Posted by: John Gilmore | September 16, 2006

A Closer Look at Gold

Here’s a great report by Chris Martenson relating to the article last week on gold. If large nations (Brazil, Russia, India, China, etc.) are calling for a new ‘global’ currency to replace the dollar as the world’s reserve currency – and China is encouraging its citizens to buy gold and silver – it’s time to pay attention. Regardless of what we’re told through the media – if our government does not take immediate action and change our fiscal policies (massive deficit spending coupled with declining revenues and Fed monetization of our debt) – we are on a path that will lead to the destruction of our currency. This isn’t simply opinion – it’s math. There’s also this little thing called ‘history’ to give us a clear picture of where we’re heading.

Due to what’s happening to the dollar and gold – Chris advises moving your wealth out of dollars (this includes dollar denominated stocks, bonds, etc.) – and into gold, silver, things you need around the house, etc. I couldn’t agree more. Since I don’t believe our government is going to do what’s necessary to prevent a collapse of the dollar (could happen tomorrow, 1 year, 5 years from now) – it’s better to be prepared now. Since we import much of what we buy – when the dollar begins a significant decline in value – things are going to become very expensive for us from a dollar perspective.

John – September 14, 2009
________________________________________

Breakout! – A Closer Look at Gold

Monday, September 14, 2009, 7:02 am, by cmartenson

Executive Summary

• Gold had the highest weekly close ever

• UN calls dollar trading a “confidence game”

• US fiscal deficit breaks all records, keeps accelerating

• Brazil, Russia, India, & China (BRICs) have dollar concerns

• China promotes owning gold to its citizens

• Examining US dollar reserve currency status (again)

Normally I like to switch up my analyses each week, but last week’s look at gold already needs some updating, due to a few important occurrences. There was a blistering array of developments and cross currents this past week that make me suspect we may be entering a new inning of this game.

The first of these is that gold just had its highest weekly close ever:

Of course, this is not an inflation-adjusted number. Gold hit $850 back in 1980, and if we bring that number forward into today’s dollars, it would equal more than $2,200.

However, a brand new all-time highest weekly close, even if not inflation-adjusted, is a matter of some importance for the people who watch such things. Heck, nobody ever inflation-adjusts the Dow Jones for comparison purposes, and I don’t hear much complaint about that oversight, so perhaps we can skip it from now on for consistency.

Looking at a slightly longer-term chart of gold, we can see that the breakout we noted last week has carried on and gone a bit further (like a good breakout should):

Part of the reason for gold’s advance is that the dollar has (again) been faring poorly. However, as we can see in the chart below, the dollar is approaching what I would expect to be a heavy band of resistance right around 76.

Also, the dollar appears to be oversold (MACD, below), or approaching oversold (RSI, above), and is therefore due for a bounce. If it happens, then this is relatively normal market activity; if it does not, then there’s potentially something else at work. That is what I want to explore here.

This week we saw a lot of fascinating and seemingly important information coming from all quarters, which, if I could sum it up, would read, “The rest of the world is getting really anxious about the fiscal recklessness of the US.”

Questioning the Dollar

The opening salvo was launched on Monday with this very boldly worded statement from a UN trade conference:

UN Says New Currency Is Needed to Fix Broken ‘Confidence Game’

Sept. 7 (Bloomberg) — The dollar’s role in international trade should be reduced by establishing a new currency to protect emerging markets from the “confidence game” of financial speculation, the United Nations said.


UN countries should agree on the creation of a global reserve bank to issue the currency and to monitor the national exchange rates of its members, the Geneva-based UN Conference on Trade and Development said today in a report.


China, India, Brazil and Russia this year called for a replacement to the dollar as the main reserve currency after the financial crisis sparked by the collapse of the U.S. mortgage market led to the worst global recession since World War II. China, the world’s largest holder of dollar reserves, said a supranational currency such as the International Monetary Fund’s special drawing rights, or SDRs, may add stability.

A new currency? That would be a rather bold departure from 65 years of dollar-reserve supremacy. The timing of this call couldn’t be more interesting.

