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Currency Wars
New York: October 11, 2010
By John Stephenson

In an attempt to stimulate exports and jump start their moribund economies, major central banks around the world are actively engaged in beggar-thy-neighbor policies of currency market interventions and quantitative easings. With governments tapped out and with fiscal programs ending, central banks everywhere have signaled that they are prepared to open the credit spigots to reflate their economies. And it is precisely this notion that the world may soon be awash in worthless dollars and drachmas that is powering the move into gold and other hard assets as a hedge against the falling value of paper money.

Nearly every major economy is engaged to some degree in trying to push down or at least restrain the value of their currencies. With global growth slowing, countries are desperate to keep their factories running and hope that a weaker domestic currency will spell a greater export-led recovery for their industry. The U.S., Europe and Japan are all seeking ways to pressure China to let its currency, which is widely regarded as undervalued, rise more quickly.

To give their domestic industry a much needed boost, central banks have been slashing interest rates to near zero and buying up bonds in the open market in an attempt to inject much needed cash into the financial system. Recently, the Bank of Japan (BOJ) announced that it was nudging down its key overnight lending rate to a range from 0.0% to 0.1 from the previous target of 0.1%. More importantly, the BOJ said that they would maintain this “virtual zero interest rate policy until medium- to long-term price stability is in sight.” In the U.S., central bankers at the Federal Reserve System have indicated that the huge government bond buying effort that ended in March of 2010, was likely to resume. That announcement alone set gold on its current upward trajectory.

With much higher growth rates in the emerging markets than in the developed world, investors in search of yield have shifted their money to emerging markets. But with dollars and euros flooding into smaller foreign markets such as Brazil, the currencies in these developing markets will likely experience upward pressure, which ultimately could endanger their exports. To keep the value of Brazil’s real competitive, Brazilian officials have initiated a four per cent tax on foreign fixed-income investments in an attempt to slow the flow of foreign investors into the country.

Today, investors are flocking into hard assets and bonds as markets everywhere are soaring on the prospect that interest rates will stay near zero for the foreseeable future and fiscal and monetary stimulus measures will need to continue to spur growth.

In the U.S., the Congress is deeply divided and unable to pass major legislation that would help the country to get moving again. Just when it seemed that the U.S. housing crisis couldn’t get worse it suddenly took another U-turn downward when allegations surfaced that American banks may have illegally seized hundreds of thousands of homes. And while the dust has yet to settle on this latest twist in the housing crisis, this current freezing of the mortgage market threatens to chill parts of the U.S. real estate market as buyers and sellers sit in limbo waiting for the banks to sort out the paperwork problems so the market can continue to function.

For Japan, a soaring yen has the potential to create a disaster scenario. After twenty years of sluggish economic growth and the worst demographic profile in the globe, Japanese officials are desperate for a way out of the box they are in. But a lifeline is unlikely to surface. The country is not blessed with natural resources, which has made them reliant on commodity imports at precisely the same time as a boom is occurring in the rest of Asia—forcing commodity prices higher. More expensive raw materials at the same time that this export-led nations’ currency is spiraling higher will likely cripple their economy unless the Japanese can find a way to lower the value of their currency.

Investors have reasoned that with America, Japan and Western Europe’s economic woes, the only solution forward for many of these countries will be the massive printing of paper money. This, in turn, would force the value of their currencies lower in an attempt to jump-start their economies.

And that has investors flocking to commodities and gold as they reason that the value of these real assets should be moving sharply higher in the years ahead. For many, gold is money and it is only a matter of time till gold resumes its rightful place as the currency of choice. Already it is acting as the fourth major currency of the world, after the U.S. dollar, euro and yen. For thousands of years, gold has been a currency and in a world where the value of paper money is looking more and more questionable, gold, silver and other forms of money have been soaring.

Not only is gold a hard asset whose value can’t be inflated away by greedy central bankers, it has one other key attribute—scarcity. While it is true that all the gold that has ever been mined is in existence today, gold grades have been falling consistently for more than 30 years. Globally, there are around 165,000 metric tons of gold sitting in vaults, or fabricated into bars and coins or jewelry and having a value of around $5 trillion. But when compared to the market capitalization of the world’s major stock markets of around $40 trillion and the notional value of outstanding derivatives globally, which is a staggering $800 trillion, the market for gold looks puny.

If there ever was a time to consider an investment in gold, this would certainly have to be one of those times. With governments around the world doing everything in their power to boost their competitiveness and to spur economic growth, the world is awash in paper currency, while the amount of gold globally remains static. Gold, silver and copper will continue their march higher as the great reflation of the world’s major economies continues.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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