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US ponders market manipulation

Barry Riley

16 Oct 2006
Markets have been moving in directions favourable to the Bush regime

Conspiracy theories have become the normal tittle-tattle of the financial markets. But ahead of the US mid-term elections on November 7, the blogging rants and radio phone-in hysteria have reached a pitch of intensity.

Are the commodities and securities markets being manipulated? Pre-election paralysis on the part of the US Federal Reserve is not unusual. Yet you do not require a suspicious mind to wonder whether smoothing and intervention may be happening on a bigger scale than normal.

President George Bush and the Republican Party are under pressure. The US army’s body count in Iraq is reaching unacceptable levels, let alone the death toll of locals. At home there are fears the country is heading for a serious recession. If the Republicans lose control of Congress, let alone the Senate, the lame duck tail-end of Bush’s second term could be calamitous.

The long-run economic problems are nothing new. Although growth has been excellent, inflation has been running well above target and with the balance of payments deficit being so large, the dollar is in continual danger of tanking. Personal savings are nil and the US is, in effect, being financially supported by China.

Until the summer, the trends appeared ominous. The Fed was raising short rates and inflation was climbing. The price of crude oil stopped short of $80 a barrel. Sales of new homes were dropping off a cliff.

Then, as if by magic, everything changed. The oil price went into reverse, tumbling to under $60 with favourable implications for the Consumer Price Index measure of inflation – although not for the core rate, excluding energy. Similarly, the gold bullion price – an indicator of the potential fragility of the dollar exchange rate – has crashed from its early summer high. The Dow Jones Average two weeks ago advanced to a high, at last beating the bubble top in January 2000.

However, the housing market poses perhaps the biggest threat. On some measures, US residential property inflation has turned negative on a year-on-year basis. The bubble is bursting.

It is hard to see how the American government could manipulate home values. And yet long treasury bond yields have been falling for weeks. This is significant because the 30-year fixed mortgage rate has tumbled 50 basis points since touching a peak of 6.8% in July. Mortgage refinancing, which can revitalise the spending power of US consumers, has begun to pick up in volume. Confident consumers are more likely to vote for the party in power.

However, the pattern is curious. Most markets have been moving in directions favourable to the Bush regime. Perhaps bonds and commodities have been anticipating a recession. But then why has the equity market climbed?

Conspiracy theories have abounded since Hank Paulson, boss of Goldman Sachs, was nominated in May to become treasury secretary. He had no political qualifications but a powerful reputation as a market fixer.

Was he brought in to shore up the financial and commodities markets ahead of the poll? Goldman Sachs has enormous market power: soon after Paulson’s transfer to Washington, it achieved annual records for revenues and earnings.

It is big in commodities. Strangely, in August, it cut the weighting of lead-free petrol in its influential GSCI commodities index. Since June, the weighting has been rolled back from 8.7% to 2.3%. Perhaps this was related to questions of market liquidity.

Analysts argued, however, that this reallocation triggered a sale and a sharp price reduction, as index trackers – running $60bn in commodity funds – cut their exposures to the new level.

Other cynical observers ask whether the US has been manipulating its strategic oil reserves stored underground in Louisiana. It ceased to top them up last April but there has been no attempt to dump crude on the markets.

The gold bullion price is controversial. Why has it slumped when global economic growth remains strong and inflation is running above target in Europe as well as the US? Gold bugs are seizing on the public admission this month by Bundesbank president Axel Weber that, although his institution was not a seller of gold, he had been asked by central banks to release reserves through swap deals – presumably so that they can sell borrowed gold and push the price down further.

The Fed, acting on behalf of the US treasury, is regarded as the prime suspect. After all, European central banks are not keen sellers of bullion: they fell more than 100 tonnes short of their 500 tonnes annual selling limit under the Washington Agreement, in the year ended September.

Intervention by governments in markets is not unusual. A “plunge protection team” of top officials has been used occasionally by the US authorities to stabilise securities markets. Governments regard it as normal to manage currencies, including gold, in that category. The US treasury has an Exchange Stabilisation Fund, the activities of which are kept under wraps. It would be irregular, though, if such techniques were to be used to pursue political objectives.

The temptation to put two and two together and make five should be resisted, however. Financial markets often behave abnormally when confronted with an uncertain political outcome. The Bush government may have been drawing on legitimate political favours, such as from the Saudis and possibly the Chinese.

Post-election responses by the markets may tell us something. If the Republicans perform well but markets tumble, we will draw conclusions about intervention.

Comment from Financial News Online US

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