Vivek Kaul
The foreign institutional investors have sold out $4.6 billion worth of bonds from the Indian debt market over the last one month. This is primarily because of the unwinding of the dollar carry trade.
In the aftermath of the financial crisis that started in September 2008, the Federal Reserve of United States, the American central bank, started printing truckloads of money. This money was flushed into the financial system. The idea being with enough money going around, the interest rates would remain low. At low interest rates American citizens were more likely to borrow and spend. And this spending would create economic growth, which had fallen dramatically in the aftermath of the crisis.
The trouble of course was that Americans were just coming out from a horrible round of borrowing binge which had gone all wrong. And given that they were in no mood to borrow more. They first wanted to pay off their existing loans. So the financial system was flush with money available at low interest rates but the American citizens did not want to borrow.
This led to banks and other financial institutions borrowing at very low interest rates and investing that money in different financial markets across the world. This trade came to be known as the dollar carry trade. Money was raised in dollars at low interest rates and invested in stock, bond and commodity markets all over the world.
The difference between the return the investors make on their investment and the interest that they pay for borrowing money in dollars is referred to as the ‘carry’ they make.
This trade has been a boon to big financial firms which were reeling in the aftermath of the financial crisis and has helped them back on their feet. But like all things which seem ‘good’, this might be coming to an end as well.
Later today the Federal Open Market Committee(FOMC) of the Federal Reserve will issue a statement in which it is likely to hint that it will cut down on further money printing. Ben Bernanke, the Chairman of the Federal Reserve, hinted about it in a testimony to the Joint Economic Committee of the American Congress on May 23, 2013.
As he said “if we see continued improvement and we have confidence that that is going to be sustained, then we could in — in the next few meetings — we could take a step down in our pace of purchases.”
The Federal Reserve pumps money into the American financial system by printing money and using it to buy bonds. This ensures that there is no shortage of money in the system, which in turn ensures low interest rates.
What Bernanke said was that if the Federal Reserve feels that the economic scenario is improving, it would taper down the bond purchases. This basically meant that the Federal Reserve would go slow on money printing.
If and when that happened, the interest rates would start to go up as the financial system would no lunger be slush with money. In fact the interest rates have already started to go up. The return on the 10 year US treasury bond has gone up. On May 2, 2013, the return was at 1.63%. As on June 18, 2013, the return had shot up to 2.19%. A US treasury bond is a bond issued by the American government to finance its fiscal deficit. The fiscal deficit is the difference between what a government earns and what it spends.
The return on 10 year US treasury acts as a benchmark for the interest rates on other loans. If the return on 10 year US treasury goes up, what it means is that interest charged on other loans will also go up in the days to come.
This means that those financial institutions which have borrowed money for the dollar carry trade will be paying a higher interest. A higher interest would mean a lower return on investment on their trade i.e. a lower carry.
This is the reason why these investors are unwinding their dollar carry trade. In an Indian context this has meant that they have been selling out on the bonds they had invested in. As mentioned earlier over the last one month the foreign investors have sold bonds worth $4.6 billion.
When the foreign investors sell these bonds they get paid in rupees. This money needs to be repatriated to the United States and hence needs to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Now its worth close to Rs 59 (around Rs 58.75 as I write).
The question that arises here is how are the foreign investors reacting in the stock market? They have much more invested in the stock market than they had in the bond market.
Over the last one month the foreign institutional investors have bought stocks worth Rs 382.88 crore, which is a low number, though in the positive territory. In the month of May 2013, the foreign investors had bought stocks worth Rs 14,465.90 crore. Since the beginning of this year they have bought stocks worth Rs 57,644.33 crore.
So that tells us very clearly that foreign institutional investors are going slow even on their stock purchases. But they haven’t sold out on stocks totally, as they have in case of bonds. The answer lies in the fact that returns in the bond market are limited. The return on the 10 year India government bond was at 7.28% as on June 18,2013. The borrowing costs for the foreign investors have gone up. A depreciating rupee also limits their overall return. So it makes sense for them to get out of bonds.