It’s kind of amusing that the UN group would try and pin the blame for the “confidence game” on financial speculators, who, by definition, take both sides of the trades. Instead, a confidence game is one where the foundation is one of fraudulent intent, which is a better description of most of the world’s existing fiat money systems than it is of speculators.

Where the UN trade commission couched their calls in some feel-good positioning (“we’re trying to save developing markets from evil speculators”), the deeper meaning that most commentators drew here was that the UN group took a firm jab at the US dollar’s role as the world’s reserve currency.

The fact that the UN is now getting into the game of bashing the reserve role of the horribly mismanaged US dollar tells us that there has been a significant shift in the political winds, specifically among the BRIC countries.

Reasons For Being Nervous

The main reason that any creditor nation starts to fear the debtor’s abilities to repay, or begins to suspect that a reserve currency may not be a credible store of value, is when the debtor/reserve nation converts an ill-advised debt spree into a reckless mess.

Speaking of which, September 8th saw the release of yet another grim budget deficit report by the US federal government, detailing the carnage for August:

In the above table, we note that every single category of federal government revenue, even social insurance (it’s never down!), is negative year-over-year by a collective, jaw-dropping 16.2%.

With personal income receipts down twenty percent and corporate income receipts down fifty-six percent, I am again hard-pressed to believe the claim of a one-percent decline in GDP last quarter.

Said more plainly, the GDP report from the BLS is thoroughly unbelievable and useless. It’s useless because it treats an increase in government debt expenditures as “growth.” And it is unbelievable because it is hopelessly debased by the statistically indefensible practices of applying hedonic and imputation adjustments to the tune of some 35% of the total GDP.

But the government deficit story becomes even more alarming when we look at outlays, which have increased by an incredible 19.8% year-over-year.

While I realize that some will say, “But we’re in an emergency!” we should take care to note the increases in the Social Security, Medicare, and Medicaid outlays. These are only somewhat driven by the emergency, and they are up by between 8% and 24%, indicating that the non-discretionary portion of the federal budget is out of control. However, there are certainly more people entering the ranks of Social Security because they lost work and cannot find a new job, thanks to the recession/depression, and have grudgingly opted to begin taking Social Security as a last resort.

This next article is a good read if you want to understand this new social wrinkle:

Out of Work, and Too Down to Search On


They were left out of the latest unemployment rate, as they are every month: millions of hidden casualties of the Great Recession who are not counted in the rate because they have stopped looking for work.


But that does not mean these discouraged Americans do not want to be employed. As interviews with several of them demonstrate, many desperately long for a job, but their inability to find one has made them perhaps the ultimate embodiment of pessimism as this recession wears on.


Some have halted their job searches out of sheer frustration. Others have decided it makes more sense to become stay-at-home fathers or mothers, or to go back to school, until the job market improves. Still others have chosen to retire for now and have begun collecting Social Security or disability benefits, for which claims have surged.

Back to the story line – one of the main reasons that foreign creditors such as Brazil, Russia, India, and China (the “BRICs”) have begun to openly express their reservations about loaning the US any more money is because of a combined 16% decline in revenue and 20% increase in expenditures.

That’s no way to run a country, and if anybody knows this from cold, hard experience, it’s a BRIC country.

So they peer into the endless parade of dismal US budget reports, like the one I’ve shown above, and they see a path to ruin. If ever there was a reason to be nervous about the dollar, the monthly budget deficit report is it.

Finally, China put its money where its words were by buying $50 billion of Special Drawing Rights (SDRs) from the IMF:

China to buy $50 billion of first IMF bonds


China is buying the equivalent of $50 billion of the International Monetary Fund’s first bond sale in a move that might boost Beijing’s standing in the Fund and help its quiet campaign to expand the reach of its tightly controlled currency.


China took the unusual step of paying for the IMF bonds with 341.2 billion yuan — a currency that is not traded on global markets — rather than dollars, which it uses for much of its trade and other foreign transactions.

While we might note that $50 billion is a relative drop in the bucket, given China’s massive foreign currency positions, it is a first step indicating that China is actively seeking an alternative to the US dollar as a reserve currency.

