Gold, the Dollar and the Failure of Currencies

Source: Julian Phillips, Gold Forecaster  (8/24/11)

"The U.S. Fed and Congress want to see a far weaker dollar against all other currencies. The only thing stopping them is the structure of the currency system."

In the last two weeks we have seen the strongest and most respected currencies being purposely weakened by their own central banks. It is at times like these, when the going gets tough that national monetary priorities are fully exposed. There are major dangers in these policies because of the role that currencies have played since gold was written out of the monetary system in the early seventies. Then the role of currencies was broadened to include:
  • Being used to engineer growth or curb growth in national economies.
  • Being used to engineer price stability.
  • Being used to measure the value of assets.
  • Being used to develop a global economy and money system.

What's Going Wrong?
These roles conflict with each other!

The system has worked to date because the world has seen growth from the early 1980's to 2007 and hardly any strain was felt during those years. But a system is always tested under pressure and pressure we have had since 2007 when the 'credit crunch' hit hard.

Like an individual, if a nation has too much debt the value of his financial commitments must fall as his ability to repay comes into question. If his income drops, then his creditors have cause for worry. If his potential for increasing that income is undermined by competition then doubts grow as to his future competence. If he has issued IOU's far and wide and it becomes clear that these may not have the value they were deemed to have, then worries rise about the future of his business.

Now add to the above that all other businesses rely on his business and behavior for their own success and reputation and one can appreciate the dangers the entire system faces. If his success and performance is the arbiter of his and all other business's value then one has good reason to question the future and value of the entire monetary system.

The System's Foundation
For forty years now the U.S. its economy and its currency have been the bedrock on which the developed world has built itself until today. Since Nixon cut the link between gold and the dollar, currencies have depended solely on the state of the U.S. and its economy. Amazingly, in 1971 all the developed world went along with the U.S. and cut their own links with gold, preferring to rely on the U.S. dollar as the final measure of value. All currencies operated with reference to the dollar and still do, so none can operate independently now.

In times of currency turmoil investors have been inclined to move from the dollar into 'alternative' currencies whose Balance of Payments was stronger, giving the currency a seeming measure of independence and value. And this worked, provided the pressures on the dollar and alternative currency were not too heavy. "Hot money," [the Carry Trade] which allowed investors to borrow cheap and lend at higher interest rates was never so heavy as to threaten the economy of the borrower or the exchange rate of a nation.

The system worked well for forty years and the world grew richer by the day, with development spreading far and wide. But all was dependent on the dollar, which in turn was dependent on the U.S. economy, which in turn relied on the dollars in the national and global economies. And today the dollar remains the lifeblood of the world's monetary system.

The Breakdown of Currencies and the Dollar
Even when the pressure started to hit, there was always a refuge currency to run to, to get value, such as the Deutschmark or the Swiss Franc or the Yen. But then came 2007 and a huge rock was thrown into the pool of calm, growth and stability. First, the dollar started to sag as its financial excesses began to reap their crop. The euro became the reference currency for the dollar and looked like it would rise to $1.70 at one point, but it only made it to $1.50 before its own woes became apparent. The monetary authorities on both sides of the Atlantic then realized that the rate between the euro and the dollar was the fulcrum of the entire currency system worldwide. This exchange rate had to be kept stable at all costs. With the banking system needing intensive care on both sides of the Atlantic, floods of newly printed money appeared through quantitative easing, currency swaps and other money creation techniques. It became clear that despite inflation being apparently contained, dark deflationary forces were at work to balance the money system and again give the appearance of stability. But everybody realized that currencies were failing in their task of providing measures of value. The economic, banking and debt catastrophes gave clear evidence that a breakdown was taking place in the monetary and currency system, at first focused on the U.S. dollar, then the euro joined in the fray.

Because of the interdependence of currencies a new phenomenon appeared. It started with China 'pegging' its currency to the U.S. dollar at a rate that gave it a huge trade advantage globally, on top of the cheapest skilled wage levels in the world. But then other nations, realizing the importance of exchange rates in international trade, weakened their currencies in line with the falling value of the dollar. Those nations that still focused on curbing inflation at home, soon found their exchange rates soaring, destroying their export profitability in the process.

Again, all seemed to be coping with the new 'race to the bottom' of the currency value chain. That is until the latest bout of Eurozone debt crises. Then the Swiss Franc and the Yen became the ultimate targets for those seeking to hold onto the value of currencies. The Bank of Japan, already fighting the effects of the tsunami and the Swiss National Bank, saw their currencies rise to the point where their economies were threatened. They had to follow the rest of the world and debase their currencies, through exchange rate intervention and quantitative easing, which they did. Yes, they are struggling to do this with the Japanese needing a Yen at 80 to 85 to the dollar [currently at 76.57 to the dollar] and the Swiss needing 0.80 Swiss Francs to $1 [currently at 0.7891].

The Result
Is there a currency left where one can keep one's wealth? Is there any one currency that will hold its value against assets, not just in the short-term but for a long, long time? No, those days have now gone! The currency system is now incapable of measuring strength or weakness or value through exchange rates, anymore.

The currency system has been defeated!

Oh, the system is still working. After all, where else can business and banks go? But the search for an alternative value retainer was over a long time ago. Since the turn of the century and since 2005 both gold and silver [two years ahead of the credit crunch] have been reflecting the falling value of currencies. Perhaps one thought that oil would do the job too, but that 'spiked' to $145, fell to $35 and then rose again to $100. Clearly, producers can manage the price of that commodity too.

The concept of value has now been lost almost entirely by paper money, with nothing standing surety behind currencies –which are simply government promises to pay more paper. Gold and silver have reflected value in the last decade. It looks so much like they have risen in price astronomically but have they really? Yes, their markets have grown into global markets and attracted demand never seen before, but every investor has believed that both gold and silver would and will hold value in the future. From $275 to the current peak of $1,900 is a nearly sevenfold rise and more is expected. Investors have to ask themselves has gold risen or have currencies fallen? The answer will pave the way of their success or failure.

Will Gold Fall Now or Rise Further?
Perhaps we should ask instead, "Will currencies rise now or fall further?" A glance only, at the problems facing nations, their money and their economies does not inspire confidence. Instead, we feel a sinking feeling when we look forward. Is a recession setting in again? If so, it is on the back of a considerably weakened system no longer able to bear the blows it suffered when the credit crunch first hit. Are governments able to resolve the developed world debt crises? Can they make the banking system healthy and begin lending profusely? Can economic growth be restored to the point where consumer confidence is resuscitated? By this we mean, as the employee said to the employer, "if you want confidence back to former levels, where you retrenched one employee, you must employ two more."

It doesn't look like it does it? So, is there a good reason why one should get out of the gold and silver markets?

Is there a good reason why they should stop rising? Have currencies stopped falling? As you know, our target is $2,090 and we are just about to enter the 'gold season'. When we gave you that target, it was the first price at which we expected a consolidation and perhaps a correction. Then we would look at the picture again and revise our targets. This does not mean that we believe that is a peak. We will only know that when we are there.

In these markets with central banks picking up gold as it appears on the market, the corrections are shallow. Once demand reappears, it has to push prices up to get the metal. Any attempt to chase prices too high see emerging market demand evaporate, as we have seen this week. Then the price pulls back to the level of the last London Fixing, where it pauses before the next move up. Physical demand remains professional, but robust and happy to see prices rise. Central banks for one have no illusions about what is happening to currencies. They see the need to build stocks of gold for themselves. These are not the actions of speculators but hardened monetary professionals who do appreciate real value. If they are continuing to buy, what should you be doing?

Will Gold and Silver fall now or rise further?

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