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Gold, the Eurozone Crisis, and How Central Banks Help the Gold Price

When crisis hits, investors run to safe havens that hold their value...

PERHAPS the greatest concern of the developed world markets over the last year has been the Eurozone debt crisis and its effect on the Euro, writes Julian Phillips at

It has brought into sharp focus the seriousness of a nation's debt situation. In the last decade, we have blithely accepted that a nation can issue debt and be safe from default. Over this last year, that perception has changed considerably, as nations have been seen to have excessive debt. 

Nations are not unlike individuals, in that if you have too much debt and not enough cash flow, you will go into liquidation. Likewise, a nation can go bust. Two years ago, the Euro was seen as counter to the Dollar. 

Then, the start of the drama with Greece confirmed its horrendous debt situation… Then, the debt crises of Ireland, Portugal and Spain… Now Italy has been put on that list of potential defaulters.

The Euro suddenly was not as safe as had been thought. In the last week people realized that the problem could grow and contagion spread to the extent that the EU was threatened. Some feel the Euro is threatened, while others say, no, the Euro will survive but with a changed Eurozone. 

The reputation and confidence in the Euro has been savaged by the whole process. It's not over yet. Gold and Silver Prices moved up on the bad news from Europe. Why? 

The Eurozone is a group of sovereign nations, each with its own independent government, its own separate economy, its own national identity, character, most with its own language and each retaining its own sovereignty. 

Each member manages its own national revenues and politics, all of which are independent of the Eurozone, while being part of it. In other words, unlike the USA, there is no fiscal union. All people in the USA are Americans, speaking English.

In Europe, they are first nationals and a distant second they are European. And that's why the European Central Bank doesn't have free rein to bail out Greece by itself. Each nation in the Eurozone is still a stand-alone country, despite having a common currency. Their unity is considerably weaker than that of the United States.

The Euro is only ten years-old, having replaced national currencies at its inception. This achievement was remarkable, particularly because such a mixed bag of independent economies with different balance of payments now have the same currency. 

It is as if the Eurozone members agreed to fixed exchange rates between each other. The weaker nations who joined were fixated by the incentives and loans while the strong nations could stop the continual appreciation of their currencies against their customers'. Germany, for example, transacts 40% of its business with other EU members. 

The Euro has allowed Germany to make huge strides as manufacturer to Europe. It also attracted a good bulk of the poorer member's capital to Germany where it could be invested in efficient industries. The poorer nations faced the opposite capital flows. Structurally, the strains and the crises we see today were inevitable.

Every state in the US is part of one country, with one economy under the federal government. In the States there is a fiscal union, the state's revenues being passed onto the State coffers and Federal taxes being passed to the Treasury of the United States. That integration has served the States well and ensured its self-sufficiency, but has not avoided some of the crises that Eurozone members are facing today. Many of the individual States are also bankrupt, but many will be bailed out by the Federal government. 

One major difference is that the US government debt has a 'ceiling' of $14.3 trillion Dollars that needs to be raised urgently. Should it not be raised, but sacrificed on the altar of partisan politics, it too will face the loss of confidence the Euro has suffered to date. 

We all know that US debts will be paid, but the loss of confidence and trust in holding to debt obligations will be irreparably damaged in the eyes of foreign lenders and banks. The Eurozone crisis has placed this US problem in the same light as the Eurozone debt crisis now. 

The major common denominator between the two sides of the Atlantic is that debt obligations are not being held to as contracted. How can confidence remain high in these nations and their currencies if debt obligations are treated so badly? It is this loss of confidence and inherent value that lies at the bottom of gold's inherent value.

For so many reasons, the US Dollar is structurally dependent on foreign capital investments to keep it stable on foreign exchanges. So long as the US has been the dominant superpower – able to ensure oil is priced in the Dollar – the importance of the structure of the US balance of payments was not of great importance. 

But with the declining value of the Dollar on global foreign exchanges and the rise in importance of China and the other emerging (and surplus earning) nations, the US debt crisis has become considerably more serious outside the States than inside it. It is the outside value, or the exchange rate of the Dollar, that impacts gold and Silver Prices.

