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Wednesday, December 23, 2009

Gold is money in extreme times, have they arrived?

It was Alan Greenspan who said that, “gold is money in extremis”. By this all understood that when times got tough, gold became money that people could trust. But what constitutes “in extremis”?

History, with hindsight, usually finds it easy to answer such a question. Event with hindsight such a precise tool, it is of no use to investors who don’t have the privilege of using it. For instance it is clear that a year before the last war, no, almost 5 years before the last World War, it was clear that the world was on the path to the war. One year before the war started the Prime Minister of Britain came back from Germany with the cry, “Peace in our time” heralding his belief that there would be no war. On the ground, opinions were divided right up until Germany marched into Poland.

This illustrates clearly that such clarification that we are in extreme times is never easy when we only have today and tomorrow to base our decisions on. That’s where we are today.

The tool that we are left with is extrapolation, defined as “calculate approximately from known values, data, etc” according to the Concise Oxford Dictionary. Put simply, it means taking the facts, attitudes and intentions and taking them forward to assess the future likelihoods. It does not include hopes and dreams, but only present realities, those that will decide the future.

So what do we see now? The Global Economic picture


Growth resumption is still being argued in the States with joblessness at frightening levels, but is edging closer. Consumer debt is still not under control nor are U.S. citizens of a mind to become savers and not borrowers. So consumer recovery is still not certain. The economy is in relative decay and has shown far less resilience than that of China. Interest rates are at such low levels that there is every incentive for the $ to fall as money is borrowed in the States, then sold to be invested in foreign countries. No matter how loud or long the Administration cries, ‘we want a strong $’it just ain’t going to happen.

In the Monetary System, we see a U.S. with the net external debt of the U.S. nearly tripled in the last year to $3,500 billion and it is projected to increase by nearly $1,000 billion every year for the next decade. Now add to that the role of the $ as the Global Reserve Currency and you have such a $ overhang that if the borrowed dollars came home as interest rates rose and pushed the $ stronger, surplus holders would be tempted to sell their $ surpluses into $ strength. Then where would the U.S. money supply stand? Overall the $ is in trouble!
With the $ being the tree trunk of the global money system, all the braches of that system will suffer its pain too, in a structural way.

Overall we see a massive shift of wealth and power to the East. In time it will subject the Western style money system to its power. As long as this is not recognized the world will be threatened by a potential collapse of the monetary system [just recall how even the Treasury department in the U.S. recognized that if they hadn’t stemmed the credit crunch as they did, they knew a collapse would have come]. Washington has no other choice but to print more dollars, let the world devalue the currency and service debt in ever cheaper greenbacks. This is a managed devaluation in the hope of avoiding a massive loss of confidence in the $.


We see in the East, China a country with a population twice the size in population of the Eurozone and U.S.A. put together. It’s growing at a double digit rate, compared to a developed West which is barely growing and facing many unknowns and fears because of the fragmentation of their economies. We see in China a synthesized approach to growth that is allowing them to build 50 cities each to hold 10 million people, sucking up world resources at an amazing rate.

It is achieving a self-sufficiency that had proved most economists very wrong. Supporting this are two factors; first the fact that the Chinese are savers not borrowers and second, they are starting from so low a disposable income level that they are considerably more resilient to economic downturns, should they come. It is building an economic empire that will overshadow the West just as Japanese goods grew from cheap transistor radios to goods that have overtaken those produced in the West [Auto industry].

Now add to that, the fact that they are controlling capital flows into China and they are refusing to let the Yuan rise. This ensures that Chinese goods will remain competitive and suck the manufacturing power out of the West. Whether you call it economic war or not, the effects are the same. After all, ‘a rose by any other name smells just as sweet’. Western economies and currencies are already carrying the wounds of this war.


In India we see rapid growth in urbanization and GDP but without the strong grip of China’s central government dictating growth. Nevertheless, such growth in a nation of 1.2 billion people who are providing cheap goods and personnel, is overwhelming Western competition to the roots of any economy.

Capital Controls

Cheap and easily borrowed money in the United States, alongside a falling $ have and are leading to flows of funds seeking better returns in emerging markets. These have and are bringing new rounds of capital controls in emerging markets to slow inflows of Capital. As each day passes the likelihood of more stringent controls spreading further comes closer. They are expected to follow any reversal of capital inflows and become Capital outflow controls. Failure to impose such controls and allowing currencies to appreciate on foreign exchanges destroys vital, difficult to establish, businesses.

So where “carry-trade” [or ‘hot’] money serves no good purpose in the economy of a country, it is slowly being made unwelcome by Capital Controls. Such capital flows have the power now, to destabilize an economy. The worst effect of it will come when such traders want to disinvest and the outward flow drains liquidity from the system and leaves the country economically littered with industries in economic distress and banks loathe to lend to them by way of rescue. Believe you me such damage is far worse than any inflationary dangers. But so many countries remain riveted to inflationary concerns that they are leaving themselves open to economic shocks that lower interest rates and adequate liquidity just will not cure.


Russia on Wednesday joined the list of countries eyeing new measures to stem currency speculation and appreciation. Moscow was careful to say it would not impose actual capital controls, which seek to regulate flows of funds into or out of an economy, but the measures they are considering would have exactly that effect, making it tougher or more expensive for money borrowed abroad to be brought into Russia.


Kazakhstan has introduced legislation allowing capital controls, but so far has not used them.


Indonesia is considering curbs on foreign holdings of short-term official debt but considers currency moves based on such flows were so far manageable.


Other Asian central banks have been intervening to cap gains in the value of their currencies, with Taiwan going so far as to ban foreign funds from investing in local time deposits.


Brazil last month announced a 2% tax on foreign investment in stocks and fixed-income securities to limit the strengthening of the Real.


If the trends we are now seeing are not drastically changed when we extrapolate the situation, we cannot see the monetary system surviving in its present state. Willingly or unwillingly we will see a huge change in economic and monetary power. There is not the political will to recognize this situation, so the likelihood of the bitter consequences of these changes rising into economic conflict on a much larger scale is growing by the day. So can one trust currencies? They are after all national obligations not real value ‘in extremis’? The future looks bleak, sad to say.

So we are in extreme times and they are getting worse by the day. Looking ahead we can see nothing among the nations large or small that is capable of stopping this.

 Is Gold a Thermometer of this?

This article is from a recent issue of the Gold Forecaster with Subscriber-only parts excluded. We will not disclose our forecasts on the gold price except to Subscribers.

Excerpts from GLOBAL WATCH | The Gold Forecaster by Julian D.W. Phillips | December  2009