Within the financial articles which appear day after day there are often terms we hear frequently and don’t quite understand what they mean – but we let them wash over us nonetheless.
Today we are going to briefly explore what is meant by Dollar Strength – together with its inverse Dollar Weakness, and most importantly for Bleyer’s clients, how this relates to the price of Gold. Is there a secret truth we can find deep beneath the illusion of such terms?
According to Investopedia “The two terms, weak dollar and strong dollar, are generalizations used in the foreign exchange market to describe the relative value and strength of the U.S. dollar against other currencies.
“The terms strengthening and weakening refer to the changes in the U.S. dollar over the period of time being mentioned. A strengthening dollar is one in which the U.S. dollar has increased in value compared to another currency. This means that the U.S. dollar now buys more of the other currency than it did before. A weakening U.S. dollar is the opposite as it means the U.S. dollar has fallen in value compared to the other currency - making the U.S dollar buy less of the other currency.”
The Dollar vs. Gold
Therefore, it follows that if there is a ratio between the dollar and other currencies there is also going to be a ratio between the dollar and gold:
“It is undeniably true that the price of gold is related to the value of the US dollar, so it is essential to understand how this association has come about and exactly how the dollar influences the commodities markets if you are considering making an investment in gold. Understanding how the relationship between the US dollar and the price of gold works can help you to make the most advantageous investment decisions.” (Kitco)
In addition, Kitco write such a good brief history of the ratio between Dollar Strength and Gold that I will quickly quote it here:
“It is worthwhile spending some time considering the history of the relationship between gold and the US dollar in order to understand why they still hold such a pull over each other today. The association developed from the use of gold and silver standards to set the values of currencies in the past. In these monetary systems, the value of a unit of currency was tied to the value of a specific amount of gold or silver. The US dollar was originally tied to a bimetallic standard, based on both gold and silver, but it moved to a gold standard after 1900, which it remained on until 1971. The gold stabilized the value of the currency, but it had to be abandoned whenever the currency faltered, in order to protect the gold reserves. The ties were temporarily cut during the Civil War, the First World War and the Great Depression. Once the separation was made permanent, a new kind of relationship between the currency and the commodity arose, in which both were freed to play new roles in the global economy. The US dollar became a true fiat currency, traded on foreign markets and used as a reserve currency without risking the US gold reserves, while the price of gold was freed from the restraints that had been imposed on it by financial policies designed to keep currencies under control.
Yahoo Finance take this one step further by explaining that “When the US dollar is in trouble, investors and global banks stocking their reserves tend to abandon it in favour of gold. Conversely, if the US dollar is appreciating, banks can begin to shift their reserves from gold into currency, raising the value of the dollar relative to gold” and I include here a graph from the same financial website, which illustrates this point perfectly:
But in case we think it is that simple….
Behind the illusion of dollar strength, Gold is not another currency – it is a timeless asset of an entirely different inherent value:
I’ll leave you with one more chart… the true chart in essence, of how far the “real” value of the dollar has fallen. By looking at the value of the dollar in relation to the grams of gold it can buy we can see just how much the dollar has collapsed. The financial markets are an illusion, on which the spotlight of gold shines such a clear bright light:
“Since 1999, the dollar has fallen in value from about 123 mg of gold to less than 21 mg today – a drop of more than 80%. Overall, from 1900 to 2010, the dollar fell from 1500 mg to 25 mg, losing over 98% of its purchasing power.” (Priced in Gold)
What about the effect of Interest Rates?
But, in recent weeks, the question has been raised, what about rising interest rates? First, let’s briefly explore why interest rates, both falling and rising, are so key to Gold. Interest rates affect debt and the debt of any economy is key to its success or collapse. “For example, “If debt is rising faster than GDP, then the typical business accumulates debt faster than it grows profits. On top of that, each tick down in interest rates creates additional incentive for its competitors to invest in additional production. The result is overcapacity. If you are a recent college graduate, with college loans to pay off, what can you do? Work and sell more of your labor. That is, dump labor on the bid. And we wonder what supports the value of the dollar! It is the struggles of the debtors. Every debtor is busily working to increase the quantity of every kind of good and service, which is dumped on the bid. Dumping on the bid tends to push the bid down. The result of monetary policy in a falling interest rate environment is that prices are falling too (unless fiscal policy can add costs commensurately)” (Silver Doctors).
This is the heritage upon which we stand financially now. We have just been through a ten year period of falling and even zero or negative interest rates. But, recently, they have been slowly rising, by 0.25% of a percentage, both here and in the U.S. What does this mean for the price of Gold?
“Most miss the trees for the forest. One thing that is worth noting. Although people think it is gold that goes up and down against a constant, stable dollar, it’s the other way around. This means that when people use leverage to speculate that gold is going up, they are actually betting the dollar will go down” (Silver Doctors). Gold is unique that way. So, can the Federal Reserve – or the Bank of England for that matter - really raise Interest Rates by much more? What happens if they do?
“Trump just signed a bill raising the debt ceiling limit for the next three months. It instantly added approximately $318 billion to the national debt, raising it to $20.16 trillion. And Trump wants to do away with the debt ceiling altogether. According to numbers calculated by the SRSrocco Report, that $318 billion increase in the debt will require an extra $7 billion interest payment annually. The US government spends a mind-boggling amount of money simply paying interest on the ballooning debt. In fiscal 2016, it paid out over $432 billion in interest. It is on track to hit a record high of high of $460 billion in 2017” (Schiff Gold).
Quotes like this take some research to find. But according to the SRSrocco Report, “There is no way the US Government will allow the interest rates to rise as it is already dealing with a $566 billion budget deficit for the first ten months of 2017. If interest rates raised just to a typical 5%, that would push the US interest payment up above $1 trillion. This would more than double the budget deficit to over $1.1 trillion a year. The Fed and central banks only have one way to go, and that is increasing debt levels and lower interest rates. If they do not continue with that policy, then the entire financial system comes crashing down.”
This sheds a different light on discussions about the Fed raising rates. Peter Schiff has been saying for months that the central bank is close to the end of its tightening cycle. During a recent interview on RT’s Boom Bust, Peter said the Federal Reserve will have a hard time raising rates in an environment with a weakening dollar. He said he wasn’t sure what the central bank would do in the short-run, but said in the long-term, the Fed is going to go back to a low-rate policy (Schiff Gold).
Keith Weiner of Monetary Metals explains what will happen to the dollar strength in such a situation, with a very prescient allegory: “Suppose the US Geological Survey says that “there will be an earthquake in Los Angeles, 15 on the Richter scale. Nothing taller than a dollhouse will be left standing.” You will not find any bids to buy real estate in LA. We suspect not from Santiago, Chile to Vancouver, Canada and as far eastward as the Mississippi River. Gold, on the other hand, behaves opposite. Suppose the Fed announces that it is “on the brink of insolvency, of failing to pay timely its obligations.” And, further, it adds, “the US government itself is at high risk of a failed bond auction imminently.” You would not find a lack of bids to buy gold. You would find a lack of offers to sell it.
This is because the nomenclature (and the thinking) have it exactly backwards with gold. One is not buying gold. One is selling dollars! This may seem like a semantic argument, but it is vitally important to understand the distinction.
Wiener summarises better than I could in one simply sentence regarding the illusion of so called future dollar strength: “We are not going to reiterate yet again that gold is money and the dollar is irredeemable credit. We have a different point.”