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Gold On the Brink

Priced in Dollars, gold throws the US currency's near-crisis into relief...

GLIMPSE AT a chart of the US Dollar, indexed against its major trading-partner currencies, and you see a frightening sight, writes Julian Phillips at the GoldForecaster.

If the Dollar now sinks any further its support will have evaporated.

We have now watched the Gold Price rise all this week, hitting new record highs in late London trade Tuesday against the Dollar. But in the Euro, gold has barely moved. Against the Swiss Franc the Dollar also looks weak. And with the technical picture looking so poor, one turns to the fundamentals to see if they conflict or support a downturn for the Dollar.

The United States, right now, is on the brink of having used up all its legislated credit capacity. At $14.3 trillion there is a desperate need for a higher credit limit. Unless, by Friday, Washington has passed legislation to raise this, the government cannot issue checks or pay staff. Yes, they can use various tricks to delay this to accommodate political brinkmanship, but the outside world will be alarmed that the government is unable to tend to such basics or allows politics to overrule finances.

Here there is a clash of systems, the need for financial correctness against the games politicians play. With President Obama's administration without sufficient power to legislate as they want at a critical time when government should be strong, there is little to inspire confidence in the US government.

Global confidence in the US Dollar will be shaken if such a financial mess were to happen. We would most likely see the ratings agencies downgrade US debt before that happens. From outside it looks as though the US is oblivious to foreign investor's opinions at a time when the US is reliant on foreign investors buying US debt.

Moving down the ladder we have seen so much in the press that individual States are on the brink of bankruptcy and some already there and little seems to be being done to rectify matters to date. Or should foreigners just presume that the Fed will rescue them with bailouts? If that is to be the path followed that again will undermine foreign investors confidence in the Dollar.

What needs to be understood is that government finances at all levels have to be sound to inspire confidence? It seems to be a simple obvious statement, so why is it not being applied? Even Fed Chairman Mr. Ben Bernanke is calling for government to sort out the Federal deficit but all we see is a partisan battle that seems oblivious to their countries crying needs. Or do we misunderstand the scene? Are politics more important than good order?

Tuesday saw the revelation that China owns $360 billion more of US Treasuries than was thought to be the case. Does the US government not worry about this dependence? Or does the government want to ensure that the Dollar weakens? This is the strong impression pervading so many foreign exchanges now.

The inflation coming from the food and energy worlds is globally pervasive and capable of threatening what little economic growth there is in the developed world. It will affect many, many countries and could reach into the US. We do expect the UK to experience a shrinking of its GDP in the first quarter of 2011, announcing the arrival of a double-dip recession, so shrinking growth could also affect the US still with its lackluster economy. What will this somewhat emasculated government do then?

For so many years now the US has run a trade deficit, balanced by a surplus on the capital account. This inflow of money is the flow of power from the US to foreign creditors, and already we are seeing a tendency to try to diversify away from the US Dollar. If this trend gathers momentum then the overall picture on the Balance of Payments could sink to a deficit. How close is it now? Or is it happening as foreign investors diversify into other currencies to stave off or reduce the impact on their surpluses of a falling Dollar? It's bound to happen if only because of prudence. And yet the US is doing nothing to address the situation.

We see that the main beneficiary of a weak Dollar would be the US on the trade front as well as on the debt front. So one question that needs an answer is, does the US government want a weak Dollar? Or is the US government unconcerned at the US Dollar's exchange rate.

It seems that Europe and other nations are more worried about the US Dollar exchange rate than the United States. This laissez-faire attitude appears to confirm that the US has no intention of protecting the US Dollar's exchange rate. For that reason we have to conclude that the US Dollar is inevitably headed to more weakness. In the past the 'top dog' nature of the US currency meant that the rest of the world had to suck it up. Now, it's only a matter of time before the US is second to China's economy in the world. By 2020 the Chinese economy will have doubled and we have no doubt that the Yuan will be the world's 'top dog' currency, eclipsing the Dollar. When that happens and it may be well before 2020, the Dollar like all other global currencies will have to pay its own bills with goods not simply freshly printed Dollars.

Is it any wonder then that the Gold Price is rising in the US Dollar? So too is the Euro, the Swiss Franc, the Pound and other currencies. So for now, it's not the Gold Price rising in the Dollar it's the Dollar falling in terms of gold. Likewise other currencies are not rising against the Dollar, the Dollar is falling against them.

To get a clearer picture of what is really happening in gold one has to look at the Gold Price in the Euro or the Swiss Franc. That will reflect demand and supply better. We have and will see the Gold Price rise in the Euro for fundamental reasons but for accuracy's sake we have to relegate the Dollar price of gold to second or third place, because that's more about the Dollar than about gold.

Today we read that the shareholders of the Bank of Italy, the Italian banks, want to use the gold held by the central bank to shore up their balance sheets. The Bank of Italy has gold reserves of 2451.8 metric tonnes (68.6% of their foreign exchange reserves) at the moment. As shareholders assets, by including these reserves at market value, Italian banks look a lot healthier. Yes, this is a touch of 'cooking' the books, but it recognizes the fact that gold has a monetary value, recognized in the monetary world. In inter-nation currency transactions gold is being used to secure loans. It has a de facto role in the monetary system that is getting harder and harder to avoid.

Of course, gold will never be confiscated for the same reasons it was in 1933 (money supply expansion). Its role today can be as collateral for international transactions, as we see it being used now. In a global world it is the only real monetary asset that bypasses nations to be global money that is truly mobile. Should a nation find itself in trouble, much like these Italian banks, then gold sits there waiting to shore up balance sheets and serve as collateral for international currency swaps for nations with questionable creditworthiness. Will the Dollar fall into that category once the Yuan is a truly international currency? Certainly holding gold will bypass that eventuality. Even in the hands of the US government its citizen's gold could give the Dollar a golden hue.

In China it is understood by all that all assets of the nation including citizen's gold is the property of the state. In the US citizens are allowed the privilege of owning gold and don't have the right. How small a step to confiscating the huge tonnage of citizen's gold...

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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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