The S & P ratings agency finally dared to downgrade U.S. debt from
triple to double ‘A", and quite rightly. It was not a reflection of the
ability of the U.S. to pay their obligations, but of the politics that
allowed partisan interests to take higher priority. The message was sent
to Congress over the entire period of the ‘debt-ceiling" soap opera,
even by the most responsible of U.S. monetary figures, Treasury
Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke,
but to no avail.
When the wrangling finally stopped and an agreement was reached, it was
totally inadequate --cutting spending by 0.5% of GDP against a deficit
of 10% of GDP -- for addressing the U.S. debt situation. Confidence
visibly withered in the week ahead of the downgrade and when it came,
the emerging world, the largest of U.S. creditors, ran for the hills and
announced the world needs a new global reserve currency.
Add to this the decaying Eurozone crisis, which has progressed to the
point where, through ‘contagion’, it may have to bail out Italy and
perhaps Spain, as well as Ireland, Greece and Portugal. The German
appetite for these additional crises is disappearing, as it wipes out
the benefits the E.U. has brought it. The E.U. is now moving towards a
crisis. The combination of crises on both sides of the Atlantic is just
too much weight to bear for the developed world"s monetary system.
Alongside these crises, expect a banking crisis.
As important as the S & P downgrade were the actions by the Bank of
Japan and the Swiss National Bank. With their currencies seen as
‘safe-haven" currencies by the world, the actions of the two central
banks to forcefully weaken their currencies destroyed their safe-haven
qualities. This has left the developed world without a safe-haven
currency. You will see speculators continue to buy the Yen and the Swiss
France because they have more inherent strength than other currencies.
Every time these two central banks sell their currencies to weaken them,
they offer their currencies at prices speculators believe are lower
than they should be. This invites more buyers and speculation. The
central banks eventually have to weaken their currencies until they have
lost this inherent strength.
The ‘carry" trade -- investors who borrow in a weak, low interest rate
currency and invest in a higher interest rate paying currency -- were
alarmed as the moves raised the risk levels in their trade. Every
currency on the planet relates to another. The South African Rand moves
against the euro, because the bulk of its trade is with the Eurozone.
Canada"s trade is almost entirely dependent on the U.S. dollar. The
Chinese Yuan is almost tied to the U.S. dollar, et cetera. But there
still remain the ‘carry" trade opportunities of interest rate
differentials. These will only disappear when the volatility levels on
these currencies wipe out such opportunities.
What does this all add up to? Confidence in all currencies is withering
fast. It has become more than apparent that all the world currencies are
failing to provide a measure of value. For example, if the price of
potatoes in the USD is $3 for 7kgs and then the dollar halves in value,
it appears that the price of potatoes has doubled; however, it hasn"t.
The price of the dollar has halved and the price of potatoes has
remained steady. So when we hear people say that the gold price has shot
up -- it hasn"t. The price of the dollar, the euro, the peso, the Rand
-- have all fallen.
The 40-year long experiment of currencies with no backing other than
their own economic and political performance is starting to reap its
consequences.
It was, after all, the ultimate confidence trick!
That it has lasted 40 years is remarkable.
The credit crunch since August 2007 has brought un-backed currencies
their greatest test to date, and it is threatening the developed world"s
banking systems as well as the world"s leading nation"s debt positions.
Manipulating the exchange rates of currencies will not resolve their
underlying crises. At best such exercises are temporary measures, which
usually end in failure.
After a currency ‘bull" market lasting 40 years we are now in a ‘bear" market.
Like the potatoes mentioned above, the price of gold appears to be
shooting up, but in reality it isn"t. It provides a globally accepted
measure of value, which in times of financial stress, appears to rise.
But the fact that it takes more U.S. dollars to buy gold than before is
more an expression of the decline in value of the dollar.
The acceptance of this reality takes a change of mindset. Such a change
is brought about by one or more crises, which forces the change. Ten
years of rising gold and silver prices has not brought this about yet,
but now that the crises have reached a new plane, the change is coming.
Why does it take so long? Our human nature is to look for and find easy
and trusted ways to understand markets. Relationships and formulae are
found that allow this and then our reliance on ‘experts" kicks in. Only
when these experts fail to produce the results we looked for, do we
re-assess this way of working.
Often we need a swirl of confusion to force us to let go of the old ways
of thinking. Once in the new investment climate we eventually find
another ‘expert" to guide us to a new way. This completes the change.
Today we need to adjust to the fact that currencies are in a ‘bear"
market and gold is simply reflecting this, before we get it right. We
were perhaps the only services to state clearly that the price of gold
and silver would not fall on the signing of a new debt ceiling
agreement.
There is a great need to understand that gold is far more than a
commodity, far more than in a ‘bull" market. There is a structural
change going on in the developed monetary world that will entirely
change the financial in which we live. If developed world central banks
persist to ignore it, then the change will be forced on them in
catastrophic ways. We are beginning to see this. The markets will accept
the changes probably before the central banks do, but in the end
central banks will have to accept them.
One of the key changes is that the gold price will not go into a ‘bear" market, nor will a gold ‘bubble" burst.
(Julian Phillips, a long time specialist analyst of the gold and
silver markets, wrote the original article for Gold Forecaster.)