I consider this to be more of a symbolic step than a meaningful one, because the SDRs represent a basket of fiat currencies, of which the US dollar is only one. Essentially, this move actually increased, not decreased China’s dollar exposure as they traded yuan for the SDRs. On the other hand, the IMF now has a big old pile of Chinese yuan, and I am wondering what they will do with them.

So we might also consider this move less in the context of China obtaining SDRs and more in the context of China finally making moves to get its own currency into play on the international stage. If this is the case, this was an important move.

Gold Has a Booster Rocket

The situation is now so obvious that even Alan Greenspan has spotted it:

Gold Rally Signals Move Away From Currencies, Greenspan Says


Sept. 9 (Bloomberg) — Gold prices that jumped above $1,000 an ounce this week are signaling that investors are buying metals to hedge against declines in currencies, former Federal Reserve Chairman Alan Greenspan said.


The gains are “strictly a monetary phenomenon,” Greenspan said today at an investment conference in New York. Rising prices of precious metals and other commodities are “an indication of a very early stage of an endeavor to move away from paper currencies,” he said.


“What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,” Greenspan said.

I truly do not like to be on the same side of the boat as Alan Greenspan. Over time I have found him to be a nearly perfect fade, meaning that whatever he was up to, it was highly advisable to consider taking the other side. I linked to this article mainly as a cautionary tale help to keep my enthusiasm for gold in check.

I do love that last line in the quote above, about gold as the ultimate source of payment, because to those who have been paying attention, this is not really all that surprising or fascinating at all. Gold is a hedge against the certainty that paper money has been, historically and without fail, mismanaged.

Also, too, I should point out that Mr. Greenspan was hardly the first prominent official to recently propose that gold should be an effective countermeasure against a global epidemic of currency mismanagement.

In fact, the President of Russia said as much last July, but more subtly:

G-8 ‘World Currency’ Coin’s Creator Seeks Russia Participation


July 15 (Bloomberg) — The gold coin displayed by Russian President Dmitry Medvedev at last week’s Group of Eight summit as an illustration of how a future global currency may look, may be made at Russian mints, its originator said.


Medvedev pulled out the coin at a news conference on July 10, saying: “Perhaps one day something similar could appear. You would be able to hold it in your hand and use as a means of payment.” Leaders at the summit in L’Aquila, Italy, received the coin as a gift, said former journalist Alessandro Sassoli, author of a project he calls “united future world currency.”


“We are thinking of involving Russian mints and school students” to find a name for the currency in a competition involving a thousand schools worldwide, Sassoli said by e-mail. He provided Medvedev with a cover letter describing the project and asking for his opinion.


The coin, resembling a euro, is 29 millimetres in diameter and weighs 15.55 grams of pure gold, Sassoli said. As many as 20 gold and 150 silver coins have been minted. Sassoli said the G-8 organizers and Italian Prime Minister Silvio Berlusconi’s government asked for 13 gold and 10 silver coins for the summit.

The story here is quite revealing, as it demonstrates that the Russian President went so far as to commission the Belgian mint to make a set of demonstration gold and silver coins in order to propose an intrinsic gold and silver backing for a new global reserve currency. I absolutely did not expect to hear such proposals from such high levels for another five to ten years from now.

This says quite a lot about the mindset of at least one BRIC country (Russia), and this next article reveals the mindset of another:

China pushes silver and gold investment to the masses


We are indebted again to Paul Mylchreest’s Thunder Road Report for news that will bring big smiles to gold and silver investors everywhere. Apparently China is pushing the idea of buying gold and silver for investment purposes to the general population in the way that Western television sells soap powder. If 1.3 billion Chinese citizens start buying gold and silver, even in tiny quantities, imagine what that will do to the market!


The report notes that China’s Central Television, the main state-owned television company, has run a news programme letting the public know how easy it is to buy precious metals as an investment. On silver investment the announcer is quoted as saying “China has introduced its first ever investment opportunity for silver bullion. The bars are available in 500g, 1kg, 2kg and 5kg with a purity of 99.9%. Figures show that gold was fifty times more expensive than silver in 2007, but now that figure has reached over seventy times. Analysts say that silver has been undervalued in recent years. They add that the metal is the right investment for individual investors and could be a good way to cash in.”


