US Dollar To Rain On Gold’s Parade

Summary

The USA is engaged in quantitative tightening while most other countries are still easing. This points to a stronger U.S. dollar.

Excess bank reserves held at the Fed should keep long-term rates lower for longer.

Actual Working Monetary Base AWMB should continue to rise keeping the U.S. economy expanding.

Unfortunately, the strong U.S. dollar should keep the U.S. price of gold subdued for some time.

Buying gold shares is only for patient Investors.

Think of Currencies as Commodities

Assuming nothing else changes, increasing the supply of any commodity, in this case, the U.S. dollar should result in its price falling. In the domestic market, this should result in lower short term interest rates while in the international market its exchange rate should fall. Contracting the supply of U.S dollars should have the opposite effect.

The general trend of the U.S. monetary base since Lehman was up until it peaked in August 2014. Thereafter, the contraction of the U.S. monetary base has resulted in a strengthening of the U.S. dollar, as should have been the case. Simultaneously, short-term interest rates have risen as the Fed moved pre-emptively against inflation.

(Click on image to enlarge)

The U.S. monetary base rose for six years post-Lehman and one might have expected the U.S. dollar to fall. However, it did not as changes were also taking place abroad which also had significant impacts on the U.S. exchange rate.  Other countries implemented QEs of their own to stave off the possible impact of a global financial meltdown and threats of recession.

Impact of Changes in Euroland

Looking at just the Euro area as an example of central bank actions taken post-Lehman, the following chart shows the impact on the foreign exchange price of the U.S. dollar.

In the immediate aftermath of Lehman, the Troubled Asset Relief Program (TARP) was funded by a more than doubling of the U.S. monetary base, the red line in the chart below. However, the ECB also acted rapidly to help stabilize the world financial system, the blue line. During the early months following the Lehman crisis the U.S. dollar rose, the green line. This, stemmed possibly from a massive flight to safety.

(Click on image to enlarge)

 

During 2009 the U.S. monetary base continued to rise while the ECB conducted a modest contraction. This gave rise to a decline in the U.S. dollar until the early part of 2010 when the ECB started to ease modestly while the U.S. monetary base fell modestly and the U.S. dollar strengthened.

By the start of 2011 U.S. QE was ramped up while the ECB tightened and miracle of miracles the U.S. dollar resumed its plunge. By the middle of that year, the U.S. monetary base stabilized when the Euro crisis hit. The ECB started to ease aggressively. More Euros and a constant U.S. monetary base through the end of 2012 gave rise to a moderately higher U.S. dollar.

Between mid-2012 and mid-2014 the ECB tightened while the U.S. monetary base grew substantially. This should have resulted in a falling U.S. dollar, which it did not. It must be remembered, however, that there are other moving parts in the equation such as monetary movements in the U.K., Japan, China, and others, which may explain the failure of the U.S. dollar to fall during that period.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not ...

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