Gold and the Political Theater: Is The Tail Wagging the Dog? / Commodities / Gold & Silver 2019

As theold saying goes, politics is a show business for ugly people. Fair enough, butwhat does it have to do with gold? Let’s jump right in and find out!

There Is No Trade War

Economicreports are rarely fun. But when we read the latestUS trade report, we could not help but laugh. It turns out that the USgoods and services deficit was $59.8 billion in December, up $9.5 billion, oralmost 19 percent, from $50.3 billion in November. For 2018, the goods andservices deficit was $621.0 billion, an increase of $68.8 billion or 12.5percent, from 2017. In other words, despite Trump’s “America First” policiesand trade wars, including tariffs aimed atshrinking the trade deficit, the US trade gap has widened. Actually, itsurged to a 10-year high last year, as one can see in the chart below. As ifthat was not enough, the shortfall with China hit a record peak! Isn’t thatfunny?

Chart 1:US Trade Balance from January 1992 to December 2018

Well,it’s a laugh through tears. We have two options here. The first is that Trump’sadministration is economically illiterate. As students of economics learn, atrade deficit simply reflects that a country chooses to consume more than itproduces. So, it must import the difference from the rest of the world. Atrade deal will not help here. If the Chinese buy more US goods, thebilateral trade with China will shrink. But the US total trade deficit will notdecline unless Americans reduce total demand by saving more.

Let’sreiterate to make it crystal clear. The real reason why the US has massivetrade deficit is not the foreign import barriers, but the fact that Americansare spending more than they produce. They can do that because foreigners lendthem money to finance their net purchases, and because the US dollar is aninternational reserve currency eagerlyaccepted by and sought after other countries both to finance theirinternational trade needs and to maintain their reserve positions in. So,please note another funny thing: the US households benefit as a whole fromtrade deficits. After all, they can consume more than they produce. Theyget real stuff in exchange for their greenbacks. Despite blaming China, its government actually subsidizes Americanconsumers.

But thereis also the second option, more probable. There is no trade war at all. Yes,you heard it well. It’s just a smokescreen, or a political theater. Thewhole US-China dispute is not about trade deficits, but about the dominance insupply chains. Uncle Sam does not care about its trade imbalance (after all,the tax cuts boosted consumer spending, while the increased federal deficit exacerbates the deficit of savings) – the aim oftariffs was rather to induce China to end stealing US technology. So, goldinvestors should not focus on trade deficits and the whole buzz around them – it’s just a show for the public. 

Interest Rates Are Not at ‘Neutral’

The US monetary policy is another great spectacle.Yesterday, John Williams, the New York Fed President, said that the federal funds rate is neither accommodative norcontractionary, so there is no hurry in hiking interestrates. In a speech at theEconomic Club of New York, he said:

My current estimate for r-star is 0.5 percent, sowhen you adjust for inflation that’s near 2 percent, the current federal fundsrate of 2.4 percent puts us right at neutral.

Well, wedo not know how Mr. Williams calculates the neutral rate, but he definitelydoes not use the Atlanta Fed’s estimations of a Taylor Rule. As you can see in the chart below, theprescription is much higher, indicating that the federal funds rate should bearound 4 percent to be neutral.

Chart 2: Actual federalfunds rate (blue line) and Taylor Rule’s prescription (green line) from 2000 to2019

We are ofcourse aware that there are many Taylor Rule prescriptions, but virtually allof them suggest that the Fed’s monetary policy is still accommodative, as onecan see in the table below. Despite different inputs used in calculations, allmethods indicate that the federal funds rate should be higher.

Table 1:Atlanta’s Fed Heatmap for Taylor rule for Q1 2019

So, doesWilliams not know Taylor’s rule? Is he economically illiterate? We doubt it. Whathe is saying is just a theater. The Fed does not want to raise interestrates further because of the $5.7 trillion corporate borrowing binge. This iswhat Robert Kaplan, Dallas Fed President, admitted on Tuesday:

It’s something that I’m aware of, which sort ofreinforces for me why I feel we should be taking no action for some period oftime.

The UScentral bank is simply afraid of bursting the bubbles it previously createdmaintaining the interest rates too low for too long. The cautious stance isworse for gold than aggressive hiking, as it postpones the day of reckoning. On the other hand, more dovish Fed and lowerinterest rates are supportive for the yellow metal as an alternative for the yield-bearing assets.

Implications for Gold

Theimplication for gold is clear. Politics is a theater, or show business for uglypeople, as the old saying goes. Hence, do not take what policymakers say atface value. Look at data. Our gold analyses are always data-based.

And onemore thing. People love spectacles, so the political factors may often dominatethe markets. But all shows eventually end. When the curtain falls, thefundamental factors of the precious metalsmarket should come to the fore. Don’t focus on the buzz, but look deeper. Then, your gold investments will shine.

Andremember: today the ECB holds its regularmonetary policy meeting. It is expected to loosen its stance, so we could somevolatility in the gold market. We will cover its monetary policy decisions nextweek. Stay tuned!

Thank you.

If you enjoyed the above analysis and would you like to knowmore about the gold ETFs and their impact on gold price, we invite you to readthe April MarketOverview report. If you're interested in the detailed price analysis andprice projections with targets, we invite you to sign up for our Gold & SilverTrading Alerts . If you're not ready to subscribe at this time, we inviteyou to sign up for our goldnewsletter and stay up-to-date with our latest free articles. It's freeand you can unsubscribe anytime.

Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

Disclaimer

All essays, research and information found aboverepresent analyses and opinions of Przemyslaw Radomski, CFA and SunshineProfits' associates only. As such, it may prove wrong and be a subject tochange without notice. Opinions and analyses were based on data available toauthors of respective essays at the time of writing. Although the informationprovided above is based on careful research and sources that are believed to beaccurate, Przemyslaw Radomski, CFA and his associates do not guarantee theaccuracy or thoroughness of the data or information reported. The opinionspublished above are neither an offer nor a recommendation to purchase or sell anysecurities. Mr. Radomski is not a Registered Securities Advisor. By readingPrzemyslaw Radomski's, CFA reports you fully agree that he will not be heldresponsible or liable for any decisions you make regarding any informationprovided in these reports. Investing, trading and speculation in any financialmarkets may involve high risk of loss. Przemyslaw Radomski, CFA, SunshineProfits' employees and affiliates as well as members of their families may havea short or long position in any securities, including those mentioned in any ofthe reports or essays, and may make additional purchases and/or sales of thosesecurities without notice.

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.