Until recently, it seems that one of the main underpinnings in the strength of gold has been fears of inflation. However, inflation data in the last several months has lead to an increased focus on the possibility that deflation may be the “flation” on the horizon.
As inflation looks increasingly distant in the rear view mirror, a new idea is gaining more mainstream attention as an explanation for gold. That idea revolves around the opinion of investors that currencies are being sacrificed by governments desperate to maintain their exports. The problem with this policy approach is that as long as each country seeks to benefit by depreciating its own currency, then other countries will suffer. In short, this beggar thy neighbor policy attempts to fix one country’s problems at the expense of the others.
The US dollar can be seen as a poster child for this policy. The criticism from countries such as Japan has been that the US government has stood by – content to see the US dollar fall – in the hopes that the level of US exports would rise. Also not lost on many investors is the fact that almost 50% of the earnings for the companies in the S&P 500 stock market index come from abroad. Thus, a lower $US is supposed to do wonders for US companies.
Last month, Japan had seen enough of the Yen being used to carry the water for the global economy. The strength in the Yen has been a thorn in the side of the Japanese government for some time. According to the Japanese finance ministry, a total of $25.46 billion was spent in order to weaken the Yen. Japanese Prime Minister Naoto Kan has stated the deflation was continuing because of weak consumer demand which stemmed from a lack of consumer confidence. If this sounds familiar, it is – this is the exact message investors are hearing from policy makers in the US and Europe.
During the European PIIGS crisis earlier this year, the Swiss National Bank increased its foreign currency investments by over 132 billion Swiss Francs in the first half of this year. In the process, it lost over 14 billion Swiss Francs. The one offset was a gain in the value of its gold holdings.
The central issue is that much of the developed world is facing the same challenges and the scary part of it is that the US, Europe and Japan are content to defile their currencies – if that is what it takes. After all, all of these countries are facing enormous debt loads, massive unemployment and flat consumer demand.
China has also drawn criticism from both Japan and the US. The US House of Representatives has recently passed a bill that would impose penalties on Chinese exports to the US in order to help domestic US industries. It seems that the Chinese Yuan is one of the few things that can unite Republicans, Democrats and the Tea Party.
With challenges like these, the nations of the world should be looking at more cooperation – the way they came together during the depths of the financial crisis. It might go a lot further than trying to outdo each other in the currency devaluation game. It seems the only victor of this game will be gold.