In case of the stock market there is no limit to the overall return that can be made. And that explains to some extent why the bond market has borne the brunt of the unwinding of the dollar carry trade. How things pan out from here depends on what the Bernanke led FOMC says later tonight.
The article originally appeared on www.firstpost.com on June 19,2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Ben Bernanke
Are you a victim of the Sajid Khan syndrome?
Vivek Kaul
The residents of the island of New Guinea first saw the white man in 1930. The white men were strangers to New Guineans. The New Guineans had never gone to far off places and most of them lived in the vicinity of where they were born, at most making it to the top of the hill around the corner. Given this, they were under the impression that they were the only living people.
This impression turned out to be wrong and the New Guineans started to develop stories around the white men who had come visiting. Jared Diamond writes in The World Until Yesterday that the New Guineans told themselves that “Ah, these men do not belong to earth. Let’s not kill them – they are our own relatives. Those who have died before have turned white and come back.”
The New Guineans tried to place the strange looking Europeans into “known categories of their world view”. But over a period of time they did come to realise that Europeans were human after all. As Diamond writes “Two discoveries went a long way towards convincing New Guineans that Europeans really were human were that the feces scavenged from their campsite latrines looked like typical human feces (i.e., like the feces of New Guineans); and that young New Guinea girls offered to Europeans as sex partners reported that Europeans had sex organs and practiced sex much as did New Guinea men.”
To the men and women of New Guinea, Europeans were what former American defence secretary Donald Rumsfeld called the “unknown-unknown”. As Rumsfeld said “[T]here are known knows; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown-unknowns-there are things we do not know we don’t know.”
People take time to adjust to unknown-unknowns, like the New Guineans did. But there are also situations in life in which individuals, institutions and even countries tend to ignore the chance of something that they know can happen, just because it hasn’t happened in the recent past or it hasn’t happened to them specifically. For such people, institutions and countries, the option tends to become an unknown-unknown even though it is not one in the specific sense of the term.
Take the case of film director Sajid Khan whose most recent movie was Himmatwala. Before the movie was released the director often said “I can’t say I am a great director but I am the greatest audience, since childhood I have done nothing other than watching films. Cinema is my life. I can never make a flop film because I make film for audience and not for myself .”
Of course this statement was right before Himmatwala released. Khan’s previous three outings as director Heyy Babyy, Housefull and Housefull 2 had been a huge success. Himmatwala fizzled out at the box office and its first four day collections have been nowhere near what was expected. As the well respected film trade website Koimoi.com points out “The numbers are too bad for a film like Himmatwala, which was expected to create shattering records at the Box Office being a ‘Sajid Khan Entertainer’ and moreover due to the coming together of two successful individuals – actor Ajay Devgn and director Sajid Khan for the first time. However, the formula didn’t work this time it seems!”
Khan’s overconfidence came from the fact that none of his previous films had flopped and that led him to make the assumption that none of his forthcoming films will flop as well. He expected the trend to continue. Khan had become a victim of what Nobel prize winning economist Daniel Kahneman calls the ‘availability heuristic’.
Kahneman defines the availability heuristic in Thinking, Fast and Slow as “We defined the availability heuristic as the process of judging frequency by “the ease with which instances come to mind.”” In Khan’s case the instances were the previous three movies he had directed and each one of them had been a superhit. And that led to his overconfidence and the statement that he can never make a flop film.
Nate Silver summarises the situation well in The Signal and the Noise. As he points out “We tend to overrate the likelihood of events that are nearer to us in time and space and underpredict the ones that aren’t.” And this clouds our judgement.
Another great example is of this are central banks around the world which have been on a money printing spree. As Gary Dorsch, Editor, Global Money Trends points out in a recent column “So far, five central banks, – the Federal Reserve, the European Central Bank, Bank of England, the Bank of Japan and the Swiss National Bank have effectively created more than $6-trillion of new currency over the past four years, and have flooded the world money markets with excess liquidity. The size of their balance sheets has now reached a combined $9.5-trillion, compared with $3.5-trillion six years ago.”
This money has been pumped into various economies around the world in the hope that banks and financial institutions will lend it to consumers and businesses. And when consumers and businesses spend this borrowed money it will revive economic growth. But that has not happened. The solution that central banks have come up with is printing even more money.