Likewise, in the Eurozone debt crisis, it is the value and reliability of the Euro outside of Europe that will affect gold and Silver Prices. The consequences of nations being over-borrowed are that currencies cannot represent stable value. Their failing to do so reflects positively on the ability of gold and silver to do so.

One key similarity now being reached in both the Eurozone and the States is the battle between finance and politics. 

In the US, partisan politics is holding government debt ceilings to ransom. Now in Greece, the debt crisis has moved from acceptance by the government to do something to this week's vote on the political acceptability of the austerity measures. That reaches into each MP's constituency and down to each voter. That's key for politicians who will be driven by potential votes rather than by financial sanity. An elected official will take a foolish course, if it gets him votes.

So if politics rules finance (and the banking system) it will affect the value of a currency. When we are talking of the 'value' of a currency, we have to include reliability, trustworthiness, the certainty that national debts will be paid on time. Once a nation has lost this, that facet of their day-to-day operation becomes risky and a deterrent to foreign investors. The exchange rate won't reflect this until the reinvestment of foreign capital in those nations starts to drop. But this will only happen when there are viable alternatives. 

For instance, we are very certain that once the Chinese Yuan is a global currency, a huge flight of capital will attempt to convert from the Dollar and Euro to the Yuan. Likewise the position of the Dollar as the prime oil pricing currency may wane fast. 

Once these consequences are included in the pricing of both the Dollar and the Euro, we will see an ebb tide of investors moving to other currency homes. More importantly the value of both gold and silver as an alternative to the Dollar and the Euro will be appreciated all the more.

 When any of the above situations – whether local or international — strike investors, they move into an investment that won't be hurt by such currency crises. Because of the ripple effect of these crises, many of the markets will be avoided. 

If a currency falls in value or trust, so will those markets dependent on it. Most assets in that scene will appreciate, unless their performance is affected by the falling currency. So a haven is sought that is outside the sphere of influence of currencies.

Gold and silver do fill that category, gold far more than silver. Gold is both an internationally-traded asset and a currency. It is not hurt by a government failing to keep its obligations. It can be paid over by a government when that is all the government has left. 

Once the credit crunch hit hard, we were reminded that a national currency's performance was linked to its economy, which meant its value depended on its performance and size and was not necessarily related to its underlying value. 

When quantitative easing began, it became clear that its value lay in the hands of central banks. Their primary task was to maintain price stability internally; however, this role soon extended to supporting the banking system, maintaining the nation's creditworthiness, and stimulating the economy.

From 2005 onwards, the Gold Price steadily rose to around $1,200. In the credit crunch it dropped back to $1,000 because the frantic search for liquidity caused a sharp sell-off of all assets including the ones that were performing well.

This left a massive gap in the instruments that would hold their value through the decades. Only assets that countered the value swings of all currencies could do that job. Once the liquidation of debt ran its course, investors turned back to gold and silver for wealth preservation. The new wealth of the emerging world added to that demand. In the emerging world gold and silver had and will always be thought of as providing value and financial security. After the worst of the crunch, the Gold Price resumed its rise, followed by silver. 

To emphasize the wisdom of precious metal buyers, the signatories to the Central Bank Gold Agreements slowed their sales of gold to a stop in 2009/10 (this ignores the IMF sales, which were executed for other reasons). Emerging nations, along with their public, began to increase the size of their purchases, taking the Gold Price up to $1,500 and silver to $35. 

Today, central banks are either buyers or holders of gold, reinforcing the idea that 'gold is money', as had been the case before currencies abandoned gold backing. 

Once we saw nations across the globe — nations like South America, Russia, India and China— buying and holding gold for their reserves, it was clear that gold was being globally recognized as a valued asset in the hands of governments. This turned a potential 34,000 tonne overhang above the gold market into an unlimited, potential group of gold buyers. 

No more can the US in conjunction with the rest of the developed world join together against gold with an oil-linked, un-backed set of currencies to keep gold on the sidelines. 

China is very different than the developed world in this respect. China has been encouraging their citizens and central bank to Buy Gold for years now. 

They watch the monetary games and currency uncertainties with alarm. Why on earth would they want to support other people's currencies unless they had to? And why should they prefer these currencies to gold? The emerging world appreciates the value of gold in their reserves as a wealth-preserver too.

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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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