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What Treasury Bonds Say About Gold

How the latest TIC money-flow report helps explain the strength in US Gold Prices...

EACH MONTH, the US Treasury publishes its International Capital account (the TIC report) which foreign currency traders and bond dealers use to gauge the flows of money from around the world into and out of the US capital markets, writes Gary Dorsch of Global Money Trends.

The demand for a nation's bonds and stocks, combined with international trade flows for goods and services – plus behind the scenes intervention by central banks – all act in concert to influence the foreign exchange market which handles $4 trillion per day.

The release of the TIC report often sparks a flurry of trading activity in the foreign exchange market, due to speculators seeking to earn a fast profit. However, the initial knee-jerk reaction to the news headlines can be very misleading, and often isn't long-lasting.

For instance, the US Dollar Index, measured against a basket of six-currencies, defied conventional logic in February by climbing 2.7% higher, even in the face of a net outflow of $91 billion on the TIC account.

Why? Because large off-shore traders are also influencing exchange rates, and their betting patterns are difficult to detect. The finance ministers of the "Group-of-20" (G20) leading industrialized nations recognize the growing threat to their control over the currency markets that this poses, and are calling for increased regulation of hedge-funds and shadow-bankers, insisting on full disclosure of their locations and other information to assess the risks they pose to the policies and manipulations of the major central banks.

The United States has become dangerously dependent upon the whims of foreign investors, needed to help finance its $2 trillion budget deficit this year and prevent a surge in long-term interest rates which would otherwise deal a devastating blow to the US economy.

If bond or currency traders detect that big investors in US government bonds – such as China, Japan, OPEC, Russia, and Brazil – have ceased to buy US Treasury debt, or worse yet, are becoming net sellers, it could spark a sharp slide in US Treasury notes, sending yields sharply higher and igniting free-fall in the US Dollar.

Last week, the US Treasury tried to reassure bond and currency traders that foreign investors haven't abandoned the American debt markets, despite the avalanche of new debt that is swamping the market. The US Treasury claims that China and Japan were net buyers of a combined $48.5 billion of Treasuries in March, and that Moscow was a net buyer of $8.3 billion. Yet the reliability and accuracy of the TIC report should be viewed with a grain of salt and a healthy dose of suspicion.

Perhaps the figures were conjured-up under the guise of "mark-to-make-believe" accounting...?

Either way, President Barack Obama's stimulus program could boomerang and have a destabilizing effect on the US economy if interest rates shoot higher. No one is asking who will purchase $1 trillion of US Treasuries to be issued and sold between now and September. Once that colossal amount of paper is digested, who will then purchase another $5 trillion of Treasury paper over the next four years, as the US government plunges deeper towards insolvency?

The Federal Reserve would be forced to print (monetize) vast quantities of US dollars to pay the principal and interest on the national debt that is not covered by tax revenue.

The US Dollar's surprising strength since last July was largely attributed to "de-leveraging" and "risk-aversion" – both references to the unwinding of "carry trades" in the foreign exchange market.

There, large investors would borrow in cheap currencies (such as the Yen and Dollar) to invest in better-paying currencies (such as the New Zealand Dollar). Thus, as famed hedge-fund trader George Soros remarked on April 6th, "The US Dollar is not strong because people want to hold the Dollar, but it's strong because people have debt in Dollars."

The enormous fortunes of Wall Street's aristocracy were built-up on the leveraging of debt, including "carry-trades" in order to buy exotic securities built around sub-prime mortgages, and other instruments of financial speculation. But when the global commodity and stock markets began to meltdown following the collapse of Lehman Brothers, carry-traders began massive de-leveraging – the selling of risky assets and buying back US Dollars and Japanese Yen – to pay-down margin loans.

There was also a stunning contraction in the US trade deficit as the economy slowed and went into reverse, narrowing from $62.5 billion in August to $26 billion this February, its lowest level in nine years, bolstering the greenback. The US current account deficit, which had increased for five straight years, fell to $673 billion in 2008 from $731 billion in 2007. The deficit equaled 4.7% of the overall US economy last year, down from 5.3% in 2007.

But the US Dollar's "risk-aversion" rally came to an abrupt end on March 18th, when the Federal Reserve shocked the markets by announcing that it would unleash its nuclear weapon – "Quantitative Easing" – by printing $1.1 trillion US Dollars off its electronic printing press to monetize US Treasury notes and mortgage-backed securities.

This quantitative easing is an all-out effort to prevent a deflationary spiral in the US economy, which in turn could lead to widespread defaults on debt and bankruptcies. By pumping vast quantities of US Dollars into the global money markets – easily outstripping the money printing operations in England, the Eurozone, Japan and Switzerland – the Fed has headed off the prospect of deflation. But instead, the Fed has reawakened the "Commodity Super Cycle"...led by the kingpin crude-oil market.

Feeding-off a weaker Dollar, and ultra-low interest rates worldwide, oil just climbed back above $60 per barrel and more, up from as low as $35 in January.

The Fed has now pumped $1 trillion into the banking system since July '08, increasing the monetary base of the United States to a record $1.87 trillion while pegging the fed funds rate near zero-percent.

Super-easy money, beloved of Fed chief Ben "Bubbles" Bernanke, US Treasury chief Tim "Turbo-tax" Geithner, corrupt Washington politicians and Wall Street oligarchs alike, is a traditional recipe for making asset bubbles. And while the rapid expansion of the US-monetary base is buoying the Gold Price above $900 an ounce, other G-20 central banks are also letting the inflation-genie out of its bottle, providing the yellow metal with a huge advantage over government toilet paper.

"Our actions have succeeded in pulling the financial markets and the economy from the edge of the abyss, beating back deflationary pressures, and set the stage for a recovery," declared Dallas Fed chief Richard Fisher on April 15th. Fisher argues the US economy's low capacity utilization rate, near 69%, will keep inflationary pressures under wraps.

"It is doubtful that inflation will raise its ugly head until employment picks-up and capacity utilization tightens," he believes.

But higher inflation down the road means the Fed must, at some point, break its addiction to easy money and dismantle the Quantitative Easing framework it's put in place, flooding the money markets with hundreds of billions of Dollars.

"Nobody I know on the [Fed policy committee] wants to maintain our current posture for any longer and to any greater degree than is minimally necessary to restore the efficacy of the credit markets and buttress economic recovery without inflationary consequences," Fisher said. Because the FOMC "can ill afford to be perceived as monetizing that debt, lest we come to be viewed as an agent of inflation, rather than an independent guardian against future inflation," the Fed's propaganda artist went on.

Typically however, Fed officials continue to keep the printing presses rolling at full-speed long after inflation has already reared its ugly head and an inflationary psychology has become deeply embedded within the minds of commodity traders and the public at large.

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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