China, the Fed and Gold

China is cutting its Dollar holdings, just as the Fed vows to devalue the currency further...

NEARLY ALL the commentary we have heard on this question says the same, writes Julian Phillips of The Gold Forecaster.

"Yes, the prospects of a Double-Dip recession have increased but it remains unlikely that it will happen."

We feel that there may be just a hint of self-interest in these answers. The shockwaves that will reverberate should some say it is going to happen, or if the news confirmed that it had started would rattle the markets hugely. Despite the ability to disseminate news instantly, we have to wait a month before reliable figures are published to confirm one way or the other that this is or is not the case.

On the other hand a recession or depression has become a state of mind too. If consumers believe it is coming, it will come and at the moment that is the mood out there among the consumer. He is saving because he could become a victim if he hasn't cut debt and save. No doubt the sight of a neighbor being evicted stimulates thrifty habits. And that's what is coming from consumers now. They aren't spending. It's becoming a financial winter out there and we believe consumers minds are bringing on the recession again.

Surely that's bad for Gold Investment?

As we now live in a global economy national economic climates heavily impact the global scene and particularly the US national scene. Look from outside in as a foreign investor that doesn't have to invest there, what would you do? Well, China is right there and this is what they're doing:

• US Treasury data show that China has cut its holdings of Treasury debt by roughly $100 billion over the past year to $844 billion. Discreetly, the main surplus countries, China, Japan, and the UK (actually Mid-East petro-dollars) have been slowing down in the last two years. In August they bought the least amount of US debt this year;
• China is diversifying as it continues to hold down its currency, buying record amounts of Japanese, Korean, Thai, and no doubt Latin American bonds, in place of US Treasuries;
• It is also 'limit' Buying Gold in quantity through the London bullion banks, buying scrap ores or buying direct from miners such as Coeur d'Alene in Alaska;
• Excessive Dollar holdings are also going to more hard assets such as strategic reserves of oil and coal, and probably industrial metals. State entities are buying up natural gas reserves in Africa and Central Asia, or oil sands in Canada, or timber in Guyana.

There are considerably more activities by countries and institutions that are Dollar diversifying that we don't have enough room to describe here, but it all leads to an expectation of a falling Dollar. The trouble is that so many dependant currencies will try to fall with it to protect their trade relationship (watch the Yen) that the fall will not be easily apparent in exchange rates, but in the falling buying power of the Dollar. When we describe this we are not talking about a change in exchange rates but changes that will bring about structural changes in the current monetary system based on the US Dollar.

Then what?

Don't think for a moment that the US will follow the path of Japan. Deflation is not an option for the consumer driven economy of the United States. We believe that the path Mr. Bernanke has chosen for the US has to be followed all the way. Today [Friday 27 Aug] he stated that he was ready to act to defeat deflation, should it arrive.

Quantitative Easing will lead to inflation. Inflation is an acceptable alternative to deflation, because it is easier to cure inflation than deflation. But the government of the US is likely to wait until deflation is biting before they act, then the stimuli will have to be heavy as will consequential inflation. This prospect is bringing tremendous doubts about the value of Dollar and other currencies.

US monetary authorities will place US interests well ahead of any others, so don't expect a globally coordinated policy against deflation. It will be every nation for himself. The surplus nations will, as they are doing now, follow the defensive measures described above. But it may take weeks before this is accepted. So now is the time to act.

And Gold Prices? Big picture, the long-term could not look better for gold. Gold has proved capable of performing well in deflation, in uncertainty, in fear. Internationally it is liquid in all parts of the world. It is internationally acceptable cash. More than that, it is an effective counter to the devaluing of currencies through quantitative easing or currency devaluations.

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