One of the risks of too much money printing is the fact it will chase the same number of goods and services, and thus usually leads to a rise in overall prices or inflation. But that hasn’t happened till now. The fact that all the money printing has not produced rapid inflation has led to the assumption that it will never produce any inflation. Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, has even gone to the extent of saying that he was 100% sure he could control inflation.
Mervyn King, the Governor of the Bank of England, has made similar statements. “Certainly those people who said that asset purchases would lead us down the path of Weimar Republic and Zimbabwe I think have been proved wrong ,” he has said. What this means is that excess money printing will not lead to kind of high inflation that it did in Germany in the early 1920s and Zimbabwe a few years back.
King and Bernanke like Sajid Khan are just looking at the recent past where excess money printing has not led to inflation. And using this instance they have come to the conclusion that they can control inflation (in Bernanke’s case) as and when it will happen or that there will simply be no inflation because of money printing (in King’s case).
As Albert Edwards of Societe Generale writes in a report titled Is Mark Carney the next Alan Greenspan “King’s assertion that because the quantitative easing(another term for money printing) to date has not yet produced rapid inflation must mean that it will never produce rapid inflation is just plain wrong. He simply cannot know.” Nassim Nicholas Taleb is a lot more direct in Anti Fragile when says “central banks can print money; they print print and print with no effect (and claim the “safety” of such a measure), then, “unexpectedly,” the printing causes a jump in inflation.” Just because something hasn’t happened in the recent past does not mean it won’t happen in the future.
People who make economic forecasts are also the victims of what we can now call the Sajid Khan syndrome. They expect the recent trend to continue. The Indian economy grew by 8.6% in 2009-2010 and 9.3% in 2010-2011. And the Indian politicians and bureaucrats told us with glee that the Indian economy had decoupled from the world economy, which was growing very slowly in the aftermath of the global financial crisis.
Montek Singh Ahluwalia, the deputy chairman of the Planning Commission is a very good example of the same. In a television discussion in April 2012, he kept insisting that a 7% economic growth rate for India was a given. Turns out it was not. The Indian economy grew by 4.5% in the three months ending December 31, 2012. Ahluwalia was way off the mark simply because he had the previous instances of 8-9% rate of economic growth in his mind. And he was projecting that into the future and saying worse come worse India will at least grow by 7%.
It is not only experts who become victims of the Sajid Khan syndrome taking into account events of only the recent past. In the aftermath of September 11, 2001, when aeroplanes collided into the two towers of the World Trade Centre, many Americans simply took to driving fairly long distances, fearing more terrorist attacks.
But driving is inherently more risky than flying. As Spyros Makridakis, Robin Hograth and Anil Gaba write in Dance with Chance – Making Your Luck Work for You “In 2001, there were 483 deaths among commercial airline passengers in the USA, about half of them on 9/11. Interestingly in 2002, there wasn’t a single one. And in 2003 and 2004 there were only nineteen and eleven fatalities respectively. This means that during these three years, a total of thirty airline passengers in America were killed in accidents. In the same period, however, 128,525 people died in US car accidents.” Estimates suggest that nearly 1600 deaths could have been avoided if people had taken the plane and not decided to drive,.
So what caused this? “Plane crashes are turned into video images of twisted wreckage and dead bodies, then beamed into every home on television screens,” write the authors. That is precisely what happened in the aftermath of 9/11. People saw and remembered planes crashing into the two towers of the World Trade Centre and decided that flying was risky.
They just remembered those two recent instances. What they did not take into account was the fact that thousands of planes continued to arrive at their destinations without any accident like they had before. So most people ended up concluding that chances of dying in an aeroplane accident was much higher than it really was.
The same logic did not apply to a car crash. As the authors write “Car crashes, on the other hand, rarely make the headlines…Smaller-scale road accidents occur in large numbers with horrifying regularity, killing hundreds and thousands of people each year worldwide…We just don’t hear about them.” And just because we don’t hear about things, doesn’t mean they have stopped happening or they won’t happen to us.
