JOHANNESBURG (Business Day) -- These are odd times, but when are they not? I have become irrationally fascinated recently by two seemingly unrelated things. The first is an extreme bet on gold. The second is the bizarre tendency for both Japan and China to hold their massive trade surpluses in dollars.
Both of these things tend to suggest a much higher level of fragility about the international financial system than the extraordinary recent bout of global growth would seem to suggest.
First the bet. Apparently merchant bank UBS recently noted a sudden surge in demand for gold options cashable at more than $1,000 an ounce expiring in December. Some "buyers" - read savvy hedge fund hyper gamblers - were even buying options dated late-2007 with a $2,500 strike.
These are extreme bets taken in the same way that ordinary people take lottery tickets. They cost little, but in the unlikely event that they pay off, they pay off big. But the interesting thing is not so much the chance of the bet paying off but the fact that they are being taken at all. So what is the significance of the fact of real money, rather than just the say-so of the usual gold-bug nutters, being placed on a gold price of more than $1000 an ounce?
What lies behind the bet is a huge international gamble that the dollar is about to fall out of bed rather dramatically. And the reason it would do so has very little to do with the U.S. and rather a lot to do with the attitudes of obscure people in the amazingly closed world of the Japanese and Chinese financial authorities.
The Japanese case is probably easier to understand than the Chinese. In a recent edition of the New Left Review, Taggart Murphy argues that since the Meiji restoration in Japan in 1868, the former samurai who ran the country played a "deft and high-stakes game in positioning themselves in a global financial-cum-military order revolving around the City of London". After Japan's disastrous experiment in going its own way in the Second World War, it returned to its previous subservient position but this time to the U.S., effectively swapping hegemons.
In the past 10 years China has joined Japan as a primary supporter of the dollar.
"Its official dollar reserves may even exceed the $880 billion Japan reported in May 2005. But when the vast dollar holdings of Japan's private sector banks and companies are added to that official figure, it becomes clear that Japan continues to play the central role it has for 25 years now in supporting the global value of the dollar, and by extension, U.S. hegemony."
The reason is simple.
"Japan finds itself in the position of a market player who has cornered so much of what is being traded that he cannot liquidate his position without destroying its value, and in the meantime, has to pony up more and more to support it."
But yet, as the traders' bets suggest, there are people who believe that the current confluence of forces could unwind. There was a flap earlier this year when China suggested it might move some of its holdings out of dollars.
Meanwhile, the gold price has risen sharply, fallen again, then made up most of its losses. Russian and Emirate central banks - those with the least to lose from dollar declines - are apparently supporting the gold market.
And through all this, the U.S. continues to rack up massive debts, with the U.S. federal deficit now sitting at $8.2-trillion, forcing the senate to raise the nation's debt limit four times in five years. It's all a bit nervy.
But, as U.S. legislators tend to say in their gung-ho manner, "deficits don't matter."
The answer to that is, they don't until they do.
And that is why the $1,000 gold bet is on.
