Part Two of the Global Monetary Crisis

Phase II marks public recognition that there is
indeed a crisis. Then the system actually begins to break down...

THE US DOLLAR crossed the $1.48 line to the Euro this week, heading for $1.50 after the US markets closed for Thanksgiving.

   The greenback then bounced after the London market opened on Friday, but should we do expect a bounce to last long? Not as the secondary phase of the global monetary crisis comes into play.

  
What crisis, you may well ask? It is the sub-prime crisis...credit crunch...and Dollar crisis all rolled into one. And it is spreading into the global economy, as well as inside the United States.

  
The onset of this crisis brought smoothing words to calm global markets, but to no avail. The second phase is when there is public recognition that there is indeed a crisis, followed by everyone involved coming together to give the impression that the crisis is being resolved.

  
This phase precedes watching the system begin to actually break down, despite the superficial efforts of global monetary authorities to prevent it.

  
Are we there yet? The global credit crisis hit Asia like a tsunami hits the shore for the first time this week, triggering a massive run for cover as investors fled their holdings of dubious commercial and corporate fixed interest investments.

  
Yields on three-month deposits in China and Korea plummeted almost 1% over this week, driven by hasty withdrawals from money market funds and credit derivatives flooding into government debt. The crisis has flowed from the US and is beginning to paralyze the whole global economy.

  
Korean and Chinese three-month yields have fallen from 4% to 1% in a matter of days. Asian investors appear to be opting for deposit accounts with government guarantees. But are investors truly under the belief that Asian banks have yet to announce horrendous losses from the US mortgage disaster?

  
The Hang Seng index in Hong Kong fell 4.15%, while Tokyo's Nikkei tumbled to its lowest level in a year-and-a-half. This sudden "flight from risk" has led to a sudden unwinding of the $1,200 billion Yen "carry trade" as hedge funds and Japanese investors close risky positions. The Yen has roared back from ¥122 to ¥107.90 against the Dollar since early October, crushing the gains of those slowest to move out of these positions.

  
The capital tsunami next flowed onto Europe where, the iTraxx index – measuring default insurance on bank and insurance bonds – hit an all-time high of 63.5. Bund-swap-spreads also went through the roof. Spreads on low-grade European bonds have been jumping 10 basis points per day for the last week.

  
Then suddenly, in a startling move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads."

  
Abbey National, a major UK mortgage lender, on Friday cancelled its sale of covered bonds, the third company to withdraw an issue this week. Then there was an alarming spike in the "Ted spread" between commercial interbank-lending rates and US Treasury yields, now near 150 basis points.

  
The London Interbank Offered Rate (Libor) is now at a premium to T-bills not seen since the dark days of Oct. 1987.

  
And we are also advised to expect problems from this crisis to last for two or more years, as the real tragedy for the sub-prime mortgage holders in the US unfolds. But now it is a Dollar and US banking problem threatening to engulf the entire global economy.

  
Authorities overseeing this crisis are blithely raising their hands, saying markets must find their own level. This is complete inaction, but is it a result of their powerlessness in the face of these massive waves of capital?

  
The finger pointing at the suppressed Chinese Yuan is ducking the issue. Simply stating that the Dollar is not a problem of the US is confirmation that the US will not do anything about its weakness. So why should the Fed? It is to their advantage to see a weaker Dollar given the huge $9 trillion in US government debt.

  
We don't expect the United States to do anything about the weak Dollar whether now or in the future. From the perspective of the US, the Dollar is bedrock, so the problem lies with those dealing with the US economy.

  
Not only is it in the interests of the US to see a weak Dollar, there is little that they can could do to rectify the Dollar's performance, not until foreigners take action against it. But they are in a strong position to do so.

  
So the ball is in therefore in the foreign debt-owners' court. Until China and Asia are far less dependent on the US, it is not in their interest to see a Dollar collapse or even to see the buying power of the Dollar diminish. It is, however, in their interests to use the Dollar to buy up all the assets they can across the globe until they are spent.

  
That would see a major rise in the power of China in the global economy. That is already well on the way and continuing at a frantic pace.

  
There is little incentive to sell Dollars to lower their presence in national reserves, because this would lower the value of the remaining Dollars still in the vault. Consequently, we all have to live with a falling Dollar, plus the rising global inflation that results, picking up speed as the velocity of the fall of the Dollar is diminished through market intervention, breeding more inflation still everywhere else.

  
The result has to be paper-currency managers across the world accepting that, to keep their economies healthy, they must accept inflation or see their international competitiveness reduce their own national growth.

  
In such a climate there is absolutely nothing to stop the Gold Price in all currencies from trending higher and higher.

  
The trigger to this rise is the awful loss of confidence in the banking system and the investments they have engineered. It is called "risk aversion", but it is more serious than that. Harsh lessons are being learned from bitter experiences that have shocked even the most experienced of investors.

  
Will the crisis go away? Not for some time to come. In fact, it could worsen as the structures on which confidence stands tumble under these new doubts and fears.

  
It becomes simply a matter of prudence and wisdom for investors of all types – and in all parts of the globe – to protect themselves against this turmoil in something that is not an obligation, not a promise, and not dependent on the performance of people or any other hope.

  
Where can they go? They need something they can be sure will not evaporate as quickly as a changing exchange rate, something they can grip in their hands, something solid that has proved itself in just these sort of times.

Buy gold, in short.

  
With the global market so integrated, so informed, so fast and now so volatile, expect the relatively small Gold Market to get a great deal of attention, forcing it to evolve into something totally different to what we see at the moment!

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