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Gold & Capital Controls

Gold will continue to rise as world governments impose new controls on the free flow of capital...

CAST YOUR MIND back to previous currency declines, those that affect currencies other than the US Dollar.

   Many were so bad that the governments of those nations believed they needed intervention to hold up exchange rates – or push them down.

The Deutschmark...the Pound...the Lira...these problems hit in the early 1970s, and then continued to create problems in different regions of the world throughout the next 30 years. Now we're in the Noughties, but the problems we face are by no means new to the currency world.

The Bundesbank in the '70s, for instance, repeatedly had to back off holding down its Deutschmark because speculators simply matched their intervention on the other side. Later, the Bank of England paid a very heavy price to defend the Pound before it had to give in to the attack on Sterling led by George Soros. Then in the Eurozone area, you may remember the Lira pegs of Europe's Exchange Rate Mechanism. Well, it ain't over yet! And lately we're seeing the same trouble in the Opec states of the Persian Gulf and also in Hong Kong.

But when the going really gets rough, the symptoms won't just be hedge funds reaping a large crop of profits. We'll see nations pulling out of currencies and piling into others. At the extreme, small nations suddenly become the darlings of international investment will have to build walls to stop the inward and outward flows of funds far larger than their competence to contain them. Surplus holders finding it difficult to find a home for their investments will watch as their currency values decline.

At the same time, watch the speculators – those aggressive predators of the markets – charging into the herds of major investors trying to organize changes in their portfolios in an orderly manner, bring bouts of panic.

Speculators will not be sated with one victory, however, but they will be invigorated and will go onto the next attack until the tsunamis of capital waves have run their course and the weak currency authorities accept their losses in the form of much lower exchange rates and an obligation to bring value back to their money.

Alternatively, nations will let themselves be infected by inflation and see their currencies cheapened as they try to retain export competitiveness in concert, giving the impression of continued order. No doubt they will do whatever works for them in the short-term.

Looking at the current picture, will the solid Eurozone be able to withstand the pressures of a strengthening Euro – or will members such as France and Italy threaten to break ranks, while Germany smiles under the umbrella of the European Central Bank in Frankfurt? Can the Euro contain the different member nations, some howling as their economies demand different remedies, different interest-rate levels and different protections for their own economic health?

Can the Global Economy Cope?

If only China would let all this "hot money" flood in and allow the Yuan to rise, the problem would be solved! Then all of us could enjoy profits from a rising Yuan, but that is precisely what China will prevent, because it then becomes the victim of everyone else's weakened currencies, stunting its own growth in the process.

Jim Rogers is trying to get in there and quite rightly from an investment point of view. But why should the Yuan accommodate someone else's currency mismanagement? Brace yourself and hide in gold.

The securities that caused the "Sub-Prime Crisis" are still not saleable. The only way they can be made so is if assets are put into the packages to completely offset the problem assets and give the securities real value. Until then, no moneyman in his right mind will touch them. At best they will go at basement prices or be put into the hands of hedge funds like Bridge Asset to be re-packaged as distressed debt and gratefully given some value.

Right now some major banks are in the process of trying to put together a package aimed at convincing the banks responsible for this mess and the other institutions involved that these securities (including Special Investment Vehicles) will have real market value. We don't know yet whether the sponsoring banks believe this is possible or not, but under the worried eyes of the US Treasury, faltering efforts are being made to make it possible.

The new entity, called a Master Liquidity Enhancement Conduit (or M-LEC for short) could raise as much as $200 billion or more through the issuance of its own securities, and use the money to buy securities that otherwise might be dumped on the market. We find it surprising that bankers should even attempt to convince other bankers of something they don't believe themselves and actually put their own money up to do so, but there it is and we await in awe for the presentation of this crisis' solution.

Or is no solution on offer? Are we going to be told that the banks will be there to lend money to those in distress, while hoping they won't have to? After all, the numbers being put up are so small, relative to the amounts involved, they can only be there to give an impression of helping. Simply put, the scheme is a front that they hope will prevent a fire sale.