Another version of this is the probability of dying due to a terror attack. As Kahneman writes “Even in countries that have been targets of intensive terror campaigns, such as Israel, the weekly number of casualties almost never came close to the number of traffic deaths.”
A good comparison in an Indian context is the number of people who die falling off the overcrowded Mumbai local train network in comparison to the number of people who have been killed in the various terrorist attacks in Mumbai over the last few years. The first number is higher. But its just that people die falling off the local train network almost everyday and never make it to the news pages, which is not the case with any terrorist attack, which gets sustained media coverage sometimes running into months.
To conclude it is important to look beyond the recent past and ensure that like Sajid Khan and others, we do not fall victims to the Sajid Khan syndrome.
The article originally appeared on www.firstpost.com on April 4, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why you should be nice to your mom – and buy some gold
Vivek Kaul
So let me start this piece by admitting Ben Bernanke, the Chairman of the Federal Reserve of United States (the American central bank) has proven me wrong.
I was wrong when I recently said that the Federal Reserve would not initiate a third round of quantitative easing (QE), before the November 6 presidential elections in the United States. (you can read about it here).
Bernanke announced late last night that the Federal Reserve would buy mortgage backed securities worth $40billion every month. This will continue till the job scenario in the United States improves substantially. The Federal Reserve will print money to buy the mortgage back securities.
I concluded that the Federal Reserve wouldn’t announce any QE till November 6, primarily on account of the fact that Mitt Romney, the Republican nominee for the Presidential elections, has been against any sort of QE to revive the economy.
“I don’t think QE-II was terribly effective. I think a QE-III and other Fed stimulus is not going to help this economy…I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation’s needs,” Romney told Fox News on 23 August. This had held back the Federal Reserve from initiating QE III.
But from the looks of it Bernanke doesn’t feel that Romney has a chance at winning and that he is more likely than not going to continue working with Barack Obama, the current American President.
This round of quantitative easing is going to help Obama and hurt Romney. Let me explain. The theory behind quantitative easing is that when the Federal Reserve buys mortgage backed securities (in this case) by printing dollars, it pumps in more money into the economy. With more money in the economy, banks and financial institutions it is felt will lend that money and businesses and consumers will borrow. This will mean that spending by both businesses and consumers will start to up. Once that happens the economic scenario will start improving, which will lead to more jobs being created.
But as I said this is the theoretical part. And theory and practice do not always go together. Both American businesses and consumers have been shying away from borrowing. Hence, all this money floating around has found its way into stock and commodity markets around the world.
As more money enters the stock market, stock prices go up and this creates the “wealth effect”. People who invest money in the market feel richer and then they tend to spend part of the accumulated wealth. This, in turn, helps economic growth.
As Gary Dorsch, an investment newsletter writer, said in a recent column, “Historical observation reveals that the direction of the stock market has a notable influence over consumer confidence and spending levels. In particular, the top 20% of wealthiest Americans account for 40% of the spending in the US economy, so the Fed hopes that by inflating the value of the stock market, wealthier Americans would decide to spend more. It’s the Fed’s version of “trickle down” economics, otherwise known as the “wealth effect.””
When this happens, the economy is likely to grow faster and hence, people are more likely to vote for the incumbent President. As Dorsch explains “Incumbent presidents are always hard to beat. The powers of the presidency go a long way…In the 1972 election year, when Nixon pressured Arthur Burns, then the Fed chairman, to expand the money supply with the aim of reducing unemployment, and boosting the economy in order to insure Nixon’s re-election.”
Bernanke is looking to do the same, even though he has denied it completely. “We have tried very, very hard, and I think we’ve been successful, at the Federal Reserve to be non-partisan and apolitical…We make our decisions based entirely on the state of the economy,” the Financial Times quoted Bernanke as saying. Given this, Romney has been a vocal critic of quantitative easing knowing that another round of money printing will clearly benefit Obama.
Other than Obama and the stock markets, the other big beneficiary of QE III will be gold. The yellow metal has gone up by around 2.2% to $1768 per ounce, since the announcement for QE III was made. In fact the expectation of QE III has been on since the beginning of September after Ben Bernanke dropped hints in a speech. Gold has risen by 7.3% since the beginning of this month.
