The man with the gold ... rules

Dennis Morrison, Contributor

By some coincidence, while there has been some debate locally as to whether the Jamaican dollar should be going up or down, activity on international currency markets has been heating up in recent months. Jamaican investors who have been addicted to safe, high-return government bonds have lost such options for the time being, but do not appear to be in the currency game as yet.

In an economic environment marked by great uncertainty, international investors have, however, been turning increasingly to trading in commodity and currency markets to deploy their funds. People who invest in gold or follow gold prices would already have seen the effects of this shifting psychology. Gold prices are up over 20 per cent, so far, this year when the returns on United States (US) government bonds are pittance.

As we observe these developments, it is important to understand the economic landscape, and why commodities are now such an attractive option. A part of the explanation is as follows: to save the global financial system and ward off deflation, central banks printed trillions of dollars in 2008-2009. In the early days of the economic recovery, investors headed for the stock markets which mopped up significant sums. But as the recovery has slowed, banks and investors have been left with mounting cash because of a lack of demand for loans by consumers and businesses.

Consumers in the US, the main locomotive of global demand, are too indebted and saving more, which leaves businesses without the growth in sales to support increased investment. The result of the printing of money, euphemistically referred to as 'quantitative easing', and the weak recovery in the US and Europe is that the world financial system is awash with funds. This is being reflected in increased trading on the US$4 trillion-a day global currency market, a good barometer of economic and political uncertainty. Not surprising, the vastly expanded supply of US dollars has pushed the value of that currency down against all other major currencies - the euro, pound, and the yen.

For the US, which is struggling with an anaemic domestic market, a weaker currency could help secure export growth with which to drive economic recovery, as has been done by Germany. This would be in line with the Obama administration target of doubling US exports in the next five years. There is also the effect that a falling US dollar would have in terms of reducing the real cost of servicing the country's debts to overseas creditors. Responding to the potential threat that a weaker US dollar-stronger yen could have on its exports, Japan has been stepping up interventions in currency markets to reverse the appreciation of the yen.

The surfeit of printed money on commodity markets is also showing up in a serious way. In spite of the slowdown in economic growth in the advanced markets since the second quarter of the year, prices of the major metals used in industrial production have taken off since mid-year. Aluminium prices have gone up by over 20 per cent since June, copper by 25 per cent, zinc by almost 30 per cent, and nickel by 22 per cent. More recently, oil prices have started to rebound after softening when US and European economies lost momentum.

These price jumps are the result of the decision by investors to place funds in commodities rather than securities. They also reflect the fact that metals are priced in US dollars, and hence a fall in the US dollar pushes up these prices. In the short term, higher commodity prices are welcome news for most developing countries. For Jamaica, the picture is mixed, as higher oil prices hurt us more than most, given our almost total dependence on imported oil, and can wipe out the benefits of increases in aluminium prices to which our bauxite earnings are indexed.

As the US dollar loses ground to the euro and the pound sterling, there may also be some short-term price advantage to Jamaica's tourist industry with respect to visitors from Europe and the United Kingdom. The euro has appreciated by over 12 per cent since June and the pound by 7.5 per cent. But warm-weather destinations in the US will also gain this advantage on top of a lower air-passenger duty which the UK charges for passengers travelling to the US versus the Caribbean.

Whatever short-term benefits that might be derived from a depreciated US dollar and higher commodity prices, there are, on the other side, the dangers of volatile currency markets and trade wars that could cause enormous damage. Further printing of money, as is being contemplated to reinvigorate the US economy, ultimately carries the risk of high inflation, not in the immediate term when demand is depressed, but when the recovery picks up.

Some economists fear that the inflation threat may be in the short term while major advanced economies are still stagnating - so-called stagflation. Those listening to this school of thought may be placing their bets on gold - the man with the gold ... rules.

Dennis Morrison is an economist. Feedback may be sent to columns@gleanerjm.com

Morrison