Gold Collateral: A New Global Role

Gold is increasingly accepted as collateral in commercial arrangements...

OVER RECENT DAYS a new market perception has been creeping in, writes Julian Phillips at the GoldForecaster.

The expectation now is that Eurozone interest rates are going to start rising ahead of US interest rates. But while the original intention in Europe was to raise them as soon as it was seen that the recovery was really taking hold, it is becoming apparent that inflation may well force the European Central Bank to act.

As energy and food inflation are here to stay, the reason rates will rise now is to tackle inflation. We find that this will be tragic. Although growth is taking hold in both the US and the northern parts of the Eurozone, the economy looks too fragile to bear rising interest rates alongside food and energy inflation. Should rates rise then we are of the belief that growth will be either extinguished or wounded so badly that it will limp along at best. Only Asia can afford this, not the developed world.

The US is not immune to such inflation, but will delay raising interest rates so as to not burden the consumer at a time when he is sensitized to bad times and will save at a time when the government hopes he will spend. What will be the effect internationally on the Dollar, other currencies and the global economy and precious metals?

Stored up for future crises at the moment in the US are:

• A 'hung' government where President Obama's administration does not have enough power to legislate as they want. The Republicans, while they have enough power to stop Obama's legislation, don't have enough power to get their own through. This is the last situation the US wants right now. It will ensure that each crisis gets to the brink before action is taken. Even then we may tip over the brink. This will shake global confidence in the Dollar and produce ratings agency downgrades for and in the US;
• A potential debt crisis from the federal government down through individual States such as California, Wisconsin and the rest. These are of a size that makes the Eurozone crises look tame;
• A governmental budget deficit that is not being addressed properly. We will see the first such game of brinkmanship when the time comes to legislate an increase in borrowing limits, soon;
• The US Treasuries are over half owned by foreigners essentially subsidizing US low interest rates;
• A loss of global power, as China's growth, not only will eclipse that of the US (China's economy will be double the present day's by 2020) but will see manufacturing move to China from the US a process well underway already;
• The future prospect that the Dollar will lose its role as the sole global reserve currency to the Yuan and perhaps a basket of other hard currencies of which it will remain only a lesser part.

The results of these crises, as we see now is an economically weakened US that will find it extremely difficult to bear up under the strain of rising interest rates in an inflationary environment. Once interest rates rise to try to contain inflation, we will see the bond markets turn to cash to avoid the dropping capital value of fixed interest rate securities. The equity markets will likewise fall in the face of rising yields on fixed interest rate rises and diminishing future prospects for the economy. Add to that the above confidence-sapping problems and we will see foreign investors unhappy to watch the steadily falling Dollar exchange rate, as we see at the moment.

The Dollar won't fall in isolation. Its trading partners cannot afford to allow their exports to suffer at the hands of a weak Dollar. As we have seen all too clearly in the last few years, the trading partners of the US intervene in the foreign exchanges to weaken their own currencies (in the face of a surplus on their Balance of Payments) to retain export competitiveness. We are of the opinion that central banks have and will be operating in the foreign exchanges to hold key exchange rates, such as the Dollar/Euro cross, within a narrow trading band to give the false appearance of stability.

To date this has led to the export of inflation as the money created in QE has seeped into the emerging nations as 'hot money' deposits. We believe that this will continue until interest rates start to rise in the US Then like a reversing ripple of water that hot money will stream home to repay the original loan. This will create major capital flow problems as it exits its emerging nation home to the US

The net result will be that the bulk of the world's foreign exchanges will look relatively stable as they all sink in value together. Hence all falls in the Dollar will be temporary in the future. How can this be measured? We expect that assets, in particular precious metals will rise against them all as they have been doing this century already. Even if the Yuan becomes a global reserve currency, we do not expect it to appreciate against the Dollar. Global currencies will then cease to operate as measures of value but will be used simply as a means of exchange with constantly varying sets of values.

As we look at the performance of the Dollar in the last couple of years, we think that much of this falling value has been absorbed in deflation and will only become apparent once inflation takes off (and rapidly when it happens). Overall the monetary system will prejudice the surplus nations like China. We expect them to take measures to protect themselves against this, which will see the Dollar and its following currencies falling lower still. The net result will be a move towards gold along the lines suggested by the head of the World Bank, as a reference point of value.

Once it is in the interests of the main global trading blocs and or individual nations, tariffs, capital controls and even in some cases exchange controls will be used to block imports of cheap goods and outflows of 'hot money', and permit the rebuilding of manufacturing in nations where it has been lost. Just as sanctions produced an economic boom of note in Rhodesia, so will these sets of controls.

It will see globalization retreat as nations just will not cooperate on an international front at the expense of national interests now. International trade and capital movements will require money that is not influenced by national conditions and remains highly liquid. Gold and eventually silver can carry this role in extreme times but as collateral, not as a means of exchange.

Such an opportunistic set of principles underlying the global monetary system that we see now will savage the remaining confidence in it. Some anchor values will then have to be incorporated into the system to stop its complete decay.

While gold has been moving back into the system tacitly, through the cessation of gold sales, by the developed world and the buying of gold by the emerging world, there is no public recognition of gold in the system. We do believe it is there already. For instance the 'gold – currency swaps' executed with the Bank for International Settlements was used last year by debt-distressed central banks to secure foreign currencies to assist in their sovereign-debt market defense. These guaranteed repayment by the debtor nation of their 'rescue funds'. It was by these golden guarantees that the loans to the nations were secured. They had nothing else of independent value with which to do it. This method neatly avoided using gold publicly and to the shame of the debtor nation. If they fail to repay the retention of that gold by the B.I.S. will nail the coffin closed on that country's creditworthiness.

Should this involve one of the major world powers in the future the global economy will then have two sides, the emerging Asian nations and the declining developed world. We have no doubt that Asia will then be the main reforming force in the reformation of the global monetary system.

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