This is primarily because 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.
But that’s just one part of the story. The governments and central banks around the world, led by the Federal Reserve of United States and the European Central Bank, are likely to continue printing more money, in the hope that people spend this money and this revives economic growth. This in turn increases the threat of inflation which would mean that the price of gold is likely to keep going up. “Gold tends to benefit from easy-money policies as investors utilize the precious metal as a hedge against potential inflation that could ultimately result from the Fed’s policies,” Steven Russolillo, wrote on WSJ Blogs.
Market watchers have also started to believe that the Federal Reserve is now only bothered about economic growth and has abandoned the goal of keeping inflation under control. Growth and inflation control are typically the twin goals of any central bank.
“They are emphasizing the growth mandate, and that means they don’t care about inflation other than giving lip service to it,” Axel Merk, chief investment officer at Merk Funds, told Reuters. “The price of gold will do very well in the years to come,”he added.
Something that Jeffrey Sherman, commodities portfolio manager of DoubleLine Capital, agrees with. “The Fed’s inflationary behavior should be bearish for the dollar in the long run and drive investors to seek protection via the gold market,” he told Reuters.
Also unlike previous two rounds of money printing there are no upper limits on this QE, although at $40billion a month it’s much smaller in size. QE II, the second round of money printing, was $600billion in size.
Something that can bring down the returns on gold in rupee terms is the appreciation of the rupee against the dollar. Yesterday the rupee appreciated against the dollar by nearly 2%. This is happening primarily because the UPA government has suddenly turned reformist. (To understand the complete relationship between rupee, dollar and gold, read this).
In the end let me quote William Bonner & Addison Wiggin, the authors of Empire of Debt — The Rise of an Epic Financial Crisis. As they say “There is never a good time to die. Nor is there a good time for a crash or a slump. Still, death happens. Be prepared. Say something nice to your mother. Offer a bum a drink. And buy gold.”
So be nice to your mother and buy gold.
Disclosure: This writer has investments in gold through the mutual fund route.
(The article originally appeared on www.firstpost.com on September 15,2012. http://www.firstpost.com/investing/why-you-should-be-nice-to-your-mom-and-buy-some-gold-456915.html)
(Vivek Kaul is a writer. He can be reached at [email protected])
How Obama and Manmohan Singh will drive up the price of gold
Vivek Kaul
‘Miss deMaas,’ Van Veeteren decided, ‘if there’s anything I’ve learned in this job, it’s that there are more connections in the world than there are particles in the universe.’
He paused and allowed her green eyes to observe him.
‘The hard bit is finding the right ones,’ he added. – Chief Inspector Van Veeteren in Håkan Nesser’s The Mind’s Eye
I love reading police procedurals, a genre of crime fiction in which murders are investigated by police detectives. These detectives are smart but they are nowhere as smart as Agatha Christie’s Hercule Poirot or Sir Arthur Conan Doyle’s Sherlock Holmes. They look for clues and the right connections, to link them up and figure out who the murderer is.
And unlike Poirot or Holmes they take time to come to their conclusions. Often they are wrong and take time to get back on the right track. But what they don’t stop doing is thinking of connections.
Like Chief Inspector Van Veeteren, a fictional character created by Swedish writer Håkan Nesser, says above “there are more connections in the world than there are particles in the universe… The hard bit is finding the right ones.”
The murder is caught only when the right connections are made.
The same is true about gold as well. There are several connections that are responsible for the recent rapid rise in the price of the yellow metal. And these connections need to continue if the gold rally has to continue.
As I write this, gold is quoting at $1734 per ounce (1 ounce equals 31.1 grams). Gold is traded in dollar terms internationally.
It has given a return of 8.4% since the beginning of August and 5.2% since the beginning of this month in dollar terms. In rupee terms gold has done equally well and crossed an all time high of Rs 32,500 per ten grams.
So what is driving up the price of gold?
The Federal Reserve of United States (the American central bank like the Reserve Bank of India in India) is expected to announce the third round of money printing, technically referred to as quantitative easing (QE). The idea being that with more money in the economy, banks will lend, and consumers and businesses will borrow and spend that money. And this in turn will revive the slow American economy.
