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Gold in a US Default

A look at the impact of a US default – and what it could mean for precious metals... 

WE WERE led to believe last Friday that the debt ceiling crisis would be over by the time Asia started trading on Monday. But the weekend has gone and so the deal, writes Julian Phillips of

The markets are very nervous and beginning to worry that a deal will not be made. This is merely a political game to earn a name because one or the other gives in first. 

But the two leaders represent national parties and not themselves; therefore, the sensitivity needed to back down just in time isn't there. The structure of politics doesn't allow it. Not only that, but it takes a few days to implement the ceiling change. 

Are we now certain to see a default by the US government?

If so just what will that mean to precious metals? 

Bear in mind that the US is not the hub of the global gold market. In fact, in terms of jewelry, bar and coin demand, the entire North America is only responsible for 8% of global demand. Europe and Russia is responsible for another 13%. In other words, these markets are not driven by the financial affairs of the developed world.

The developed world is responsible for the provision of the distribution networks and the markets of the gold world. Physical supplies primarily come into London and bullion banks, sent from the refineries that refined gold and silver, which the mines supply. Then the bullion banks – mainly through the London Gold Fix — supply investors, manufacturers, industry and central banks with the gold they want. 

The developed world also provides the speculators and traders who are constantly dealing either in gold itself, shares of gold Exchange Traded Funds, or in the financial derivatives that can influence the Gold Price.

It is the global speculators and investors that have the most dramatic effect on the prices, but their effect is primarily short to medium term. The daily pressures these professional have on the market have a similar effect as the immediate waves do at the seashore. There is a constant ebb-and-flow of prices, because a price rarely, if ever, goes straight up. 

Where there are seasonal flows of demand and supply these have the same impact as the daily tidal changes on the sea shore. But the most dominant price pressures come from forces similar to the currents in the sea. A look at a long-term price chart shows the sum total of all these pressures on prices. In both the silver and gold markets, these flows are far more complex than a simple commodity.

For instance, the effect of the debt ceiling impasse had on the gold and Silver Price today had nothing to do with the gold or silver fundamentals, but on the threat to financial stability and the US Dollar. Precious metals act as a counter to the main cash and currency markets; therefore, we have to take a look at the sum total of the influences on the gold and silver prices, not just the short-term speculative ones. These are simple and clear –gold and silver prices have been reflecting the uncertainty and instability of the currency worlds and the undermining of the value of paper currencies.

In the Far East there has never been that kind of trust in paper money systems. In the developed world there has been absolute trust in paper money systems; however, this century we have witnessed a decline in this trust, which accelerated from the first point of impact of the credit crunch. 

This decline has widened and deepened since then, as it progressed from the banking system across to European sovereign debt problems and now is a victim of political ploys in the US The most disturbing aspect of this degeneration is that the problems have not been rectified properly, leaving national economies wallowing in or close to stagflation. With the buying power of currencies waning in the hands of people who cannot do anything about raising their incomes, the loss of confidence is moving towards desperation. With no sight of political or monetary reform, the instability and uncertainty we are witnessing is becoming deeply entrenched.

It is strange that the least sophisticated parts of the world have the greatest appreciation of the value of precious metals. It is also strange that the most sophisticated sides of the world are taking so long to recognize the dangers facing the present monetary system. We are so caught up in what is a "normal" money system that we deny the dangers because they threaten our "normality". 

Aren't we capable enough to put matters right when necessary? 

So why are they getting worse?

Against this backdrop, we can now see that the main impact of a default by the US would be a further fracture in the developed world monetary system, pressuring investors to seek alternatives over the long term. This damage will not be repairable. 

? One of these long-term consequences will be the acceleration of the internationalization of the Chinese Yuan, so that China reduces its vulnerability to the undermining of the Dollar, internationally.

  • Another consequence will be the long-term diversification of national assets out of the US Dollar to incorporate a broad spectrum of other currencies and government bonds.
  • Stagflation or worse will be another global consequence.
  • Over time there may be a far greater fragmentation of the global economy, leading at worse to Protectionism and Exchange Controls.

With the Eurozone crisis so fresh in our minds, the consequences seen there can act as our guide. The main difference is that instead of member nations being the problem, the equivalent of the Eurozone itself is the indecisive problem – the US government itself. The consequences that flow out from the US become more dramatic for that reason. 

  1. A significant weakening of the US Dollar is the first hard blow to be felt globally.
  2. The second is the impact on the currency world, in total, as currencies whose economies cannot afford to see their currencies strengthen further take action to weaken them. Take the Yen, for instance. Earlier this year, the Bank of Japan intervened to weaken the Yen as its economy reeled from the tragedies that struck it and the diminution of international trade because of the strength of the Yen. The Swiss Franc is in the same boat. Previously it also acted to weaken its currency to support local exports; however, each nation favors one or the other major blocs (Europe or the US) and so manages its currency against that major currency. For instance you will see the South African Rand move against the Euro and not the US Dollar. If the Euro is strong then the Rand will be strong. Expect a solidifying of these relationships perhaps to the exclusion of others.
  3. 3The third impact is that interest rates will rise in the US and weaken the bond (Treasury) markets. If this holds then we will see the next major financial crisis in the US Treasury markets just as we saw it in the more dubious members of the Eurozone.
  4. Rising interest rates undermine equity markets, house prices and in turn the overall economy. With such low growth rates in the States already we would expect deflation to take hold.
  5. With energy and food inflation already high, add deflation to the formula and unemployment rates will rise alongside the weakening economy.
  6. Asset values will fall.
  7. The only assets that will rise inside the US are those that act both as cash and assets, internationally, namely precious metals. With emerging nation's demand for precious metals already rising unstoppably, the addition of developed world safe-haven demand will keep precious metals rising to new levels as the world adjusts to an economic climate that is destructive to the developed world and at the same time will favor the developing world.

We are describing a global economic climate that the world has not seen before. In the past when such pressures have arisen they have led to wars. Today's pressures cannot be fought over. Where battles can occur is in the financial and economic areas of life. Such battles are called "Protectionism", "Currency Wars" and there are few winners in such wars. These wars lead to global fragmentation and distrust. 

Internationally, precious metals will become the preferred reserve assets, not just an important one. Their prices will then relate more closely to the total volumes of each international currency in the world. As you can imagine, the prices of precious metals will then have to be higher than most people even thought possible. With the gold market being such a small one in volume terms, silver will then become a monetary metal too, at considerably higher prices.

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JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

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