What appears to have happened in China is a total relaxation of strictures on holding precious metals by the individual with the government pushing gold and silver as an investment option, seemingly at every opportunity. This is a far cry from the situation only a few years ago where the distribution of gold and silver was strictly controlled. Now, the Thunder Road Report notes that every bank will sell gold and silver bullion bars in four different sizes to individuals and gold related investments are said to be soaring in popularity.

There are two ways to increase your country’s holdings of gold and silver, if that is an aim. One way is for the central bank or government to buy precious metals in the open market. This naturally tends to have a volcanic impact on the precious metals markets, and it is usually done as surreptitiously as possible. The other way is to encourage your citizens to buy them on their own.

Both result in more gold and silver crossing and remaining within your borders. All indications are that China is now running both strategies for increasing gold and silver holdings within the country.

The Golden Boom

In all the years that I have been watching gold and silver, the above news items constitute about as important a set of developments as I’ve ever seen.

From a monetary standpoint, I am thrilled that some countries are openly questioning the wisdom of allowing individually-managed fiat currencies to dominate and dictate the terms of international trade, and especially that they are questioning the role of the US dollar, which is being managed in a way that would make a third-world dictator blush.

I personally view these developments as the beginning of the end for the US dollar as the world’s reserve currency. If the US government does not read the signs appropriately, it runs the risk of mistakenly losing its vaunted reserve currency status. If that happens, the US will rapidly discover that it did not actually hit a triple; instead, it was granted third base by an overly kind umpire who has been overruled and replaced.

On a related note, I was quite surprised by the news that the US decided now was a good time to hit China with some heavy import tariffs on tires. Given all that’s been going on, I wonder if this is really the best time to be wagging stern fingers in China’s direction.

I track the price of gold because it might give us an early indication about what’s going on behind the scenes.

The smoke signals indicate that a tectonic shift in appetites for and attitudes about the US dollar is underway.

What Happens If the US Loses Reserve Currency Status?

As I wrote this past week in the Martenson Insider, Poland recently suffered a failed bond auction, meaning that investors did not buy all the government securities offered by the Polish government. Naturally this is a terminal sort of event, and the US is not yet (seemingly) near that same fate. If or when it does, everything will change.

The signs that we’ll be looking for that will indicate that the US dollar is losing its grip on the world will be both a decline in the price of the dollar relative to other currencies and a rise in US Treasury interest rates.

For now, the dollar is falling, but Treasury interest rates are holding firm, so according to this pair of indicators, it seems that we are “not there yet.”

But if (or when) this does happen, the most obvious and immediate impacts will be the imposition of capital controls (blocking the flow of money out of the country), an immediate increase in the price of most commodities, a skyrocketing gold price, rapidly rising interest rates, and quite probably a banking holiday (because the big international banks would be quite paralyzed by the capital controls).

One other predictable ‘feature’ of a dollar crisis would be an FDIC funding crisis. For now, the FDIC will insure $250,000 per account, and it has a $500 billion line of credit from the Treasury, so all is well for the moment.

But this means that if the Treasury has a funding crisis, the FDIC has a funding crisis. For this reason, the moment I detect that a dollar crisis is underway, I will personally be removing, converting, or spending my bank-deposited funds as rapidly as I can, in case the banking system seizes up and lacks the funds to operate. While this is a remote chance, it is a non-zero chance.

Needless to say, a funding/dollar crisis would result in another body blow to the US economy, which will, of course, only exacerbate our existing and future problems.

Because I view the probable outcomes of a dollar crisis to be so severe, I would support any and all measures to curtail federal government deficit spending and Federal Reserve monetization of debt. Unfortunately, these actions would undoubtedly be immensely unpopular with politicians and crowds.

However, sooner or later we will have to bite the bullet and admit that we are never going back to our former levels of growth and consumption and that we’ll have to go through a period of austerity, saving, and investment. My strong preference would be to do it now and not further add to our risks by increasing our borrowing and spending, but that’s not even remotely the same tune that DC is currently humming. And China knows it, too.

I am personally concerned by the pressures that I see mounting in the international arena, and I think gold is one signal telling us that something is not quite right.

