US Dollar To Rain On Gold’s Parade

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The lagging GDP performance compared to the total rise in the US Monetary base can be attributed to the failure of the commercial banks to push the money out into the real economy. Whether this is the result of fear, the changes in bank regulations or ultra-conservatism it is not known. However, the result of holding unprecedented amounts of reserves at the Fed has stymied the rate and magnitude of GDP recovery that might otherwise have been the case had the entire monetary base been allowed to pass through to the real economy.

Overall Quantitative Contraction Underway but not AWMB

The $O.645 trillion or 16% decline in the total monetary base from its peak has been quantitative tightening by the Fed, with all the ramifications of a pending recession. However, such an interpretation seems misguided as the GDP has responded only to the continued expansion of the AWMB.

The Fed does not have the control over the Funds rate that it used to have as the excess reserves the commercial banks have reduced the need for overnight funds compared to pre-Lehman. However, the Fed can now control the amount of excess reserves the commercial banks hold at the Fed by either increasing or decreasing the IOER. The former to slow down or reverse the growth of the AWMB and the latter to speed it up.

There remains almost $1.6 trillion in excess reserves for the Fed to use its new lever to speed up or slow down the growth in the AWMB.  Such an option was not available prior to Lehman.

Much Room for AWMB to Expand even as Total Monetary Base Contracts.

The excess reserves held at the Fed stand at US$1.6 trillion so there is certainly a great deal of room for both the total monetary base of US$ 3.4 trillion to decline and the AWMB of US$1.8 trillion to rise. This should provide fuel for continued expansion of the US GDP at a pace in concert with the growth in the AWMB.  Simultaneously, the contraction of the total monetary base should hold inflation in check but push the U.S. dollar higher.

Likely Outcome - Strong U.S. Dollar and Lower Rates for Longer.

Unfortunately, QT is taking place in the United States while QE is taking place elsewhere. This suggests strongly that the US dollar should strengthen relative to other currencies. While this would be negative for commodities priced in U.S. dollars, it should mean that the US bond market will attract yield-seeking international investors and momentum-following, domestic market participants.

Gold – the outlook is becoming clearer.

Unfortunately, a stronger U.S. dollar should put a lid on the U.S. dollar price of gold despite the wishes of the gold Bugs for a runaway price. According to Chairman Powell, the reduction of the Fed’s balance sheet is on autopilot. Thus it could be quite a while before there is an opportunity for the U.S. dollar gold price to rise to where the fundamentals suggest it should be.

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Gold has risen in foreign currencies, or rather they have fallen in relation to gold. This holds true for most currencies from Australia and Canada to Venezuela and Zimbabwe.

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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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