Price of Gold Drops in Aftermath of Mini-crash, Yen Rises

Watch out; the yen is rising.

Here’s our theory: Hundreds of billions of dollars are caught up in the ‘carry trade.’ Speculators borrow yen at preposterously low interest rates. They trade the money for other currencies – notably those of English-speaking countries – in order to place the money in higher-yielding investments. They then pocket the difference and think they are geniuses.

The game works beautifully. Nothing goes wrong. That is, until something goes wrong. Then, the speculators get spooked and begin to look for the narrow door that leads out of the trading room. In the best of cases, they exit in an orderly fashion, selling their high-yielding investments and buying back yen so they can repay their loans. Dollars, pounds, and New Zealand dollars go down. Yen and Swiss francs (another low-interest rate currency borrowed for the carry trade) go up.

You will know when the game is over when you see the yen and Swiss franc rising.

Recently, both seem to be moving up. The British pound, on the other hand, took a step down. So far, the movements are so orderly they haven’t even been noticed. But watch out…if something goes really wrong, speculators will make a mad dash for the door and many will be crushed.

Last week’s mini-crash in China scared a few speculators. U.S. stocks, for example, got hammered down below where they began the year. The stocks and bonds of the money shufflers – Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Merrill Lynch (NYSE: MER) – seem to have topped out. The swap market tells us that their own traders regard their bonds as though they were junk.

The real action may come today, tomorrow…or a year from now. But when it comes, you will be better off holding yen and Swiss francs than dollars or pounds. Sterling looks particularly risky to us – since so much of the hot money of the money shuffling trade has found its way to London.

In the meantime, we note another curious thing… gold is getting clobbered too. How could that be? Remember, there’s no magic to the yellow metal. It goes up and down like everything else. Gold is money; it represents purchasing power. The excess liquidity pumped into the world economy by the central banks, the carry traders, and the financial industry represents a kind of inflation of purchasing power, too.

And when inflation increases, so does the price of gold – typically overshooting. A collapse of the liquidity bubble, on the other hand, represents a decrease in purchasing power…a deflation. Gold will not necessarily go up when that happens; it could go down. People will need cash to pay their debts. Cash means dollars.

We don’t buy gold because we think it is going up (though we do think it is going up). We buy it because we see the financial world as much riskier than most people think. Inflation…deflation…we expect some kind of ‘flation’ as a result of all the debt and credit pushed onto the world over the last 15 years.

Remember, a correction should be equal and opposite to the deception that preceded it. This new ‘liquidity‘ – trillions of dollars worth – pretends to be real money. It is not. It has no resources…no real savings behind it. Since it is not real…when the correction comes, it will disappear – along with many of the ‘assets’ and much of the “wealth” that people today think they have. The good thing about gold is that it will still be there.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.

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