Money and Metals

Bloomberg reports on the gold market. "Gold climbed in New York, snapping a two-day slump, as a slowing U.S. economy sent the dollar lower against other currencies, boosting the appeal of the precious metal as an alternative asset. Gold futures for December delivery rose $4.40, or 0.7 percent, to $623.50 an ounce at 12:52 p.m. on the Comex division of the New York Mercantile Exchange. The price dropped 1.9 percent in the past two days, touching $615.50 yesterday, the lowest since July 24."

"Every 1 percent move in the trade-weighted dollar has prompted a 3 percent move in gold this year, compared with a ratio of 1 percent to 1.5 percent from April 2001 to November 2004, John Reade, an analyst at UBS AG in London, said in a report today."

"'We suspect this is due to the increased interest in gold from funds and investors,' Reade said. 'This relationship indicates that should the dollar weaken as we expect, then gold's rise should outperform the dollar's fall by a considerable margin.'"

"The Financial Times looks at central bank policy. "Central banks’ near universal success in bringing down inflation over the past two decades has led many policymakers to conclude that they have pretty much solved the problem of high inflation, once and for all. Market participants have bought into this story. But have central bankers truly slain the hydra of inflation?"

"We should consider the possibility that the unprecedented pace of modern globalisation, recently emphasised by Ben Bernanke, the Federal Reserve chairman, might also have played a role. If so, what will happen if the winds of globalisation ever reverse course?"

"Why should globalisation matter for inflation? A very popular but wrong-headed view is that 'China exports deflation,' so that more rapid growth in China automatically translates into lower inflation everywhere. This is nonsense. As long as a central bank has monopoly control over its currency, as most do, it can set medium and longer term inflation trends at any level it likes. If the central bank really wants to stabilise the country’s overall inflation rate, it will respond to lower import prices by allowing an offsetting rise in the prices of domestic goods. In this sense, it would be more accurate to say that China exports inflation rather than deflation."

"Central banks have been able to establish and maintain low inflation while delivering growth results that have often outperformed expectations. Rather than face the usual historical trade-off, central banks have let citizens have their cake and eat it. No wonder central bankers have become so popular. But Precisely because globalisation has produced such a steady stream of upward surprises, there is an element of illusion to central banks’ success, as most people have only sluggishly adjusted their expectations to the faster growth trends."

"But life cannot always be this good for a central bank. If big Fed interest rate surprises are always cuts, markets will eventually catch on, ratcheting up inflationary expectations. Economists Milton Friedman and Ned Phelps elegantly illustrated this point way back in the 1960s."

"So the question is: what happens if the winds of globalisation turn? What if a combination of economic and political problems leads to a sharp slowdown in China? What if a slowdown in trend growth exacerbates the fiscal problems that most countries are already going to face as their populations age? Or, more immediately, what if there is a disorderly unwinding of the oversized US current account deficit? Having built up public expectations about their ability to deliver high growth and low inflation simultaneously, central bankers might have a hard time explaining what went wrong."

"Perhaps central banks will get lucky and not have to face any severe problems for another couple of decades but, unfortunately, that is not likely. Thus, there is some urgency in the need for central banks to take greater pains to avoid taking too much credit for upside performance."

"Already today, central banks face steeply higher oil prices combined with a pause in falling import prices from developing Asia. But the current conjuncture is just a small test compared with what might happen if globalisation hits a really large bump in the road. Then, at least in a few big countries, inflation will end up being far higher than policymakers or market participants now seem to think possible. Market convictions that inflation is forever dead will be shattered."