorsing the idea that if a president doesn’t get his way, he should simply twist the law like a pretzel and essentially do what he wants by fiat?”
The big danger in this case is that if something like this were to be implemented, the American government can easily keep getting the Federal Reserve of United States to keep printing money and keep repaying that money through issuing one trillion dollar platinum coins. That cannot be a good idea after all. A government which has the power to print unlimited amount of money, even though indirectly, is not something that world wants, specially given that the dollar continues to be the international reserve currency.
To conclude, it is ‘absurd’ ideas like these that make me remain bullish on gold despite the recent attempts to discredit the yellow metal as being useless.
The article originally appeared on www.firstpost.com on January 9, 2013
(Vivek Kaul is a writer. He can be reached at [email protected])
Sahara’s numbers don’t add up: ads confuse, don’t clarify
Vivek Kaul and R Jagannathan
The Sahara group sure has a way with numbers. A separate number for separate occasions.
On 1 December this year, an advertisement issued by the group said two of its companies — Sahara India Real Estate Corporation (SIREC) and Sahara Housing Investment Corporation (SHIC), which fell foul of Sebi – had returned Rs 33,000 crore of money collected through optionally full convertible debentures (OFCDs).
The ad read: “We started OFCD in these two companies in 2008/2009. Most of the money deposited with us was for 5 to 10 years. But now we have cleared around Rs 33,000 crores liability.”
On 5 December, a Supreme Court bench headed by Chief Justice of India Altamas Kabirextended the deadline for repayment till February. It ordered Sahara to pay Rs 5,120 crore immediately to Sebi, Rs 10,000 crore by January, and the rest by February. This suggests that the court still thinks nearly Rs 25,000 crore may be owed to investors.
A Sahara ad released on 9 December claimed it owed investors only Rs 2,620 crore as on date. It mentions that “Total liability was around Rs 25,000 crores of both the OFCD companies” (Note: since there are no dates, nothing can be verified), but then says only Rs 2,620 crore of this Rs 25,000 crore was left unpaid, for which it had given Sebi a cheque – adding an extra Rs 2,500 crore in case there were any discrepancies.
Sahara has a lot of explaining to do. The group, whose attitude has been described as “shaky” by the Supreme Court, is not telling us the real story.
The Supreme Court judgment of 31 August 2012 takes note of an outstanding of Rs 24,029.73 crore as on 31 August 2011 between the two companies that was owed to 29.61 million OFCD investors. (Read the full judgment here)
One wonders at what point did Sahara managed to pay investors Rs 33,000 crore when the figure was only around Rs 24,029 crore in August 2011?
The only way the group could have repaid Rs 33,000 crore over the lifecycle of the OFCD investment was if there was a huge churn even in the initial years of the scheme in 2008-11. Sebi banned them from continuing the scheme in June 2011.
Sahara offered investors three types of bonds through SIREC – the Abode 10-year bond, where early redemptions were possible only after five years; the Real Estate bonds of five years, where no early redemptions were possible; and the Nirmaan four-year bond, where redemptions were possible after 18 months.
The bulk of the investors opted for the first two bonds – Abode and Real Estate, where no redemptions were possible for five years. Since the SIREC OFCDs were issued only from 2008 (SHIC began only towards end-2009), how is it possible that such a large bulk of OFCDs were refunded to investors when they were not due?
As Firstpost noted earlier, a majority of SIREC’s investors (13.036 million) preferred to invest in Real Estate bonds worth Rs 7,120 crore. And Abode bonds came in for second preference, as 7.06 million invested in them, but the amount invested was larger at Rs 8,411 crore. Nirmaan bonds had a small following of 13.06 lakh investors with an investment of Rs 1,959 crore.
The big question is this: how can Sahara claim that it repaid nine-tenths of the money collected (only Rs 2,620 crore left out of Rs 25,000 crore or more) when the two biggest OFCDs issued by SIREC did not have any clause for premature encashment before five years – which meant only in 2013 and not earlier?
There was, of course, a provision for premature refunds in case of deaths, but Sahara is not claiming that most of its investors had passed away during the term of the OFCDs.
The refund patterns disclosed in the Supreme Court’s judgment tell their own story.
Of the total amount of Rs 19,400.87 crore collected by SIREC till 13 April 2011, only 11.78 lakh investors out of 23.3 million had cashed out with Rs 1,744.34 crore by 31 August 2011 – leaving a balance of Rs 17,656.53 crore.
In the case of SHIC, premature redemptions were a meagre Rs 7.3 crore (involving just 5,306 investors) out of total collections of Rs 6,380.50 crore – leaving a balance of Rs 6,373.20 crore.
