This endless currency war is set to benefit gold - The 5 Minute WrapUp by Equitymaster
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This endless currency war is set to benefit gold

Sep 9, 2011

In this issue:
» Immense scope for growth in India's consumer credit
» India may soon launch its sovereign wealth fund
» Is the dangerously high jobless rate in the Western world curable?
» Indian markets will soon be more accessible to neighbours
» ...and more!
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00:00
 
Common sense suggests that in an era of devaluing currencies and negative real interest rates, gold will continue to be a winner. But that would be an understatement, given the fact that the currency war is getting worse with every passing day. Let us elaborate a bit.

When some currencies devalue themselves, they have far-reaching ramifications for other currencies. Amidst the ongoing currency war, the Swiss franc is one currency that rivals gold as a safe haven. Though a steadily rising Swiss franc may sound like great news for its economy, ironically, it has been a concern for the Swiss National Bank (SNB), the central bank of Switzerland. An appreciating currency is a big dampener for an economy that depends significantly on exports. A testimony to this is the recent move by the SNB wherein it announced a "minimum" exchange rate target of 1.20 francs per euro. Consequently, the Swiss franc fell 7-8% to fall in line with the central bank's target. In fact, the central bank has expressed its willingness to create Swiss francs to buy "unlimited" amounts of foreign exchange.

As has been aptly pointed out by The Economist, this scenario is pretty much reminiscent of the 1930s. During that period when certain countries went off the gold standard, they gained a competitive advantage against their rivals in the form of a cheap currency. This put a lot of pressure on the other countries to abandon the gold standard as well. As result, when one country devalued its currency, the other had no option but to follow suit. Now, this forms a self-perpetuating loop of endless currency devaluation exercises. A similar episode is being played out today in the form of more and more quantitative easing (QE). In such a situation, gold is the only real currency or preserve of value that is safe from the hands of central bankers. You cannot mint excessive gold the way you can print paper money. Similarly, you cannot impose capital controls on it or fix price targets. In the absence of all these factors, there is a strong likelihood that gold will continue to rule the roost.

Do you think the currency war will take gold prices to newer highs? Share your comments with us or post your views on our Facebook page.

01:07
 Chart of the day
 
Just recently, we had mentioned about a recent study that tried to gauge the tipping point of a debt crisis, meaning the level of debt beyond which it begins to weigh down on the economy. As mentioned in that article, the tipping point for household debt is about 85% of Gross Domestic Product (GDP). Today's chart of the day shows that India's consumer debt to GDP ratio is very low compared to other Asian economies. Of course, the main reason for that is the relatively lower income level. Despite this fact, there is immense scope for growth in India's consumer credit market.

Data source: Mint Money

01:41
 
Readers may recall our story in The 5 Minute Wrapup that discussed why the RBI continued to park its funds in US Treasuries. Especially after the US government paper has fallen from grace both in terms of ratings and returns. It seems that the CEOs of India Inc have now offered RBI some interesting alternatives to diversify its holding. Drawing inspiration from China, formation of a sovereign fund which can be used as an overseas investment vehicle seems the ideal alternative. For instance, China Investment Corporation, with a corpus of over US$ 400 bn has been the critical vehicle to buy natural resources abroad for Chinese firms. According to the chief of HDFC, Mr Deepak Parekh, even if 1% of India's foreign exchange (forex) reserves (approx US$ 319 bn) are invested in such assets, it would be a good start. We could not have agreed more. At a time when finite natural resources are becoming increasingly inaccessible and expensive, the RBI cannot have a better investment. Further, the resources will not just bring good returns on India's forex fund but also long term availability of resources for India's growth.

02:15
 
Is it possible to hide the true economic health of a nation by resorting to certain cover up tactics? It certainly is, we believe. If inflation is high, it can be covered up by dropping some key constituents of the index. Likewise, if the fiscal deficit is high, one can certainly take the help of off balance sheet liabilities. But what about unemployment, can the same also be covered up? Not quite we think. Because when we talk of unemployment, we are talking about real people, in skin and flesh, trying hard to make ends meet. Thus, to get an idea of how bad the economy is really doing, it helps to go out there on the streets and watch people in action.

A leading magazine notes that things are not really looking good on this front in the developed regions of US and Europe. With the unemployment figures as they are, these regions are clearly facing the gravest crisis since The Great Depression. To make matters worse, the ones rendered jobless have a disproportionately high number of young people. This has an even more adverse impact on the overall economic costs arising out of high unemployment. Is there a solution to the problem though? There indeed is but it is a long winding road we believe. The skills that most of the unemployed people do not seem to be in sync with the post-recession era. They were good while the credit induced economic growth lasted. But if they are to have any chance of getting employed, skills that add value need to be developed. In fact, the onus lies more on the governments of these regions. However, whether an entity that is so much used to applying bandage when a surgery is required will take the desired steps remains to be seen.