Of course if they fail, they could precipitate a far worse crisis than the one we saw in July, and one that will take a very long time to recover from. Imagine the sight of disrupted credit markets and a Fed desperately trying to pick up the pieces while not actually saving the investors themselves? Ben Bernanke, the Federal Reserve chairman, said recently that "Despite a few encouraging signs, conditions in mortgage markets remain difficult...A weak economy could reinforce problems in the credit markets."

Not too encouraging, I'm afraid. The reality is that global credit markets are in trouble, confirmed now by the first IKB Deutsche Industriebank AG Structured Investment Vehicle, which has lost about half its value and is unlikely to repay all its debt.

After IKB's asset management arm determined the SIV may be unable to pay back its debt now coming due, Rhinebridge – a Dublin-based fund – suffered a "mandatory acceleration event". Rhinebridge had $1.2 billion in commercial paper outstanding as of Oct. 5. Now Rhinebridge, Cheyne Finance and other SIVs which borrow from the short-term commercial paper market to fund purchases of asset-backed securities are struggling as investors retreat from all but the safest debt.

SIV's have dumped about $75 billion of assets as a result, prompting US Treasury Secretary Henry Paulson to organize an $80 billion bank-run fund to buy some of the securities. In August, Rhinebridge had to sell $176 million of its assets to cover obligations, and as much $320 billion of holdings by SIVs worldwide may be dumped if the market doesn't improve.

The path forward for credit markets is not a happy one. Whereas gold is no-one's obligation, so this trouble is again positive for the Gold Price.

Capital Controls Have Already Begun

In one fortnight during the second half of September, India alone received inflows of over $15 billion. That compares to barely averaging $16 billion per year during 2000-2006.

No wonder that emerging equity markets are up over 440% since 2002 compared to a bare double for US stocks. But emerging equities are not yet overpriced. Emerging nations are good growth stories, particularly for those oriented towards China. Many emerging nations are creditors now, as growth infuses vast flows of capital to them. No doubt as the developed world shows a poor performance relative to these rapidly growing nations, alongside commodities, superior returns are being achieved.

But the excessive amounts of capital, a consequence of deficit trade financing – meaning far too much money – will attempt to squeeze into those markets, taking values beyond achievable expectations and leaving a empty big drop below. Where the growth does continue, most especially in the nations providing commodities for the major growth stories such as China, prices will hold at higher levels. But as with oil, these prices will not be seen as high once the depreciated value of the currency – the US Dollar – is brought to bear.

There is such a huge amount of capital readying itself to move into sound markets, the dangers of overpricing will trigger nations into preventing asset bubbles from forming by using capital inflow controls. Right now, many large institutions are researching the Gold Market, the commodities markets, and emerging equity markets. Just a tiny portion of the institutional money lying around (estimated to be just under $200 trillion) would mean a massive tsunami of capital. And if they can get in, most emerging nations are just not capable of absorbing these flows.

Here in South Africa, foreign funds now getting into the country may find it becomes a fool's paradise. The government believes they have attracted such capital because they are an attractive investment home. A dropping interest or exchange rate will soon cure that.

So what can these poor nations do? As we wrote last week, many governments will turn to imposing Capital Inflow restrictions. To those who remain unbelievers and think we are pipe dreaming, please note that recently the Indian government moved to impose restrictions on non-resident equity inflows, which led to a sharp correction in the Indian stock markets and the Rupee, from which the Indian markets have only partially recovered.

The curbs were sought to keep the Indian Rupee low against the US Dollar, and reasonably so, in view of the Bank of India's objective. Since then the Rupee and the stock markets have recovered to some extent.

Here at the, we have warned that many emerging economies will find it impossible to continue their current policies. Attempting simultaneously to target exchange rates, as well as pursuing independent monetary policy – and yet allowing the free movement of capital – cannot succeed on all three points.

This "trilemma" as it's known is just not workable. Be certain that similar measures – blocking the free flow of capital – will spring up in many other countries. And in such a climate, Gold Bullion Investment and also silver have always proved themselves. When governments have to intervene to control money directly, confidence in money evaporates, and gold benefits.

This time, we will see controls imposed on a broad global front. will be providing a guide to what can happen under Capital and Exchange Controls – and how you can cope with them.

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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