Desperate Times Call for Desperate Measures

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The Hard Assets Alliance Blog

Desperate Times Call for Desperate Measures

Once upon a time, currency debasement was used almost exclusively by emerging markets as a way to drive export-led growth. Today, there are few countries in the developed world that haven't put this tactic to use.

In an attempt to revive their ailing economies, the United States and Japan have both performed several rounds of quantitative easing (QE). The Bank of Japan outdid itself (and the Fed) last year when it unveiled an open-ended asset purchase program that will double the nation's monetary base in just two years.

The US and Japan aren't the only countries working tirelessly to bury their currencies. Australia, Canada, New Zealand, Brazil, India, and South Korea have all recently warned of weakening their respective currencies.

The race to the bottom is expected to get a lot more crowded, and this has big implications for gold. One place QE has yet to rear its ugly head is the European Union (EU), though this could soon change.

From ZIRP to NIRP: The Global Currency War Escalates

On June 5, the head of the ECB Mario Draghi announced that bank deposit rates would decline from zero to negative 0.10%starting June 11. The objective of this policy is to discourage banks from hoarding capital, by charging interest on cash held in excess of minimum reserves. At the same meeting, the central bank lowered its main financing rate from 0.25% to 0.15% and introduced a policy that rewards banks that lend money to businesses and households with lower interest rates. With Europe still mired in a sluggish recovery, these initiatives are intended to stoke inflation and ultimately consumer demand.

Although zero interest rate policies (ZIRP) are becoming increasingly commonplace, this is the first time a major central bank has embarked upon a negative interest rate policy (NIRP). The policy may be unprecedented, but it is unlikely to stimulate Europe's economy for the simple reason that the EU does not operate in a vacuum.

In today's interconnected global economy, capital is free to flow across geographic and political lines. Just because the ECB is now charging banks an overnight interest rate doesn't mean these institutions will suddenly begin issuing loans to European households and businesses.

With consumer demand still lagging across Europe, it is more likely that these financial institutions will redirect capital, abroad where it can actually generate a positive return. Should this happen, expect the ECB to follow up with additional stimulus, but don't just take my word for it.

Mario Draghi himself has expressed concern over the Euro's strength. In 2012, he vowed to "do whatever it takes to preserve the euro," and following the ECB's June 5 meeting, he proposed the following question: "Are we finished? The answer is no, we aren't finished." ECB executive board member Benoit Coeuré conveyed a different message after the June meeting, when he described quantitative easing as being "in the toolbox" though not currently needed. Coeuré's opinion could easily change should the new policies prove ineffective.

What this Race to the Bottom Means for Gold

Although the ECB has yet to implement its own large-scale asset purchase program, the introduction of NIRP and hints of additional stimulus by one of the world's most powerful central bankers signal that the global currency war is heating up. This could have profound implications for your wealth.

With the developed and emerging world both embracing currency dilution, there are no longer any traditional safe havens for investors. Owning hard assets is one of the few ways investors can preserve purchasing power in the face of these destructive policies. Gold is particularly suited for this task, due to its long history as a reliable store of value. Regular readers have heard us hum this tune before, but it is a message worth repeating, considering how skepticism of gold is growing louder even though the metal's long-term outlook continues to strengthen.

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