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Dollar up, gold down; why?

The U.S. Dollar Index closed last Friday at 84.25. For the ninth consecutive week, the Dollar Index has finished higher than the quote from the end of the previous week. This is the longest string of consecutive weekly increases since the first quarter of 1997.

The U.S. dollar reached its highest level in six years against the Japanese yen.

This is the highest the index has been over the past couple of years except for two days in May 2013.

In reaction, the price of gold fell to a multi-month low and silver dropped to its lowest levels since May 2010.

There are several reasons why the dollar is temporarily strong. The economies across Europe are proving to be weaker than the politicians were pretending, which had encouraged some investors to abandon the euro and replace it with the dollar. The military actions and economic sanctions involving the Ukraine and Russia are also putting more pressure on Europe than the United States. American politicians are still talking about the economic news in the United States being positive rather than negative as several reports (a horrible jobs report for August, mortgage applications are declining precipitously, the percentage of home sales being settled for cash is dropping sharply, a growing number of people qualifying for food stamps, the Federal Reserve’s continuing inflation of the money supply at far higher levels than it is admitting, and so forth) are indicating. This is quieting potential clamor from the public as we enter the final few weeks before elections.

However, behind the scenes, various regulatory changes are coming that are all likely to hurt American financial markets.  As they impact the value of other kinds of assets, there will be fallout for the values of gold and silver.

On Aug. 28, the CME Group, which owns the COMEX, NYMEX, GLOBEX and other commodity and financial exchanges in New York and the Chicago Board of Trade and the Chicago Mercantile Exchange in Chicago, announced a change to its Rule 575, which became effective Sept. 15.

The first paragraph of the notice explained that the changed rule “provides additional regulatory guidance on various types of prohibited disruptive order entry and trading practices which the Exchanges find to be abusive to the orderly conduct of trading or the fair execution of transactions.” In particular, the revised rule prohibits “the type of activity identified by the [Commodity Futures Trading] Commission as ‘spoofing,’ ‘quote stuffing practices,’ and the disorderly execution of transactions during the [daily] closing period.”
In announcing that such market manipulations would be banned in the future, the CME Group basically admitted that it has allowed such manipulation in the past.

On the very same day, the CME Group notified the world’s central banks that it was changing some of the discounted commission charges to conduct transactions on its exchanges. In virtually every exchange owned by the CME Group, there is no need for central banks to make transactions on them unless they are made for the purpose of manipulating markets.

On Sept. 3, a joint announcement by the Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency changed the definition of what kinds of assets U.S. banks with $250 billion or more in assets could own that would qualify as High Quality Liquid Assets. Such holdings demonstrate that a bank has the ability to survive a run on the bank in the event of a credit crisis. The compliance date for the revised regulation is Jan. 1, 2015.

The greatest change wrought by this announcement is that municipal bonds are no longer considered High Quality Liquid Assets. The reason given is that these bonds are not sufficiently liquid because they are not traded on exchanges. Instead, the large U.S. banks can hold U.S. Treasury debt, debt backed by the full faith and credit of the U.S. government, investment grade corporate bonds and stocks listed in the Russell 1000 Index.

The National Association of State Treasurers strongly opposed this change.  It pointed out that the change would reduce demand for municipal debt, resulting in issuers having to pay higher interest rates. In turn, state, county and local governments and government school districts that issue such debt would be forced to cut back on other expenses in order to cover the higher interest costs. The association warned that this regulatory change could hurt infrastructure needs such as bridge and road repairs. It also warns that there could be a surge in governmental bankruptcies.

While attention is focusing on the damage being done to the municipal bond market, I have not seen discussion on the alternative assets that large U.S. banks could acquire. Like municipal bonds, high grade corporate bonds are not traded on exchanges. Many of the stocks listed in the Russell 1000 Index are also illiquid, as there is no broker serving as a market maker to guarantee liquidity.

I suspect that the real purpose for dropping municipal bonds from allowable High Quality Liquid Assets is that the Federal Reserve will be able to get banks to absorb more Treasury debt instead.  This change, therefore, has ominous implications. If the federal government is trying to access funding from the same bankers who have been financing lower levels of government, that is a sign that the U.S. dollar is far closer to a major decline or collapse than the politicians are admitting. If the Federal Reserve is losing the ability to inflate the money supply from its previous sources, the dollar is in serious trouble.

Next, at the end of August the Governmental Accounting Standards Board closed off the public comment period for three exposure drafts. The three all involved changes in reporting by the various levels of governments in how they report unfunded pension and retiree health care benefits. The purpose of the changes is to force governments to be more transparent in disclosing the depths of their insolvency. The city of Lansing, Mich., where I work and live, has over $650 million of unfunded liabilities for city employee pensions and retiree health care benefits – equal to more than $5,000 for every man, woman and child living in the city. These unfunded liabilities are not reported directly on the city’s financial reports of assets, liabilities, revenues and expenses.

Nationwide, the present value of the unfunded liabilities at all levels of government in the United States is somewhere between $100-$200 trillion. This amount exceeds the value of all the assets around the world other than currencies. My best guess is that the final changes in accounting standards will be applicable for the 2016 fiscal years. When this happens, I expect there is going to be an enormous public clamor over how politicians let government finances get so much in the hole.

Looking at the current strength of the U.S. dollar and these three regulatory changes, what does this mean for the prices of gold and silver? I have some ideas:

1. The U.S. dollar is temporarily strong because of the weakness of other currencies. People around the world are looking for the United States to be able to magically resolve all of the world’s economic, military and political crises, as has happened numerous times in past decades.

When people realize that the United States is no longer able or willing to do so, the value of the dollar will decline to a huge degree. Trillions in U.S. dollars and U.S. Treasury debt now held outside the borders of America will be repatriated for goods and services.

2. I believe these regulatory changes are attempts to buy a little more time before a huge economic collapse hits the United States. In order to gain this time, politicians and bureaucrats are being forced to admit that markets are rigged, and that government budgets are massively misleading. This collapse will hurt everyone in the nation, but I anticipate that government workers and those receiving government benefits will be hit hardest of all.

Before the American economy crashes, I expect the prices of gold and silver to soar to many multiples of current levels.  To me, it is a question of when, not if.  We could easily see some major problems as each of these regulatory changes take effect.  Since the CME Group changed its Rule 575 as of Sept. 15, we could see the dominoes start to fall sooner rather than later.

Patrick A. Heller was the American Numismatic Association 2012 Harry Forman Numismatic Dealer of the Year Award winner. He owns Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Coin Week (http://www.coinweek.com and http://www.coininfo.com). He also writes a bi-monthly column on collectibles for “The Greater Lansing Business Monthly” (http://www.lansingbusinessmonthly.com/articles/department-columns). His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com).

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2 Responses to Dollar up, gold down; why?

  1. Aardvark says:

    This article truly presents a frightening future. I certainly agree that our illustrious politicians have spent us, and we the people have in many cases demanded it, into oblivion. While I hope this future does not come to pass one can at least take heart that such a massive collapse would go a long way towards cleaning up our balance sheet. Our public pension system is such a mess that we are spending hundreds of billions of tax payer dollars for people who no longer produce anything. People really need to start saving through private investment plans like most of us private sector employees have to now. Pension for me? Nope. I have a 401K.

  2. modrare says:

    It isn’t necessarily important which snowflake triggers the inevitable avalanche, just that conditions are right for a single snowflake to have this effect! ((And there are so many snowflakes!))

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