Ben Bernanke, the current Chairman of the Federal Reserve, has been resorting to what investment letter writer Gary Dorsch calls “open mouth operations” i.e. dropping hints that QE III is on its way, for a while now. The earlier two rounds of money printing by the Federal Reserve were referred as QE I and QE II. Hence, the expected third round is being referred to as QE III.
At its last meeting held on July 31-August 1, the Federal Open Market Committee (FOMC) led by Bernanke said in a statement “The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.” The phrase to mark here is additional accommodation which is a hint at another round of quantitative easing. Gold has rallied by more than 8% since then.
But that was more than a month back. Ben Bernanke has dropped more hints since then. In a speech titled Monetary Policy since the Onset of the Crisis made at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, on August 31, 2012, Bernanke, said: “Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Central bank governors are known not to speak in language that everybody can understand. As Alan Greenspan, the Chairman of the Federal Reserve before Bernanke took over once famously said ““If you think you understood what I was saying, you weren’t listening.”
But the phrase to mark in Bernanke’s speech is “additional policy accommodation” which is essentially a euphemism for quantitative easing or more printing of dollars by the Federal Reserve.
The question that crops up here is that FOMC in its August 1 statement more or less said the same thing. Why didn’t that statement attract much interest? And why did Bernanke’s statement at Jackson Hole get everybody excited and has led to the yellow metal rising by more than 5% since the beginning of this month.
The answer lies in what Bernanke said in a speech at the same venue two years back. “We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly,” he said.
The two statements have an uncanny similarity to them. In 2010 the phrase used was “additional monetary accommodation”. In 2012, the phrase used became “additional policy accommodation”.
Bernanke’s August 2010 statement was followed by the second round of quantitative easing or QE II as it was better known as. The Federal Reserve pumped in $600billion of new money into the economy by printing it. Drawing from this, the market is expecting that the Federal Reserve will resort to another round of money printing by the time November is here.
Any round of quantitative easing ensures that there are more dollars in the financial system than before. To protect themselves from this debasement, people buy another asset; that is, gold in this case, something which cannot be debased. During earlier days, paper money was backed by gold or silver. When governments printed more paper money than they had precious metal backing it, people simply turned up with their paper at the central bank and demanded it be converted into gold or silver. Now, whenever people see more and more of paper money, the smarter ones simply go out there and buy that gold. Also this lot of investors doesn’t wait for the QE to start. Any hint of QE is enough for them to start buying gold.
But why is the Fed just dropping hints and not doing some real QE?
The past two QEs have had the blessings of the American President Barack Obama. But what has held back Bernanke from printing money again is some direct criticism from Mitt Romney, the Republican candidate against the current President Barack Obama, for the forthcoming Presidential elections.
“I don’t think QE-2 was terribly effective. I think a QE-3 and other Fed stimulus is not going to help this economy…I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation’s needs,” Romney told Fox News on August 23.
Paul Ryan, Romney’s running mate also echoed his views when he said “Sound money… We want to pursue a sound-money strategy so that we can get back the King Dollar.”
This has held back the Federal Reserve from resorting to QE III because come November and chances are that Bernanke will be working with Romney and Obama. Romney has made clear his views on Bernanke by saying that “I would want to select someone new and someone who shared my economic views.”
So what are the connections?
So gold is rising in dollar terms primarily because the market expects Ben Bernanke to resort to another round of money printing. But at the same time it is important that Barack Obama wins the Presidential elections scheduled on November 6, 2012.
Experts following the US elections have recently started to say that the elections are too close to call. As Minaz Merchant wrote in the Times of India “Obama’s steady 3% lead over Romney has evaporated in recent opinion polls… Ironically, one big demographic slice of America’s electorate could deny Obama a second term as president: white men. Up to an extraordinary 75% of American Caucasian males, the latest opinion polls confirm, are likely to vote against Obama… the Republican ace is the white male who makes up 35% of America’s population. If three out of four white men, cutting across Democratic and Republican party lines, vote for Mitt Romney, he starts with a huge electoral advantage, locking up over 25% of the total electorate.” (You can read the complete piece here)
If gold has to continue to go up it is important that Obama wins. And for that to happen it is important that a major portion of white American men vote for Obama. While Federal Reserve is an independent body, the Chairman is appointed by the President. Also, a combative Fed which goes against the government is rarity. So if Mitt Romney wins the elections on November 6, 2012, it is unlikely that Ben Bernanke will resort to another round of money printing unless Romney changes his mind by then. And that would mean no more rallies gold.
