Exchange and capital controls are going global as extreme problems in money send gold higher...
IT WAS Alan Greenspan himself who said that "Gold is money in extremis" writes Julian Phillips at Gold Forecaster.
When times get tough, in other words, gold becomes money that people can trust. But what constitutes "in extremis"...? History, with hindsight, usually finds it easy to answer such a question. But 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, if not five years before 1939, it was clear the world was on the path to the conflict. Yet 12 months 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 clarifying whether we are in extreme times is never easy. That's the confusion we face today. And absent hindsight, the tool we are left with is extrapolation, defined as "calculating the future approximately from known values and data". Put simply, it means taking the facts, attitudes and intentions of the present and taking them forward to assess future likelihoods. It does not include hopes and dreams, but only present realities as those that will decide the future.
So what do we see now?
The resumption of growth is still being argued over in the United States, with joblessness at frightening levels. Consumer debt is still not under control nor are US citizens of a mind to become savers and not borrowers. So a 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 Dollar 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 Dollar", it just ain't going to happen under these conditions.
In the monetary system, we see a United States with its net external debt nearly tripled in the last year to $3,500 billion and projected to increase by nearly $1,000 billion every year for the next decade. Now add to that the role of the Dollar as the Global Reserve Currency, and you have such a monetary overhang that if the borrowed Dollars came home as interest rates rose and pushed the Dollar stronger, surplus holders would be tempted to sell their Dollar surpluses into strength. Then where would the US money supply stand? Overall the Dollar is in trouble either way.
With the Dollar being the tree trunk of the global money system, all the branches of that system will suffer its pain too, in a structural way. But 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, however, the world will be threatened by a potential collapse of the monetary system. Just recall how even the Treasury department in the US 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 Dollar.
Over in the East, China has a population twice the size of the Eurozone and USA put together. Its economy is 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.
China is achieving a self-sufficiency that has 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.
China is thus 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, such as in the auto industry. Now add the fact that Beijing controls 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. Western economies and currencies are already carrying their wounds. In India too 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.
Cheap and easily borrowed money in the United States, alongside a falling Dollar, is leading to flows of funds seeking better returns in emerging markets. These 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 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.
Last Wednesday Russia 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 also 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. The trend is widening and gaining speed.
If the trends we now see 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 national currencies? They are after all national obligations, not real value "in extremis". The future looks bleak, sad to say. But we believe there are ways to protect yourself. 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.
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