Gold: Is It Different This Time?
Gold: Is It Different This Time? by John Ing – Maison Placements Canada / MPC
As if the world economy isn’t fragile enough, it appears that we are on the brink of a trade and currency war, compounded by a protectionist reversal of globalisation that could sink the dollar which already has lost its traditional safe haven appeal. As the United States inflames relations with China and Japan, it risks a retaliation that could cause fearful investors to dump dollars and seek refuge in yen, euros and gold. Stock markets around the world plunged on fears of an old fashioned “tit-for-tat” trade war, evoking dark memories of the Smoot-Howley Tariff Act of 1930 that exacerbated the Great Depression, when global trade collapsed under a 40 percent duty increase. Ironically that disaster was the genesis for more liberalized trade,with America one of the chief architects. Yet politicians never seem to learn from history.
Start with trade, in 2002 President Bush slapped a 30 percent tariff on steel imports, causing the market to drop 30 percent sending the US dollar lower but only 21 months later, reversed those tariffs to avoid a trade war with Japan and Europe. Today, although the US imports four times as much steel as they export, Trump called for a trade war, declaring them “easy to win” and then imposed a global tariff on steel and aluminum imports affecting some 100 countries. Ironically,
China sends less than 2 percent of its steel to the US. Risky as well is the expected defensive reaction to America’s new found economic nationalism, in the form of a “beggar thy neighbour” stance where every country turns to protect their own national interest. The omens are bad. History shows that trade wars are bad and impossible to win.
Of concern is that this confluence of events echoes the blunders of the 1930s. And, with inflationary pressures already stalking the market, we believe the trade moves will further fan the inflationary fires, increasing a growing trade deficit. This move on tariffs has already triggered the resignation of Trump’s economic czar, Gary Cohn who thought the levies would kill jobs, blunt economic growth and further marginalize the United States. And with the firing of Tillerson, Trump’s anti-trade advisors are on the ascendance, undermining the very rules-based trading system America helped create over seventy years ago.
American Economic Hegemony Is Changing
Yet the market thinks it is different this time. At the core of this argument is a basic misunderstanding of the role of trade. There is no zero-sum equation. Currencies are the key and the supply is controlled by the cartel of central banks. In the US, the Fed controls the supply of dollars. Recently the US dollar has slipped on concerns that Trump’s budget and trade policies would add up to a weaker greenback and change in an American world order. Moreover, Trump is set to become the biggest spender since the Depression.
In the Sixties, President Johnson introduced deficit spending to finance his Great Society program as well as pay for the Vietnam War. Yet, US debt to GDP was only 30 percent then and America was a creditor nation. However, that bout of money printing caused the Great Inflation which flirted with hyperinflation until Fed Chairman Paul Volcker drastically cut back money supply, sending interest rates to double digit levels. In the Eighties, Ronald Reagan introduced the Tax Reform Act of 1986, which saw supply-siders predict tax cuts would stimulate growth. Instead inflation soared and the US dollar collapsed as foreign lenders realized Mr. Reagan was debasing the very currency they held. In 1988, the Plaza Accord was signed, which devalued the dollar to reduce America’s current account deficit. Ironically, only two years later Japan emerged even stronger, giving way to the Louvre Accord to halt a subsequent 40 percent slide in the dollar.
Gold, the classic hedge against inflation, was the best performing asset, increasing 1,500 percent in a 20-year run from $32 an ounce to over $500 an ounce. Today, what is different is that the debt burdens are much higher with debt to US GDP over 100 percent and, America’s spending is much higher. The common denominator of then and today? The persistent rise in the supply of money. It is not so different this time. Gold is set for its next bull run.
China Has Many Levers to Pull
Importantly, there appears to be a sea-change in the relationship between Washington and Beijing. Washington views China as a “strategic competitor” citing China’s exports and trade policy as threats to America’s economic future. This change has several ominous dimensions. Tariffs was America’s first volley as the White House hopes to cut the annual trade deficit by $100 billion by slapping a whopping $60 billion of tariffs on Chinese goods. China’s initial response to the salvo was levying only $3 billion of tariffs on American imports. So it begins. China also offered to loosen investment rules and purchase American semi-conductors, even after US blocked earlier moves. Yet China has many levers to pull.