Summits, Trade War, Gold (Jim Willie CB)

Created by : Francis Goodwin View profile

Few see how the trade war will affect gold yet. They will soon enough.

Feb. 23, 2007 -- Numerous international events took place within the last month. The Economic Summit was held in Davos Switzerland. It convened a large collection of world renown economists, corporate chieftains, and some financial market kingpins. The G8 Meeting of finance ministers was held in Germany. Back home, USFed Chairman Bernanke issued a grave warning to the US Congress on the shattered US financial balance sheets. My commentary on money supply explosion comes next. Lastly, the Chinese trade disputes have taken a big step toward outright trade war and protectionism. Few see how the trade war will affect gold yet. They will soon enough. Restricted trade flow always results in higher prices. It is always accompanied by a scramble for resources in today's context. This trade war will include a massive bidding war and staggering battles to build stockpiles of all critical commodities.

See the Hat Trick Letter special report entitled "Economic Summits & China" for a deeper analysis and discussion.

The three greatest mega forces behind the gold bull in the next couple years will be:

the housing debacle, which will infect the banking sector like a grand contagion

endless military war instigated by the US, as it desperately secures energy supply

trade war with China, whose expansion was sponsored by US firms, costing US jobs

THE UNHEEDED DAVOS WARNING

The Davos Summit provided an opportunity for economists to mingle with central bankers, and frankly to hear an earful of dire warnings, most of which will go in one ear and out the other. This was the annual meeting of the World Economic Forum. The old guard of Europe accentuated the impending risk to global financial markets, the inherent risk to currencys, and increasingly likely financial crises sure to reach global proportions. With Secy of Inflation Greenspan no longer on the scene at the helm, the duty to explain the current situation has fallen on the German kingpin Max Weber. Unlike Greenspan, who relied on justification of inflation and obfuscation to keep a cloud from full open discovery of his actual devices, Weber is reality based from the old reliable German roots. He speaks in plain language without a foot standing in any punch bowl.

European Central Bank council member Axel Weber attempted to sound the alarm. Weber cited the price structure in particular, and focused upon risk. He urged the investor community not to expect central banks to bail them out in the event of what he described as a potential 'abrupt' fall in financial markets. He spoke of the danger of a 'rush to the exit' if investors wait too long. Stocks and bonds do not properly price risk in financial assets. Of course one central bank would provide an avalanche of liquidity in the event of a market crisis, that being the U.S. Federal Reserve. When they do, gold will rejoice, and the USDollar will groan in pain.

Weber said the following:

"If you misprice risk, don't come looking to us for liquidity assistance. The longer this goes on and the more risky positions are built up over time, the more luck you need... It is time for financial market to move back to more adequate risk pricing and maybe forego a deal even if it looks tempting... Global liquidity will dry up and when that point comes some of this underpricing of risk will normalize. If there is much less liquidity around, people will not go into such high risk engagements and will unwind them."

Weber cited a potential catalyst to disturb the financial markets, the Bank of Japan interest rate hikes. They had widely expected to raise their benchmark borrowing costs from the current 0.25 percent gradually until it reaches 1.0 percent in the first quarter of 2008. This week the BOJ did just that, hike to 0.50 percent, but they carefully refrained from offering any forward guidance toward additional rate hikes. So far the impact has been muted. The Japanese yen currency has even risen, evidence of firm controls in place, for which one might credit Goldman Sachs. Compare thiirwith the US Federal Reserve 5.25 percent, the English 5.25 percent, and the Euro Central Bank 3.5 percent official rate. Existing carry trades lie at great risk. The higher BOJ borrowing cost hurts that trade, and higher rates will encourage a runup in the Japanese yen currency, for a second blow to that trade. Carry trade participants borrow cheap Japanese money, which just rose in cost. They carry a yen currency risk, which just move in the wrong direction. They invest in USTreasury Bonds, which are at risk from higher yields and a weaker USDollar. For some unexplained reason, probably toeing the line, Weber expects an orderly adjustment in risk assessment, with a denial of systemic threats to financial stability, deemed to be a different issue.

Recent economic data inside Japan has been mixed, some areas of strength, some ongoing softness in prices. Pressure abounds wherein Tokyo politicians and powerful ministries have exerted influence for the absurdly low rates to continue. Current indications are for Japan to do nothing for as long as possible. Politicians have taken control. Nevertheless, the risk remains for a BOJ rate hike and colossal disruption to what is estimated as between $1 Trillion and $3 Trillion in global carry trade volume.

A quick glance at the comatose VIX and VNX verifies the absent price assigned to risk in the past several months. They are at 10-year lows, reflecting almost zero risk within price structures. Some label it the "Paulson Put" as though the "Greenspan Put" has witnessed a handoff. As Secy of Treasury, Paulson's other job is to maintain the stock bull market, ensure purchasing power to the citizenry, and along the way continue to line Wall Street pockets with fantastic profits. He has done a riproaring great job. One must ask about the moral hazard, which begs the questions "Do markets seek trouble in their managed upward paths?" and "Do economic displacements perpetuate to cause different worse problems?" and "Does structural political damage result when the next crises occur?"

Other measures signaling dangerous low assessed risk are the tiny spreads in the credit market, covered in more detail in the report. When distress returns, control is lost, and things unravel, the solution is always the same: print more money, flood the system, rescue the aristocratic positions. Gold shines in such a climate, as the meter on money.