Conclusion

Gold broke out and closed the week at a new high. This is an important development, both because it has meaning all on its own and because of what it is potentially telling us about things happening beneath the surface.

There’s enough smoke coming from a variety of news sources and foreign countries to suggest that we might even glimpse a bit of flame. Under all of this pressure is the deep-seated concern by creditors to the US that the US is operating in a fiscally ruinous manner and shows no intention of willingly changing course.

Reserve currency status is an “exorbitant privilege” (credit: Valéry Giscard d’Estaing) that has conferred tremendous advantage and latitude to the US. Loss of this privilege would result in a very sudden drop in US standards of living and impose harsh austerity measures to which the US is only accustomed to being on the giving, not receiving, end.

Instead of adopting a humble stance, the US appears to be digging in its heels, most recently exhibited by the imposition of import tariffs on Chinese-made tires.

Meanwhile the BRIC countries are talking about and taking significant action towards limiting their exposure to the US dollar, and they have been extraordinarily vocal in recent weeks and months in their attempts to prompt a serious discussion of the matter by other countries.

The US is playing a dangerous game and risks an even more serious economic and financial adjustment by running deficits that would simply not be tolerated in any developing country. Should this lack of imposition of two-way austerity reach the breaking point, a dollar crisis would be the most likely result.

As always, when I see mounting risks, I would vastly prefer to be a year early than a day late.

This would be a good time to continue to move your wealth out of dollars and into other forms of wealth. I am currently a big fan of direct wealth in the form of productive land (soil, trees, hydropower), gold and silver, and anything that you might need around the house, especially any critical items that are imported.

__________________________

UN Says New Currency Is Needed to Fix Broken ‘Confidence Game’

Bloomberg

By Jonathan Tirone

Sept. 7 (Bloomberg) — The dollar’s role in international trade should be reduced by establishing a new currency to protect emerging markets from the “confidence game” of financial speculation, the United Nations said.

UN countries should agree on the creation of a global reserve bank to issue the currency and to monitor the national exchange rates of its members, the Geneva-based UN Conference on Trade and Development said today in a report.

China, India, Brazil and Russia this year called for a replacement to the dollar as the main reserve currency after the financial crisis sparked by the collapse of the U.S. mortgage market led to the worst global recession since World War II. China, the world’s largest holder of dollar reserves, said a supranational currency such as the International Monetary Fund’s special drawing rights, or SDRs, may add stability.

“There’s a much better chance of achieving a stable pattern of exchange rates in a multilaterally-agreed framework for exchange-rate management,” Heiner Flassbeck, co-author of the report and a UNCTAD director, said in an interview from Geneva. “An initiative equivalent to Bretton Woods or the European Monetary System is needed.”

The 1944 Bretton Woods agreement created the modern global economic system and institutions including the IMF and World Bank.

Enhanced SDRs

While it would be desirable to strengthen SDRs, a unit of account based on a basket of currencies, it wouldn’t be enough to aid emerging markets most in need of liquidity, said Flassbeck, a former German deputy finance minister who worked in 1997-1998 with then U.S. Deputy Treasury Secretary Lawrence Summers to contain the Asian financial crisis.

Emerging-market countries are underrepresented at the IMF, hindering the effectiveness of enhanced SDR allocations, the UN said. An organization should be created to manage real exchange rates between countries measured by purchasing power and adjusted to inflation differentials and development levels, it said.

“The most important lesson of the global crisis is that financial markets don’t get prices right,” Flassbeck said. “Governments are being tempted by the resulting confidence game catering to financial-market participants who have shown they’re inept at assessing risk.”

The 45-year-old UN group, run by former World Trade Organization chief Supachai Panitchpakdi, “promotes integration of developing countries in the world economy,” according to its Web site. Emerging-market nations should consider restricting capital mobility until a new system is in place, the group said.

The world body began issuing warnings in 2006 about financial imbalances leading to a global recession.

The UN Trade and Development report is being held for release via print media until 6 p.m. London time.

To contact the reporters on this story: Jonathan Tirone in Vienna at jtirone@bloomberg.net

Last Updated: September 7, 2009 09:52 EDT

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