27th June 2024  - Gary Mead

Soft landing maybe

Soft landing maybe

The world has been kept on tenterhooks for months now, wondering when/if the US Federal Reserve will start cutting interest rates. Any such cuts should in theory weaken the Dollar and thus give the gold price a push higher, as the Dollar price of gold would be relatively cheaper. What the Fed, America's central bank, decides, will give leadership to other major central banks. Some of those others, such as Canada's central bank and the European Central Bank (ECB) have already cut their rates but the US and the UK - where the rate has been stuck at 5.25%, the highest for 16 years - are reluctant to do so. Most central banks target an annualized inflation rate of 2%; while inflation has fallen to 2% in the UK (May's figure), in the US consumer prices unexpectedly were unchanged in May, at 3.3% - a nasty surprise for the Fed, one that means the Fed is unlikely to start cutting rates before September this year. The UK's inflation rate (see chart) is now back on target but services' inflation remains an annualized 5.7%.

The Fed's rate-setters are understandably nervous that the inflation monster has not yet been extinguished - after all the most recent data from Australia, that for May, showed this week that the country's consumer price index rose from 3.6% in April to 4%. In the US consumer price inflation has risen by almost 22% since the start of 2020; to buy the 2020's amount of product X consumers need to be more than a fifth richer. That's the insidious effect of cumulative inflation.

Borrowing splurge

Relatively high interest rates risk creating recessions, but the US Fed is relaxed about that possibility - for now. The US is currently enjoying what the BBC's economics editor has called a "strange economic boom", with unemployment at its lowest rate for five decades; spending on manufacturing construction has more than trebled, to nearly $20 billion/month.

How is this super-spend on manufacturing being funded? Borrowing. The Federal government's annual deficit is now about 6% of the size of the economy, almost twice the historical average of 3.7%. Total US national debt is around $34 trillion and the interest bill for this debt is some $870 billion/year, more than the US spends on defense. The fiscal trajectory of the country is "unsustainable" - and that's not just my opinion but that of the Treasury, the Federal Reserve and the International Monetary Fund (IMF). The US isn't going bankrupt; it can print all the Dollars it wants.

But there is a serious risk from turning on the printing presses. The potential peril is the damage to the credibility of the US, and the concomitant erosion of the Dollar's international status. President Biden has opted for a dose of Keynesian economics, that is hoping to achieve improved economic performance by massive government spending, on energy and infrastructure, and large tax breaks for industries such as the production of semiconductors, among other things.

President Biden's rival for the White House, Donald Trump, has said he wants a weaker Dollar, with the aim of boosting American exports. A weaker Dollar would indeed make America's exports cheaper, but it also risks stoking inflation. Given we are just five months away from the Presidential election it perhaps is not surprising that the Fed is dragging its feet over interest rate cuts.

Is the Dollar about to lose its international reserve status? No. Currencies don't lose that status overnight. In the 1950s the Pound Sterling, another former international reserve currency, still comprised 55% of global foreign exchange reserves; it took 20 years for that share to drop to 45%. Today, only monetary historians remember the heyday of the Pound. The slide from international status takes decades rather than months, but, once started, proves inexorable. Right now there is no obvious fiat currency alternative to the Dollar; which is one obvious reason why the world's central banks are busily stocking up gold.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.