Can Gold & Silver Tolerate a $1.70 Euro?

The plight of the US laid bare in the rise of the Euro and the leap in gold and Silver Prices...

FEDERAL RESERVE Chairman Ben Bernanke said Friday he thought the current high unemployment and low inflation environment would linger into 2011 and as a result there is a "case for further action" on the monetary policy front, reports Julian Phillips at GoldForecaster.com.

Mr. Bernanke said the Fed might expand its holdings of longer-term securities. He also said that the Fed has little experience in judging the economic effects of more asset purchases. This tells us that we are stepping off into new territory. The same will be true of the rest of the world.

It signals that the Dollar will fall lower and probably substantially lower. Hitting $1.50 or even $1.70 to the Euro is on the cards. The Yen, the Swiss Franc and the Pound Sterling and just about all other currencies will try to follow the Dollar down, but struggle to keep up. This isn't just a 'pebble in the pond', but a great big boulder. The ripples will start over this weekend. They will hit every market there is, we believe.

The US Dollar is the globe's sole reserve currency. It is responsible for pricing virtually everything that is traded internationally. It has been relied on to price and value every item we buy. Now that the Fed and the Treasury are indicating they will debauch the Dollar in the interests of resuscitating the US economy. So what choice do other nations have with their currencies?

Most nations including China are doing all they can reasonably do to diversify away from the Dollar in their reserves. The pressure is on to change the pricing of internationally traded goods to other currencies. The only other alternative is to try to sell their own currencies on the markets to lower the exchange rate. This implies importing inflation, unless they follow China's path of 'sterilization' of such through draining liquidity from their own economies. As we can see with the Yen, this is not a good road to follow because of the likelihood of attracting not just speculators but nations dumping their own Dollar reserves as they diversify.

Imagine international prices being made in a selection of currencies, including emerging nation's currencies. China is already following that road. Is it possible that we see oil priced in and producers accepting, a variety of currencies? Not only would that lead to a diving Dollar, but a considerable reduction in the role of the US Dollar. Where would these surplus Dollars go, except home.

More than a declining Dollar such a policy emphasizes that it's every man for himself from now on, as the US cares only for its own interests. China will ask how the US can point a finger its way on its currency. Other nations fear direct intervention in exchange rates as that attracts the 'carry trade' speculators. The international anger will be palpable. As we have often said, governments will always choose internal interests over external ones. The US is not alone on this, so a breakdown in cooperation in the foreign exchange world will be only a symptom of the underlying fragmentation.

You can see nations from Brazil to Thailand imposing taxes on inflows of money already. Watch this spread to many, many more countries now. As markets become increasingly volatile, governments and central banks will become precipitous in their imposition of defense mechanisms. We may well see measures as draconian as the split currencies that we saw in Belgium and the UK in the 1970s, where there was a currency for commerce and one for capital with the two being separated by a discount or premium.

The main pressure this time though will be from inflows of 'hot' money (easily withdrawn capital) which can be catastrophic for an economy both when money enters and when it leaves, en masse.

So what will markets do in the face of such actions? Every market will react to compensate for the falling value of the Dollar in one way or another. Equity markets will rise too, but not for good reasons.

Reactions in the Gold Bullion, silver and oil markets...? A look across there three markets in the last week shows quick reactions to the falling Dollar. All three went up, but both silver and gold went up the amount that the Dollar fell.

If that were to continue and the Dollar fell, say, to $1.70 against the Euro, then without the Gold Price being pushed up by demand, the Gold Price would go up to $1663.57 from the current $1370. In Euros, the Gold Price would not rise at all.

Silver would follow a similar path, too. Technically, to discount the Dollar's fall alone the price would go from $24.3 to $29.51 per ounce.

As for oil, we know that member states in the Opec cartel are calling for a $100 oil price to remove the impact of a falling Dollar at current levels. With the Dollar falling to $1.70 per Euro, we should be looking much higher as well.

Initially, on the Dollar falling to new lows against the Euro and other currencies, the US Balance of Payments would look great (except on the China account). But internally there would be howls, as inflation took off at a rate of knots. The point made by the Fed that they don't have experience in this area worries us. They might have a tiger by the tail.

When former Fed chairman Paul Volcker shattered 25% inflation in the early 1980s, there were very different circumstances – such as a healthy economy and undisputed Dollar hegemony, as well as significantly lower levels of Treasury indebtedness. The US dominated the gold market, with European cooperation. But this time they have none of these strengths, and actions to survive inflation won't work without them!

Much more will happen than a Eur/Dollar adjustment on values. So what of gold and silver then?

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