Gold News

Gold Whipsawed by Eurozone Deflation

The risk of a prolonged deflation in the Eurozone economy has dented Euro Gold Prices...

A BATTLE IS BREWING within the European Central Bank (ECB), writes Gary Dorsch of Global Money Trends, pitched between two opposing camps with different views of the economy.

The risk of a deflation-trap – where falling prices lead to lower wages and then falling demand, forcing prices lower again – could spell long-term danger for the Eurozone economy. Producer prices fell 0.7% in March to stand 3.1% below their level of a year ago, reinforcing expectations the ECB would cut its repo rate by 25 basis points to 1% at its meeting on May 7th.

The main driver behind the annual fall in producer prices was a 7.3% drop in energy costs. But "in the foreseeable future," warned Bank of Austria's chief Ewald Nowotny on May 5th, "the risk potential is to be seen on the side of deflation rather than inflation."

"The vicious cycle of deflation is not easy to overcome without drastic conventional and non-conventional measures, which several governments and central banks have adopted and continue to adopt," added Bank of Cyprus' Athanasios Orphanides.

So while central banks in the UK, Japan and US have already started buying-up bonds with newly-printed money to supplement near zero-percent interest rates, ECB chief Jean-Claude Trichet has resisted "quantitative easing" to date, and will lay out his thoughts at the May 7th news conference instead.

Resisting the hallucinogenic drug of QE, he's joined by the Bundesbank's Jürgen Stark and Axel Weber, who point to historical evidence that pumping vast quantities of money into an economy leads to hyper-inflation, from Germany in the 1920s to Argentina in the late 1980s.

A damaging downwards price cycle is still seen as unlikely, but there is danger for the ECB in waiting too long to pull-out all the stops, if deflation takes root.

In Spain, the Eurozone's fourth largest economy, consumer prices just fell for the first-time since records began in 1962, and the jobless rate jumped to a record 17.4%. And once the jobless rate spreads into the double-digits throughout the Eurozone, consumers could recoil, and the risk of a vicious deflationary spiral jumps.

With the threat of deflation rising, Gold Prices in the Eurozone have tumbled from a record high of €793 an ounce set in Feb. '09 to around €675 today, also falling in reaction to a strong rebound in European banking shares. Indeed, Austria's Nowotny said the "bulk of the banking and financial crisis is over." The ECB's six rate cuts since October, totaling 300-basis points, coupled with liquidity injections in the interbank market, look to have subdued financial market turmoil for now.

Still, gold traders want to see if the ECB decides to start printing money, and further expand its balance sheet through purchases of bonds or other assets. Although the risks of deflation in the Eurozone are weighing on the yellow metal, the prescription for fighting the disease – slashing interest rates to near zero-percent, and printing money to buy long-term bonds – continues to buoy gold.

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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