But even all this is not enough
All the connections explained above need to come together to ensure that gold rallies in dollar terms. But gold rallying in dollar terms doesn’t necessarily mean returns in rupee terms as well. For that to happen the Indian rupee has to continue to be weak against the dollar. As I write this one dollar is worth around Rs 55.5. At the same time an ounce of gold is worth $1734. As we know one ounce is worth 31.1grams. Hence, one ounce of gold in rupee terms costs Rs96,237 (Rs 1734 x Rs 55.5). This calculation for the ease of simplicity does not take into account the costs involved in converting currencies or taxes for that matter.
If one dollar was worth Rs 60, then one ounce of gold in rupee terms would have cost around Rs 1.04 lakh. If one dollar was worth Rs 50, then one ounce of gold in rupee terms would have been Rs 86,700. So the moral of the story is that other than the price of gold in dollar terms it is also important what the dollar rupee exchange rate is.
So the ideal situation for the Indian investor to make money by investing in gold is that the price of gold in dollar terms goes up, and at the same time the rupee either continues to be at the current levels against the dollar or depreciates further, and thus spruces up the overall return.
For this to happen Manmohan Singh has to keep screwing the Indian economy and ensure that foreign investors continue to stay away. If foreign investors decide to bring dollars into India then they will have to exchange these dollars for rupees. This will increase the demand for the rupee and ensure that it apprecaits against the dollar. This will bring down the returns that Indian investors can earn on gold. As we saw earlier at Rs60to a dollar one ounce of gold is worth Rs 1.04 lakh, but at Rs 50, it is worth Rs 86,700.
One way of keeping the foreign investors away is to ensure that the fiscal deficit of the Indian government keeps increasing. And that’s precisely what Singh and his government have been doing. At the time the budget was presented in mid March, the fiscal deficit was expected to be at 5.1% of GDP. Now it is expected to cross 6%. As the Times of India recently reported “The government is slowly reconciling to the prospect of ending the year with a fiscal deficit of over 6% of gross domestic project,higher than the 5.1% it has budgeted for, due to its inability to reduce subsidies, especially on fuel.
Sources said that internally there is acknowledgement that the fiscal deficit the difference between spending and tax and non-tax revenue and disinvestment receipts would be much higher than the calculations made by Pranab Mukherjee when he presented the Budget.” (You can read the complete story here).
To conclude
So for gold to continue to rise there are several connections that need to come together. Let me summarise them here:
1. Ben Bernanke needs to keep hinting at QE till November
2. Obama needs to win the American Presidential elections in November
3. For Obama to win the white American male needs to vote for him
4. If Obama wins,Bernanke has to announce and carry out QE III
5. With all this, the rupee needs to maintain its current level against the dollar or depreciate further.
6. And above all this, Manmohan Singh needs to keep thinking of newer ways of pulling the Indian economy down
(The article originally appeared on www.firstpost.com on September 11,2012. http://www.firstpost.com/economy/how-obama-and-manmohan-will-drive-up-the-price-of-gold-450440.html)
(Vivek Kaul is a writer and can be reached at [email protected])
Why gold is not running up as fast as it can…
Vivek Kaul
Gold is on a roll. Again!
The price of the yellow metal has risen 8.5% since August 1 and is currently quoting at $1,735 per ounce (one ounce equals 31.1gram). In fact, just since August 31, the price of gold has risen by around $87, or 5.2%.
Still, the price is nowhere near how high it could go. All thanks to the US Presidential elections, as we will see here.
Today, it is widely expected that the US Federal Reserve (Fed), the American central bank, will soon carry out another round of quantitative easing (QE) — that’s the big reason for the spurt.
