Dollarindex,BrexitdeadlineandspectacleatFortKnox

The Dow Jones ended the day yesterday with marginal gains and the futures in the Asian session are looking strong. The Dollar Index is trading around 91 levels which were last seen in April 2018. During the pandemic crisis hey days in April this year, the Dollar Index had gone up to 103.

The current optimism floating around the global markets can be traced to three things f:irstly the approval by the UK government to one vaccine for the mass immunization program, which represents a first approval of such kind by the western developed world. British PM Johnson has touted the UK “go ahead” as a global win and a ray of hope for the end of the pandemic. However, logistical challenges remain. Such heavy words are sure to have a salubrious effect on market health making people itch to take on more risk.

The other two sources of hope are the restart of the second pandemic relief package dialogue in the US and expectations that we might hear some good news on the Brexit front. A bipartisan package of USD 908 bn was put forward in the US supported by some Democrats and Republicans which signalled some break through in the current impasse. On the Brexit front as any deal has to be approved by the European parliament before the transition period ends on Dec 31, negotiators from both sides have to come to conclusion quickly if they don’t want to ruin their Christmas holidays. This expectation can be sobered if any party takes a line that they don’t want to rush into an unsatisfactory deal just to meet the deadline.

Now we will carry on the discussion from yesterday on what uncontrolled money printing can lead to and how the current situation can be seen with the historical lens of the Bretton Woods agreement. Under the BW system any party which is holding foreign currency reserves could have demanded the equivalent gold from the country whose currency reserves it was holding. This would have resulted in depletion of gold reserves of the countries which were running a perennial trade deficit. When the system came into place, the currency values against each other and against gold were fixed (mostly). The US Dollar evolved into the trade currency of the world with an implicit (or explicit) promise that dollars will be converted into gold.

James Rickards, in his book The Currency Wars, takes his readers through a thought experiment. He asks his readers to imagine what will happen in case a country, lets say China, tries to redeem USD 100 bn of US Treasury notes (a small part of their total reserves). Gold is currently at 1835$/oz, so USD 100 bn means 1540 metric tonnes of gold. With US current gold reserves at 8130 metric tonnes, this gold transfer would be close to 20% of its total reserves. Rickards asks us to imagine not just the economic but the social and political implication of the spectacle when the Chinese naval vessels arrive to take delivery of this gold as it moves out of the safety of Fort Knox and gets loaded into the ships to sail east. Readers would do well to note that the agreed BW parity of gold to USD was 35$/oz (1835$/oz is the current price!). We will return to this discussion on gold again in future notes.

Domestically we will have the MPC tomorrow. The rupee is trading at 73.30 currently and 10 year benchmark bond trades at 5.91.