These numbers are a part of the disclosures made by Sahara to the Securities Appellate Tribunal, which heard and threw out its appeal against Sebi, as on 31 August 2011, and remained part of the Supreme Court order a year later.
The questions are clear:
Why did Sahara not tell the Supreme Court what it owed investors during the hearings on the case? How come the Rs 2,620 crore figure came up only when the Supreme Court ordered it to pay Rs 24,029 crore?
How did Sahara manage to refund most of the money when the bulk of the bonds were not meant to be prematurely redeemed till 2013? How did dues of Rs 24,029 crore become Rs 2,160 crore, or even Rs 5,120 crore?
Did Sahara really refund the money or shift it to different schemes? Or why else would Sebi issue ads warning investors to avoid Sahara approaches? Business Standard clearly reports that investors under pressure are moving their money.
The newspaper reported that agents of the Sahara group were being pushed to collect sehmat patras (consent letters) from investors to show that their money had already been returned to them. “Agents, estimated to be a million strong, who sold OFCDs, often termed housing bonds, have been ordered to collect these letters, failing which their commissions are being stopped. With these consent letters, many of which are pre-dated, with dates ranging from as early as April to show that refunds were spread over a long period, documents such as account statements and passbooks in the hands of the customers are being collected,” the newspaper reported.
Also, money was being transferred to the new Q Shop venture launched by the group. The newspaper adds: “While this documentation process has been on, a significant portion of the money deposited in the accounts have already been transferred to the Q-Shop plan, another money raising plan being marketed as a retail venture.”
What is interesting nonetheless is that the December 1 advertisement of Sahara makes a slightly different point. “Surprisingly in the Hindi belt particularly, we find the name of hundred of different persons, even the area names, including Village, Mohalla, Towns, Cities match. Most surprisingly many many fathers/husbands names also match, so it is very difficult to authentically ascertain the pattern of reinvestment, but through verbal conversations and also through computer data matching we try to understand the pattern. There is always persuasion by field workers out of their good relation with investors for reinvestment. We have vaguely observed that a good percentage of depositors/investors do not come back and go away with 100% of maturity/redemption amount. Another good percentage keep back their principal investment amount but they accept field workers request and reinvest the amount of earning with the company and a big percentage reinvest the full amount”.
How different is good percentage from a big percentage? Why can’t the company put out some real data especially when the advertisement goes onto to claim with utmost confidence that “if you go through the figures, you shall see a similar behaviour in all other institutions where commission is paid like Post Office, LIC etc.”
If Sahara can be so confident about the money going into Post Office investment schemes, and premium being paid towards Life Insurance Corporation of India’s insurance plans, then it can surely give us a little more detail about the money that it raises.
Sahara has a lot of explaining to do. The group, whose attitude has been described as “shaky” by the Supreme Court, is not telling us the real story.
The article originally appeared on www.firstpost.com on December 10, 2012.
Obama is good for gold: Target $3,500 by 2013-end?
Vivek Kaul
So now that Barack Obama is all set for a second term as the President of the United States of America, gold is set for another rally. As I write this gold is quoting at $1723.2 per ounce (1 troy ounce equals 31.1grams), up $40 or 2.4% in a day.
And this rally is likely to continue. There are several reasons for the same.
a) The Second Term President phenomenon: Second term presidents in the United States(US) usually tend to go overboard with spending money. This extra spending cannot be always matched by an increase in government revenue and is matched by printing dollars to meet this gap. This money printing devalues the dollar.
As Jan Skoyles the head of research at a U.K. bullion dealer called The Real Asset Co., put it in a recent research note “our research also found Presidents granted a second-term have a marvellous time showing everyone just how much money they can spend, devaluing the currency further and making that precious metal glister even more. It seems that during their first terms Presidents are more tempered than in their second. Is this because they decide to blow the doors off and show everyone what a great person they are, leaving the next guy to pick up the mess?”
And the numbers tell the story. Gold rallied 88.8% during George Bush Junior’s second term. It had rallied only 24.6% in his first term. The same stands true for Bill Clinton as well, with gold losing 5.6% in his first term and gaining 16.9% in his second term. The table here tells the complete story.
b) Democrats destroy the dollar more than Republicans: The Democratic Party to which Obama belongs, has a better track record of destroying the dollar and hence pushing up the gold price. As Skoyles puts it “The evidence showing Democrats destroying the dollar more than Republicans…is over-whelming. Even though Democrats prove to be the best party for gold investors worried about the gold price, the Republicans don’t do too badly themselves – accounting for a net increase of 121.27% across their terms in office since Nixon, versus 358.68% for the Democrats.” Richard Nixon was the President of America between 1969 and 1974.
c) Ben Bernanke will continue to be the Chairman of the Federal Reserve of the United States: One of the things that Mitt Romney, the Republican challenger to Barack Obama, had made very clear was that he would fire Ben Bernanke, the Chairman of the Federal Reserve of the United States, the American central bank, if he became the President of the United States.
