Jude Wanniski
January 20, 2004


In puzzling last week on the steep drop in gold and strengthening of the dollar against the euro, we began with the statement of ECB President Jean-Claude Trichet that "brutal swings" in the euro were unwelcome. ECB Chief Economist Otmar Issing later echoed these comments. ECB council members Ernst Welteke and Lucas Papademos then said last Thursday that the comments had the desired effect, after the euro declined from a record high of $1.2899." 

Today, gold jumped almost $6 on the news the ECB has no plans to sell euros to support the dollar. At the same time, the Bank of Japan pumped yen liquidity into its system to weaken the yen against the dollar, which had the side effect of weakening the yen against the euro dramatically. Otmar Issing was quoted as saying that he did not know how to stop the dollar`s slide. 

Certainly, the Fed could stop the slide by either raising the funds rate from 1% or switching to a euro target, which would get the Fed closer to a gold target as the ECB has been keeping the euro stable against gold. As it became evident that there was no deal between Fed Chairman Alan Greenspan and the ECB when he was in Berlin last week, the market saw that there has been nothing but jawboning. If the Fed continues to pump out unwanted liquidity, either private speculators have to be jawboned into buying it in fear they will lose their shorts, or governments have to buy it and be willing to hold low-interest U.S. debt. If neither, gold will resume its advance and so will the euro. 

Last week, Bloomberg News quoted Bob Mundell, who e-mailed them after he saw the Trichet statement. We are still puzzling about it:

"'There is a change of opinion at the ECB, from benign neglect of exchange rates to the view that exchange rates are too important to be left to the vicissitudes of systemic speculation,' said Robert Mundell, a professor at Columbia University in New York and 1999 winner of the Nobel Prize for economics. Mundell... predicted the euro may peak by `early spring` before weakening to as low as $1.05 in coming months."

I am trying to track down Mundell to get his reasoning, although I do not think that he has a fix on what is going on or he would be blaming Greenspan, not speculators. In any event, it does look like gold will resume an upward march with the euro, unless the ECB is talked into easing to keep pace with the dollar. Then, only gold will go up. Jawboning does not work unless it is followed by policy change, which we will not see until the Fed governors get smarter than they are at the moment.

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