Central Banks, Gold & the Currency Market

CENTRAL BANKS, which in essence are the arbiters of the value of money and control the liquidity of currencies, are always at odds with the foreign exchange markets, writes Miguel Perez-Santalla at BullionVault.

Central banks wish they could mandate exchange rates, and that they would maintain their stability once set. However, they cannot – not since the Bretton Woods agreement fell apart four decades ago, leaving each economy’s performance to speak to the value of a currency.

Increased free trade between countries is well known as the single most important positive action when initiating a scheme of prosperity. But as our world grows smaller through communication, the value of goods and services become that much more knowable, and the balance of payments between countries, which play a significant role of the value of a currency, are reported regularly. The study of free trade will show that it equals growth for the participants, but it also brings fluctuation of values.

So it is free markets that truly determine value. Yet, there needs to be trust and transparency for markets to function. In the news of late, in the major Western economies, we have seen what almost appears to be a wildfire of legislation and investigation targeting trade. The principal targets have been the trading rooms of the banks. For many decades the largest trading businesses in all the money markets, the banks shared their currency profits with their shareholders and employees. Then came the recession, caused in no small way by manipulation of the money markets by central banks depressing interest rates, and by government intrusion into existing banking policies.

In the case of the USA, those were the Federal Reserve and US Congress. The same Fed and Congress now sending an armada out investigating every trading action taken by a bank and extending their reach across international borders.

The catalyst for this attack on the banks trading rooms is really the failure of CDOs(Collateralized Debt Obligations) to perform as sold.  One of the primary causes of the financial crash leading to the Great Recession, CDOs were instruments created by the banks and securities firms backed primarily by mortgage securities, as well as other “stream of income” investments, which could be packaged together to create something that looked like a fixed-income bond and sold to investors.

These CDOs were later revealed to rely on subpar value instruments, and yet had received high ratings from independent agencies. Mortgages had been made during the boom under government pressure to lend to under-qualified (subprime) borrowers, so they could purchase a home under the low interest rate regime imposed by the Federal Reserve.

During this period, gold became increasingly attractive to investors as they realized which of their other assets were rated trustworthy but were not. Gold became a stand-out answer to this financial crisis. The advent of ETFs (exchange traded funds) in gold and easier access to privately owned and secured bullion due to the internet helped many people to diversify and participate in an alternative asset that is never subject to central bank or government creation or direction. It is not even possible to misrepresent the value of commodity gold, as is possible with securities such as CDOs (due to the rating agencies) or stock market equities (due to misreporting or outright malfeasance by management).

Though the CDO collapse was caused in great part by the machinations of the investment banks we must be cautious not to become overzealous in our search for justice and retribution. I am not defending the banks or their trading rooms. I am defending the principle of our freedom to trade and risk. Without risk there are no rewards. If we marginalize banking activity, and kill the ability to trade, we then diminish supply and demand for goods and services and this will hurt in the long run.

Yes, banks and trading houses took unjust actions prior to the collapse of the economy, and they contributed to the Great Recession. A multitude of other reasons also applied, however, to which the same governing parties at the Fed and Congress were themselves party. In the end we must avoid swinging the pendulum too far. Or else it may cut off our heads.