QE is a technical term that refers to the Fed printing dollars and pumping them into the American economy.
“Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability,” Ben Bernanke, the current Fed chairman, said in a speech titled Monetary Policy since the Onset of the Crisis at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, on August 31.
Fed chairmen are not known to speak in simple English. What Bernanke said is, therefore, being seen as Fedspeak for another round of easing.
Interestingly, in a speech he made at the same venue two years earlier, on August 27, 2010, Bernanke had said, “We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the committee (Federal Open Market Committee, or FOMC) is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.”
The two statements bear an uncanny similarity to each other. Bernanke’s August 2010 statement was followed by the second round of quantitative easing, in which the Federal Reserve pumped in $600 billion of new money into the economy.
QE2, as it came to be known as, started in November 2010.
Between August 2010 and beginning of November 2010, gold prices went up by around 9% to around $1,350 per ounce. QE2 went on till June 2011, and by then gold had touched $1,530 an ounce.
No wonder the market is now expecting another round of easing — QE3 if you please.
To be sure, the Fed has been hinting at another round of QE for a while now. At its last meeting, held on July 31 and August 1, the FOMC said in a statement, “The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.”
Mark the phrase “additional accommodation”, which is a hint at another round of easing.
Gold has rallied 8.5% since then.
But these hints haven’t been followed by any concrete action, primarily on account of the fact Mitt Romney, the Republican candidate against the current US President, Barack Obama, has been highly critical of the Fed’s quantitative easing policies.
“I don’t think QE2 was terribly effective. I think a QE3 and other Fed stimulus is not going to help this economy… I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation’s needs,” Romney told Fox News on August 23.
Paul Ryan, Romney’s running mate, echoed his views, when he said, “Sound money… We want to pursue a sound-money strategy so that we can get back the King Dollar.”
The theory behind quantitative easing is that with more money in the economy, banks and financial institutions will lend that money and businesses and consumers will borrow. But both American businesses and consumers have been shying away from borrowing. Hence, all this money floating around has found its way into stock markets around the world.
As more money enters the stock market, stock prices go up and this creates the “wealth effect”. People who invest money in the market feel richer and then they tend to spend part of the accumulated wealth. This, in turn, helps economic growth.
As Gary Dorsch, an investment newsletter writer, said in a recent column, “Historical observation reveals that the direction of the stock market has a notable influence over consumer confidence and spending levels. In particular, the top 20% of wealthiest Americans account for 40% of the spending in the US economy, so the Fed hopes that by inflating the value of the stock market, wealthier Americans would decide to spend more. It’s the Fed’s version of “trickle down” economics, otherwise known as the “wealth effect.””
That suggests the economy is likely to grow faster and hence, people aremore likely to vote for the incumbent President.
Given this, Romney has been a vocal critic of quantitative easing, knowing that another round of money printing will clearly benefit Obama.
But Bernanke is unlikely to start another round of quantitative easing before November 6, the day the Presidential elections are scheduled, because he might end up with Romney as his boss.
Currently, most opinion polls put Obama ahead in the race. But the election is still two months away, a long time in politics.
Romney has made clear his views on Bernanke by saying, “I would want to select someone new and someone who shared my economic views.”
This has held back the price of gold from rising any faster.
As such, any round of quantitative easing ensures that there are more dollars in the financial system than before. And to protect themselves from this debasement, people buy another asset — gold — something that cannot be debased.
During earlier days, paper money was backed by gold or silver. When governments printed more paper money than they had precious metal backing it, people simply turned up with their paper at the central bank and demanded it be converted into gold or silver.
Now, whenever people see more and more of paper money, the smarter ones simply go out there and buy that gold.
So, all eyes will now be on Bernanke and what he does in the days to come. From the way he has been going, there will surely be some hints towards QE3 in the next FOMC meeting, scheduled for September 12-13.
(The article originally appeared in the Daily News and Analysis on September 8,2012. http://www.dnaindia.com/money/column_why-golds-not-running-up-as-fast-as-it-can_1738192))
Vivek Kaul is a writer and can be reached at [email protected]