Let's call this credit crisis what it really, a crisis in confidence...
EVENTS IN THE BANKING, credit and foreign exchanges are behaving in a startling and frightening way, believes Julian Phillips of the GoldForecaster.com.
Not only are equity markets crashing, but currencies are worrisome – especially now that what appears to be a strong Dollar is in fact falling against the Yen. We've seen a dropping Euro, with news from the Eurozone confirming it is infected with the same financial virus as the States.
With both currencies now weakening, their relationship to each other is losing relevance as they fall fastest against Gold. This is now confirmed after this week's break through $900 an ounce barrier this week. Because as all currencies are falling against gold, it's not simply a credit crisis out there.
Let's call a spade a spade; it's a confidence crisis! Confidence in the banking system has been mortally wounded. This is contracting the biggest global economies, even if Asia can limit the decay in its own system. Central banks meantime are in danger of losing their own credibility as the crisis persists and as they slash interest rates. After all, it's not a matter of rates, but confidence in the entire system and its instruments.
Investors are seeing their own wealth fall victim to the markets on a daily basis and are searching for something that can avoid this violent decay. Therefore Gold is moving back into the spotlight.
The decay of confidence is moving with the speed of a contagious disease, because bankers simply don't trust each other! The Federal Reserve is doing all it can to restore confidence not amongst the public, but within the banking community. But trained to examine creditworthiness, bankers won't even give credit to each other.
Ben Bernanke, Fed chairman, has effectively said that the US Treasury, if not the United States itself, stands behind credit amongst bankers to the extent that it will take the debt they now have, re-package it with a government guarantee, and put it back into the market. Foreign governments need that reassurance, as well as American, European and all other bankers in the world, too. The principle behind this "solution" is that bankers are supposed to realize how, if governments go down, they are going down too.
So why refuse government debt?
But the high levels of interest required before bankers will consider lending to each other (LIBOR – the London Interbank Offered Rate) continues to soar at exorbitant levels. This bodes more ill for the financial world itself, regardless of Paulson's package. After all, if the package and lower interest rates do not work, it means that confidence is lost! The next move will leave disarray in currency markets.
The contagion is now spreading through Europe, and governments are falling over themselves to guarantee deposits as customers pull out their cash from the banks. Major surplus countries are staring in horror at this; they are also major depositors in the Western banking system too, and captured by their many deposits with the US government they can't afford to pull out.
China, South Korea, Taiwan and Japan are stuck with the Dollar in their own central-bank vaults as well, and see little alternative to it as the Euro seems to be headed in the same direction (i.e. down!). It is unlikely though that they will just sit still and absorb losses. So what will they do? Could they begin to unload some currencies and retain some value with Gold?
These two global trading blocs – the rich West and fast-growing Asia – have most other smaller nations dependent on them for their own economic viability, towing them along through the ills affecting them. There is no way out of the situation for almost any economy unless they are relatively self-sufficient (such as China). The only solution is the restoration of confidence.
Please be sure, however. I am not saying that the banking system will run to using Gold as money, because it would not be practical to replace gold where paper is right now. First, it would have to be taken into government custody. Then, as in 1935, it would need to be revalued so that it could be spread far and wide, with bankers – cap in hand – promising not to print money to excess while telling their customers, "live now, pay later".
We're not there just yet, but are we headed that way? Until governments reform the financial system in a manner that can restore trust in banking, credit and savings, gold will remain where it is now, in private individual hands worldwide and in the vaults of governments wise enough to retain their holdings in the event of that inevitable 'rainy day'.
Because that day is here!
But as confidence wanes, will gold be pulled down with other assets? We believe that once the de-leveraging in financial assets has abated, investment funds moving into gold will take the reins. Gold will do its job of retaining value where other assets don't. After all, the net effect of inflation and deflation is the same – you have less value to buy goods with!
With money being issued in seeming trillions, one quality of gold stands head and shoulders above the rest; gold is a limited edition item. It can be traded from Mongolia to Central Africa, Dubai to Denver and anywhere else in the world. It doesn't rely on government support, or handouts, or promises of payment. And that means everything at the moment.
The gold market is about to enter the final stage of its current evolution. This stage springs from failing confidence in paper money, currently as bad as any pre-war situation. If governments can accede to the disciplines (and thus security) that gold imposes on them, they will also start to Buy Gold. But this is the hardest leap for them because, they have been fighting gold off from being relevant to the money world (and promoting paper money) for nearly 40 years since Nixon Closed the Gold Window in 1971.
Once they endorse gold by buying it, there will be a flood of funds looking for it. So will governments turn back to gold?
It is possible, perhaps probable, that as in 1933-1935, gold captures the attention of governments again. As we said above, if it does, they will want to hold it away from the public and for the same reasons. What has become starkly evident is that gold cannot be manipulated long-term, as it was over the last 30 years by governments. Too much confidence in the monetary system has been lost in the last year for a credible attack on gold to persist, not with the Dollar being held up as the alternative.
So gold perhaps will be used to shore up that confidence, in some way. But this will not happen until the monetary system is in abject disarray. If governments do then return to gold, remember that you will have no short-term notice whatsoever.
Most likely on a Sunday evening (since that seems to be the way of notifying private individuals of the biggest these days), you will find it is a done deal. Will you be sitting at home, forced to give up the gold in your hands?