As he had said in August earlier this year “I would want to select someone new and someone who shared my economic views…I want someone to provide monetary stability that leads to a strong dollar and confidence that America is not going to go down the road that other nations have gone down, to their peril.” His running mate, Paul Ryan wanted dollar to be “Sound Money” again. “We want to pursue a sound-money strategy so that we can get back the King Dollar,” Ryan said.
With Obama getting a second term, Ben Bernanke is likely to continue as the Chairman. Also he might now even get a third term when his current term ends in 2014. This means that the easy money policy run by the Federal Reserve is likely to continue and this can only mean good things for the price of gold.
Bernanke has been running a policy of quantitative easing and printing dollars, in the hope that banks lend these dollars, and people spend them, and this in turn helps in the revival of the American economy. But this money printing has also led to a stupendous rise in the price of gold.
Any round of quantitative easing ensures that there are more dollars in the financial system than before. The threat is that the greater number of dollars will chase the same number of goods and services. This will lead to an increase in their prices. But this hasn’t happened till now. Nevertheless that hasn’t stopped investors from buying gold to protect themselves from this debasement of money. Gold cannot be debased. Unlike paper money it cannot be created out of thin air.
During earlier days, paper money was backed by gold or silver. When governments printed more paper money than the precious metals backing it, people simply turned up with their paper at the central bank and government mints, and demanded that paper money be converted into gold or silver. Now, whenever people see more and more of paper money being printed, the smarter ones simply go out and buy that gold. Hence, bad money (that is, paper money) is driving out good money (that is, gold) away from the market.
d) The US Fed will go slow on manipulating the gold market: Another theory going around is that the US Federal Reserve has been manipulating the price of gold over the years with help from bullion banks. As the gold expert Tehmaas Gorimaar writes “One form of manipulation is the through setting of low lease rates for gold and silver. Low rates encourage bullion banks like J.P Morgan and HSBC to borrow gold and silver from central banks, dump the metal on the market and use the proceeds to invest in paper assets, thereby driving up the prices of these assets.” (you can read a more detailed argument on this here).
This manipulation to hold back the price of gold seems to have gone up in the run up to the Presidential election. As Gorimaar puts it“Because the dollar, like all other currencies, is a fiat currency, and gold is the antithesis of the dollar. A runaway gold price means that the so called “strong dollar policy” touted by American presidents isn’t working. Also, higher gold and a lower dollar would mean higher commodity prices, since commodities are priced in dollars. A weak dollar would also have given Mitt Romney more fodder for attack.” Hence, Bernanke was helping Obama here. Now what would be the quid pro quo for the same? Another term for Bernanke as the Chairman?
With the elections over the Federal Reserve is likely to take a breather on this front and gold is set to rally. “I think you’ll see gold at $3500 per ounce and silver above $100 per ounce by the end of 2013. This is because of the extreme suppression of their prices in this election year,” says Gorimaar.
e) Does that mean gold will rally in India? While the gold is set to rally in dollars, for Indians to make money it has to rally in rupee terms. For that to happen the Indian rupee either has to remain at the current levels against the dollar or depreciate further. Let us try and understand this through an example. Gold currently quotes at around $1723 per ounce. One dollar is worth Rs 54.3. This means one ounce of gold is priced at Rs 93558.9 per ounce (one troy ounce equals 31.1grams). If one dollar was worth Rs 50, then gold would have been at Rs 86,150 per ounce. If one dollar was worth Rs 60, gold would have been at Rs 1.03,380 per ounce. Hence more the rupee depreciates against the dollar; the greater will be the return on gold in rupee terms. For that to happen the UPA government needs to continue running the screwed up economic policy that it has been over the last few years. And that’s one thing they have been doing even better than all the scams that they have been running. So gold should rally in rupee terms as well.
The article originally appeared on www.firstpost.com on November 7, 2012. http://www.firstpost.com/economy/obama-is-good-for-gold-target-3500-by-2013-end-517752.html)
(Vivek Kaul is a writer. He can be reached at [email protected])