02:59
 
Amidst the global economic slowdown, South Asian countries are making efforts to promote intra-regional trade. India has announced that it will cut its sensitive list by a fifth to allow greater market access to its neighbours under the South Asia free trade agreement (SAFTA). SAFTA allows a duty free access to trade among the member countries. However, each member country maintains a 'sensitive list' of items that are not offered any preferential tariff cuts. The sensitive list provides protection to domestic industries which otherwise cannot withstand competition from imported goods.

We fear that India's latest step will increase competition for domestic companies involved in the items removed from the sensitive list. It may also lead to shift of investments in those sectors from India to other countries. This is similar to the agony of vanaspati industry in India in the last decade. Unhindered import of vanaspati from Sri Lanka caused significant damages to the domestic players. Various small and medium-sized vanaspati companies in India operated at just 30% of their capacity, forcing many to shutdown.

On the other hand as per experts, India will gain most if there is no sensitive list and total tariff liberalisation is there among SAFTA member countries. In the long run which of the two issues win and whether India emerges as a beneficiary on a whole or not is something that remains to be seen.

03:48
 
The developed countries (read US, Europe and Japan) have always been renowned for their competitiveness. But as Asian economies have gradually increased their might in the economic arena, their competitiveness on a global scale has also considerably improved. For instance, according to the Global Competiveness Report (GCR) 2011, over the last five years several countries in the Asian Pacific regions, including China, Indonesia, Vietnam and Sri Lanka, have made big strides in the GCI rankings. In such a scenario, India's performance has been poor as it slipped 5 places in the rankings. This also means that the gap between India and China has now widened.

Not so surprisingly, the biggest impediment to India's success has been attributed to lack of adequate infrastructure. Further, the GCR has given the thumbs down to India due to the country's 'mediocre accomplishments' in areas which are considered to be the basic factors underpinning competitiveness. India's supply of transport, communication and energy infrastructure remain largely insufficient and ill-adapted to the needs of business. India does not fare well on the quality of public health and basic education either. Indeed, India has set for itself an ambitious goal of sustaining GDP growth above 9%. But for that to happen, some of these basic issues will have to be addressed on a priority basis.

04:30
 
In the meanwhile, Indian stock markets have been quite volatile today and were trading mostly in the red. At the time of writing, the benchmark BSE Sensex was down by 37 points (0.2%). The sectoral indices were trading mixed. IT and Metal stocks were dragging the markets down while Consumer Durables and PSU stocks were on the gaining side. Asian stock markets too were trading mixed. Taiwan (up 0.8%) and Indonesia (up 0.4%) were among the top gainers. South Korea (down 1.8%) and Japan (down 0.6%) were the maximum losers.

04:45
 Today's investing mantra
"During these seventeen years (1964-81), the size of the economy grew fivefold. The sales of the Fortune five hundred companies grew more than fivefold. Yet, during these seventeen years, the stock market went exactly nowhere." - Warren Buffett

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6 Responses to "This endless currency war is set to benefit gold"

Neel

Sep 12, 2011

Please give back links to the original articles from which the excerpts have been extracted.

Like 

Sanjay Dharamdas

Sep 9, 2011

I Would certainly agree..but even for the so called 'safe haven' investment that Gold has so often been mentioned,there will be a time where the bubble will burst..what goes up must come down.

Like (2)

bimal dugar

Sep 9, 2011

There may be temporary setback but this is the only real currency and value of it will always remain intact.as other currencies suffer with economical fluctuation we feel prices of gold are goimg high, in reality others are going downwards and this will continue

Like (2)

S JANMOHAMED

Sep 9, 2011

WITH EXCESSIVE PRINTING OF US DOLLARS WITHOUT ANY GOLD DEPOSITS AS A LIEN, FINALLY THESE DOLLARS WILL BE WORTHLESS CURRENCY WHICH WILL BRING DOWN AND EFFECT ALL CURRENCIES OF THE WORLD WHICH ARE MOSTLY PEGGED TO US DOLLARS; EFFECTING THE WORLD ECONOMY TO CHAOS AND SHAMBLES. THUS GOLD IS THE ONLY WAY TO SAFEGUARD YOUR CASH LIQUIDITY - EXPECTED TO ROCKET ITS VALUE TO EURO 2,500= BEFORE END OF THE YEAR. SO NOW GET RID OF YOUR DOLLARS AND INVEST IN GOLD. POOR OBAMA POLICY OF FURTHER FUNDS IN THE SYSTEM CREATING MORE JOBS WILL NOT WORK ON A LONG TERM!! USA IS ALREADY IN DEPRESSION!!

Like (2)

Nimish Parekh

Sep 9, 2011

yeah the report is true...Currency war shall ruin the economy and gold value will rock....Secondly States shall have to go back to Gold standards...but news such as Gadafii selling Gold in huge quantity shall impact the gold prices..

Like (2)

Debapriya Adhikari

Sep 9, 2011

This is interesting to know but I personally feel that
every nation is trying to cut down its costs...which means
the cost of importing goods by devaluing money.....this
helps in reducing the cost of goods sold in the profit and
loss account and enhances the profit...the shortest way
for any goverment to show that their economy is performing
well

Like (2)
  
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