Members of the G-7 made a loophole-riddled commitment not to engage in currency wars and no doubt the G-20 will reinforce that along with talk that the world economy is improving, but there was no intention of shelving one of the most potent devaluation weapons of all: Quantitative easing (QE).
There is always a strenuous effort to make these big global summits look positive with displays of unity and common purpose. The G-7 statement was no doubt designed to smooth the way for the G-20 meeting starting Thursday as some of its members namely Russia and South Korea were voicing concerns about currency wars. It helped JPY reverse some of its declines and an upbeat summit could also see gold prices fall further.
However, the financial system has become hopelessly addicted to QE, it's become the ultimate opiate for sustaining values of equity and commodity markets, it's also a key support for gold's 12-year rally. There's good reason to believe that the grand experiment with QE still has further to run, even though there are signs that it is steadily becoming less effective.
Many politicians and policy makers still think that it's just a case of creating enough new money and consumers eventually will start spending again like they did in the pre-2007 days. In the spirit of Federal Reserve Chairman Ben Bernanke's infamous speech in 2002 about dropping money from helicopters, there is a strong possibility that central banks will merely do QE on an even grander scale should advanced economies continue to remain sluggish. And that remains the long-term bullish case for gold.
XAU/USD chart – short-term bearish, but longer-term?
The G-7 statement does suggest some effort at discipline in the ranks or at least an openness to coordination and pre-emptive discussion:
“We, the G-7 Ministers and Governors, reaffirm our long-standing commitment to market-determined exchange rates and to consult closely in regard to actions in foreign exchange markets.”
But in an excellent display of semantics:
“We reaffirm that our fiscal and monetary policies have been and will remain oriented toward meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates.”
So when using QE just don't mention that it is also designed to depress the currency to boost exports as the Japanese did recently. Leave it to the markets to figure that one out. Also, the statement is merely a reaffirmation of commitments made several years back. But currency wars have been ongoing largely because the U.S. Federal Reserve, through its monetary policy, has left other nations with the choice of an appreciating currency vs. the U.S. dollar making their exports less competitive or importing inflation if they try to maintain exchange rates.
The U.K. has been quietly pursuing a similar approach and Japan has recently jumped on the bandwagon and promises some monetary shock and awe of its own. No doubt there will be statements from the G-20 this week about avoiding currency wars, but it is unlikely that the summit will call timeout on QE by some G-7 members.
The justification for doing QE and fiscal policy adjustments is usually attributed to domestic objectives such as stimulating the economy. And that particular objective is still top priority. Fears over currency wars could see the major central banks decide to do QE in a coordinated fashion, say in response to a global stock market crash for example.
If the main central banks all went together, there's less likely to be big swings in exchange rates between the major currency pairs and they could be argued to be acting in the spirit of their commitments. The casualties will be among those not party to the concerted intervention.
XAU/JPY chart – bulls pause for breath
Recently there's been a wave of optimism that the worst of the economic malaise is ending and that sentiment has manifested itself via a strong performances in equities and corporate bonds. The fact is growth in the U.S. is still relatively weak, Europe continues to look anaemic, Japan appears no closer to a genuine sustained recovery and there are worrying signs of a China bubble.
It's probably only a matter of months before the financial markets are once again in turmoil over fears of recession brought on by a resurrection of the Eurozone crisis, U.S. political disagreements over fiscal policy or just a run of poor economic data. If policy makers remain true to form, then the response will be to do more QE.
So far the main activity being stimulated by QE is not in the real economy, but the financial one and particularly speculation. There's a serious risk that ongoing monetary stimulus will eventually go from distorting market valuations to causing deep instability in the financial system followed by another crisis.
At some point central banks will probably give up on QE, reasoning that the balance of risks outweighs positive outcomes. Until policy makers come to that conclusion, there's still a bullish case to be made for gold.