The year was 1985 and the global economy was only 14
years into the new monetary regime of free floating currencies (even
contrary to the hundreds of centuries littered with failures of never working
in longer terms). After abandoning the gold standard in 1971, the U.S.
endured a destructive decade of stagflation (high inflation coupled with
high unemployment).
U.S. citizens were hurting more than at anytime
since the Great Depression as an average savings account of $100,000 was
losing roughly $10,000 in purchasing power annually (10% inflation) with debt
burdens growing rapidly.
Is it a coincidence that the Federal debt, money
supply, and cost of living have all increased exponentially since the
stagflation decade? Readers can asses the correlation for
themselves:
One man, Paul Volcker – newly appointed Fed Chairman in
1979 – knew the only way to save the dollar from runaway inflation was to
curb the money supply. By doing so, the years of loose credit became tight
credit and the demand for dollars soared. There were significant defaults as
the debt that compounded over the prior decade now had tremendous interest
payments, unemployment surged and the economy’s business activity
contracted. But it had to be done…
Volcker, in office only two months, took the radical
step of switching Fed policy from targeting interest rates to targeting the
money supply. The days of “easy credit” turned into the days of “very
expensive credit.” The prime lending rate exceeded 21 percent. Unemployment
reached double digits in some months. The dollar depreciated significantly
in world foreign exchange markets. Volcker’s tough medicine led to not one,
but two, recessions before prices finally stabilized.
After hiking the Fed Funds rate to around 20%, inflation
started declining in the early 1980’s – just as Ronald Reagan was elected
President.
By 1985, the side-effects of the high interest
rates created an extremely strong dollar. The “King Dollar” era was
damaging to the U.S. economy as imports surged and exports weakened. This
further added to the national deficit and domestic business pain.
Thus the Plaza Accord was commenced. Finance
ministers from around the world came together and intervened,
cooperatively, within the foreign exchange market. The intended goal
was to weaken the U.S. dollar against their own respective
currencies – but mostly against the Japanese Yen.
A few years later, the dollar was cheaper across
the board and the Yen had appreciated by 40%. The effects it had on the
Great Japanese Bubble (1985-90) and its similarities to China today should
not go to noticed. The events of the Plaza Accord were symbolic as
global leaders came together simultaneously to weaken a currency in a
slow and controlled manner.
The Shanghai Accord: Plaza Accord Redux?
It appears that history does repeat. Fast forward
to February of 2016 and the economic system is once again
facing global financial turmoil. Following the Fed’s genius idea
to raise interest rates just months before Q1 GDP came in at a
paltry 0.05%, the worlds major economic policy-makers once again convened.
The attendees this time around included Janet
Yellen (Fed Chairwoman), Jack Lew (US Treasurer), Mario Draghi (ECB Chief),
Christine Lagarde (IMF Chief) and central bankers from Japan and China. They
joined together in Shanghai for the G-20 Summit and are now engaging in the
currency markets – but in complete secrecy and denial.
While not yet widely understood, I believe this meeting
took place in order to weaken both of the world’s largest currencies,
the US dollar and the Chinese Yuan. This is being done in a desperate attempt
to conjure economic relief as growth stalls out around the globe.
Recap: Jim Rickard’s famous book Currency Wars
stated the premise that countries will share growth with one another by
taking turns depreciating their currencies to boost exports, generate higher
import prices, and create employment. This is a more stealth
method than central bankers announcing such unprecedented measures
as Quantitative Easing (QE; money printing), Zero Interest Rate Policies
(ZIRP; keeping rates at 0%) and the newly used Negative Interest Rate Policy
(NIRP; make saving costs expensive to persuade consumers to consume
today or reach for yield in riskier assets).
This all makes sense, given the dollar strength since
mid-2014. Observe the US Dollar Index:
As the Fed started talks of hiking rates
in late 2014, the Yen and EU have engaged in their own monetary easing with
QE and Negative Rates.
The sum of government bonds worldwide that carry
negative yields was $9.9 trillion in late April, with Japan accounting for
two-thirds of the total and the rest in Europe, Fitch Ratings said on
Wednesday. Of that total on April 25, $6.8 trillion were in long-term
bonds and $3.1 trillion short-dated maturities.
Since the Chinese Yuan is basically pegged to the US
Dollar, as the Fed tightened, so did China. The stronger the dollar became,
the more market volatility has been experienced globally along with business contraction and anemic growth.
The EU and Japan had their couple years of relief from a
cheaper currency, now it is the U.S. and China’s turn – the typical Currency
War agenda.
Since the G-20 summit, the FED has been more dovish,
weakening the dollar, by reducing the amount of rate hikes “expected” during
2016, while the Bank of Japan and European Central Bank have
sounded more hawkish, strengthening their respective currencies.
The Shanghai Accord is pure speculation as it has yet to
be announced. But this author is not the only one who speculates that it indeed
exists.
As the dollar weakened following the 2008 financial
crisis, gold and silver were at record highs. Since February of 2016,
precious metals have been trending higher and higher – even after
the Feds rate hike last December. Mining equities have returned to offering
leverage of 3x the gain in the price of the metals.
When the dollar (orange line) weakens, gold (blue line)
strengthens. Vice Versa.
Ironically, central bankers have made gold logically
more preferable than their negative-yielding bonds. In a world of negative
interest rates, precious metals actually offer an attractive yield (zero),
huge value and the potential for significant capital appreciation. Central
banks trying to move currencies and manipulate markets is dangerous and
will suffer blowback as history has shown. And if the goal of the Shanghai
Accord is to weaken the dollar quietly, gold will continue to move upwards
loudly.
Gold Stock Bull Premium Members get real time access to
the GSB portfolio, our top stock picks, the monthly Contrarian Gold
Report, trade alerts, detailed guides to surviving and thriving during
crisis and much more. Click
here for instant access and start profiting with us!