Baby boomer bummer, or a golden parachute courtesy of the government?


Why gold's glittering

The upswing in gold prices may be due
to countries' efforts to keep their currencies weak.

By Justin Lahart
CNN/Money Senior Writer
September 3, 2003

NEW YORK -- Gold has been soaring lately and observers have
been reaching for reasons behind the move almost as avidly as
investors have been reaching out to get hold of the glittery stuff.

Gold is up because investors are becoming wary about inflation
and are looking for a hedge. Gold is up because the bombing
in Mumbai made heavy Indian demand even heavier. Gold is up
because China's central bank is going to start buying more of it.

But it may be that the strength in gold, which jumped $29 to
$375 an ounce over the past month, owes less to any specific
event than it does to countries around the world fighting to
keep their currencies weak. Because currencies can't weaken
against each other in the world of competitive devaluations,
they must weaken against other things. Gold, because it
shares the characteristics of both a currency and a
commodity, fits the bill nicely.

"You can sort of think of it as a tide going out," said Rhodes
Analytics head Bill Rhodes. "Gold isn't affected by the tide,
because it isn't a fiat currency. So when the value of
currencies drops, it emerges as a big rock."

Lovely image, but how does it work in the real world?

The starting point is to look at the U.S. dollar, because
if there is one major currency that deserves to be
weaker, the greenback is it. Nearly half the respondents
in Merrill Lynch's latest fund manager survey thought the
dollar was overvalued versus just 14 percent who thought
it was undervalued -- a view that most economists
heartily agree with.

But a weak greenback is not something that the world's
economies, many of which are hugely dependent on
exports to the United States for growth, want. Front and
center is Japan, which has regularly intervened in the
currency markets this year in an effort to keep the yen
from strengthening.

In a bit of finger pointing, Japanese officials say they
have to keep the yen weak because China has its
currency, the yuan, pegged to the dollar at unnaturally
low levels. The yuan peg has also angered other Asian
countries (many of which have reacted by working to
drive their currencies lower) and U.S. manufacturers --
all of them say it gives China an unfair competitive
advantage because it allows it to sell its products

"Nobody wants a strong currency, and since the U.S.
currency is fundamentally weak, foreign central banks
need to buy up dollars to keep their currency from
appreciating," said Northern Trust chief U.S. economist
Paul Kasriel.

When a central bank weakens its currency by buying
dollars, it is left with a bunch of greenbacks on its hands
that it has to do something with. The easiest place to
put them is Treasurys. China, to keep its dollar peg,
ends up doing the same basic thing. The footprint of all
this activity can be found in Federal Reserve statistics
on foreign Treasury holdings. Through June -- the last
month there are statistics available for -- foreign official
Treasury holdings at Federal Reserve banks had a face
value of $747 billion. That's nearly $130 billion more
than in the previous June -- the smoking gun of an
unprecedented amount of dollar buying.

It's easy for central banks to come up with the money
to buy dollars, of course -- they all own printing presses.
So a side effect of their dollar buying is that there's
more of their home currencies in circulation. And when
there's more of something, it tends to cheapen in value.
Gold, on the other hand, exists in only limited supply.
For investors, that makes the choice between gold and
currency easy to make: They'll take the gold.

"Since central banks aren't letting their currencies
appreciate against the dollar, that implies that all the
currencies will depreciate against gold and commodities
in general," said Kasriel.

The end result will be inflation -- much more of it, thinks
Kasriel, than the Fed and other central banks are
currently bargaining for.