IMF Gains Importance - Dollar Declines
The G7 meeting last weekend produced some results for a change. The statement released after the meeting said for example "In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, lessening reliance on export-led growth strategies, and actions to strengthen financial sectors" and also "We recognized the important contribution that the IMF can make to multilateral surveillance." These subtle statements caused havoc in the currency markets the following Monday. What could have happened that one of the most meaningless "Rich Boy Clubs" in the world all of a sudden became so influential that even currency traders (notoriously the most cynical lot you will find anywhere) started to pay attention? What happened was, that the International Monetary Fund had been given a new role in this world by the 7 richest countries. The IMF was given a mandate to start immediate negotiations between the countries with the largest trade imbalances. Its goal will be to secure agreements to reform economic and exchange rate policies to close trade gaps and prevent a global financial crisis. If successful, it could lead to big changes in economic policies, including an appreciation of China's renminbi. Rodrigo Rato, IMF managing director, said the IMF's analysis would be published, putting additional pressure on countries to agree, since it would not have any tools to force policy changes. All IMF members, including China, supported the new procedures. IMF members also agreed that some emerging countries should be given greater ownership and voting rights. The US, in particular, is pleased at the growing recognition that its record trade deficit is the product of global forces, not just its own government deficit, and has to be resolved in a way that sustains global growth. The result was that currency dealers sold the dollar, which broke support and lost against all major currencies.
The G7 communiqué also said "In the United States, further action is needed to boost national saving by continuing fiscal consolidation, addressing entitlement spending, and raising private saving." Raising private saving means that Americans should consume less, therefore import less from Asia, which in turn makes the Dollar less attractive as a Reserve Currency.
"Other current account surplus countries should encourage domestic consumption and investment, increase microeconomic flexibility and improve investment climates." This was clearly directed at Europe, which, if it follows this advice, would become more attractive as a destination for Asian goods and by extension the Euro would become more attractive as a Reserve currency for Asian countries. Either way one reads this communiqué, it invites speculators to sell Dollars and buy Euros and Yen. Precious metals rose as a result.
But differences remained on the responsibility for the world's trade gaps and the meaning of the IMF's new surveillance role. European Union ministers continued to insist that Europe's trade is in balance and that the issue was primarily one between the US and Asia. On the other hand, the governor of the People's Bank of China warned the IMF not to use multilateral surveillance as a mechanism to attack Chinese exchange rate policy. A senior IMF official said it would ultimately be up to member countries to make the new system work. "It is perfectly reasonable to be sceptical as to whether the members will actually allow us to do what they say they want us to do," he said. But he also said that there were encouraging signs that policymakers in all big economies were starting to realize the need to deal with imbalances even as they aired their different points of views.
Whether this new IMF role will be a success or not, it seems to me that the Dollar is entering another bear market phase and that the interest rate advantage that has supported the Dollar for the past 12 months is disappearing fast. This became even more obvious when our new Fed Chairman Ben Bernanke announced this week that the Federal Reserve might be inclined to stop raising interest rates for a while to asses the impact of the past 16 rate hikes (including the upcoming May increase). This statement sent the Dollar tumbling some more and the precious metals soaring some more. The charts above show you that both gold and silver have entered the parabolic phase already. Dramatic moves of this magnitude show extreme emotions and come usually at the end of a longer term move. Whether this marks the end or a pause in the precious metals bull market I do not know, but I hear that smarter people than I are starting to have their doubts about this price explosion in precious metals. Let me end this letter by quoting the legendary Bill Miller who routinely outperforms the S&P; 500:
"Today people want commodities, emerging market, non-US assets, and small and mid-cap stocks. Those were all cheap 5 years ago and had you bought them then you would be sitting on enormous gains. But 5 or 6 years ago, everyone wanted tech and Internet and telecom stocks, and venture capital and US mega caps. The time to buy them was in 1994 or 1995, when they were cheap. But in 1994 or"1995, people wanted banks and small and mid caps, which should have been bought in 1990, and well, you get the picture.”