Too Big for Gold and Too Big to Handle: Major Funds Dominate the Global Economy

Source: Julian D.W. Phillips, Gold Forecaster - Global Watch  (10/19/07)

...While the gold market is just too small at the moment and will be until several noughts are added to the $ gold price, it cannot provide any protection for these monsters of money, but it is a place to protect yourself, if you are an individual or smaller institution...


Their appearance has been sudden spread over just a few recent years. For the rapid growth of sovereign wealth funds, petrodollar investors [government controlled], hedge funds, and private equity groups [profit seekers] poses risks for the world economy as large as themselves. The prospect of major financial tsunamis can come from these monsters of capital. How big are they and just how big is the danger? Asset bubbles, excessive lending, market distortions, and bank failures are all possible consequences as we are seeing right now in the U.S. and Europe and much further afield.

For all of their benefits, the rise of these funds pose awful risks to the global financial system, the first of which is on us in the “Credit Crunch” we are seeing unfold on a nearly daily basis now. The threats are different with each group, the nationally dominated group and the private profit-seeking group.

— The non-governmental funds are there for profit and provoke price changes as a way of profiting often, or change positions as fast as they can, if profits threaten to dissipate. They can be a source of heavy and persistent volatility in currencies and markets, should it suit them.

— Governmental bodies move carefully and slowly, so as to protect the longer term benefits of their investments. But when they move, they are large enough to change investment currents and dominate trends.

Evidence of their influence is seen in real estate values in developed countries, which have increased by $30,000 billion between 2000 and 2005, far outstripping economic growth. This partly reflected property purchases by petrodollar investors but was also a side effect of lower interest rates caused by investment in government securities, especially in the U.S., by Middle Eastern and Asianinvestors as well as the private investors. They, alongside European investors are suffering the pain of the present credit crunch associated with property, but they are unlikely to go bust.

The size and leverage of hedge funds, their nepotistic relationships with their banking creators threatened the sort of contagion we saw in July when the sub-prime crisis exploded. [Please note that these funds are outside the banking system, but usually under their control] So as we are still seeing in the on-going ‘credit crunch’ damage amongst them feeds through the entire banking system, as they are interrelated through syndication and markets. This crisis is by no means over as we are now seeing in the bankruptcy of the Dublin based Rhinebridge, a Structured Investment Vehicle and one of its Investors in Germany, IKB Deutsche Industriebank AG today, which has lost about half its value and is unlikely to repay all its debt. Their fall can be attributed to the dramatic growth in high-yield debt, and lax lending covenants to satiate demand from private equity groups. Such easy lending of itself increases credit risk.

Oil investors, Asian central banks, and hedge and private equity funds collectively held $8,400 billion in assets at the end of 2006. These assets have tripled since 2000 and they are now equivalent to 40% of the size of the world's pension funds and a similar proportion of global mutual funds. Altogether, they represent 5% of the world's $167,000 billion in financial assets. With $ deficits, rapidly rising oil prices and massively growing $ surpluses in the hands of mainly Asian and oil producing nations their growth rate has been meteoric. Between 2000 and 2006, the assets held by Asian central banks grew by 20% a year, four times as quickly as the world's pension funds. At the current growth rate, the assets of the four groups will exceed $20,000 billion in five years' time, 70% of the size of the world's pension funds. Biggest of the four is the petrodollar reserves, which has grown rapidly after a tripling in the oil price since 2002 to up to $3,800 billion in foreign financial assets. At a minimum pace of growth on an oil price less than half the present one petrodollar assets would continue to grow rapidly over the next five years. Using the base of $50 oil, an extra $1 billion a day will pile up in the financial markets by 2012. Take that higher to the $80 level and it rises to $1.6 billion at least, a day.

Central banks, mainly those of China and Japan, are the next most significant player, with $3,100 billion held in foreign reserve assets at the end of last year. Most of this has found its way into U.S. Treasury bonds, helping keep interest rates artificially low. The central banks of China, South Korea, and Singapore have announced plans to shift a collective $480 billion into more diversified assets. Clearly they will aim to keep the buying power of the $ high, so that they don’t face losses in their reserves, but they hold so much this is impossible to do with a declining $.

Hedge funds are less significant but have still grown from less than $500 billion in 2000 to $1,500 billion today. Together with the leverage they typically employ, hedge funds could have $12,000 billion of financial firepower by 2012.

Now this has the potential to make the recent credit crunch look tame. Their interests are specific, national, bottom line oriented and respect no foreign domain in which they are invested. If the global major Central Banks put a foot wrong in this present delicate situation, the quake that sets off the tsunami of capital flows we have repeatedly warned of will happen.

These can no longer be ignored or thought of as a blessing to stimulate long-term growth, in these smaller emerging nations, except where they are tied into securing future resources for the developing East [effectively passing ownership of their resources to foreigners in exchange for some infrastructural developments].

We live in a pretty integrated global economy, where the web of banking has already shown that what happens in one nation, spreads across the oceans, in a heartbeat. So small nations receiving these massive inflows of capital, could see them withdraw, not for local reasons, but those lying outside the nation. So, brace yourselves for more Capital Controls such as those we are seeing in India now, as it seeks to protect its Rupee against inflows of capital.

Expect higher interest rates in these nations as inflation takes off as a result of the inflows, but more aggressively, expect Capital Controls to prevent this ‘hot money’ from draining capital from these emerging countries and also expect Capital Controls from even the largest nations on earth to prevent foreigners as well as locals from controlling the well-being of their economies by withdrawing major amounts of capital from them.

We live in a financially dangerous world now, with the warning lights flashing brighter and brighter.

While the gold market is just too small at the moment and will be until several noughts are added to the $ gold price, it cannot provide any protection for these monsters of money, but it is a place to protect yourself, if you are an individual or smaller institution.

And even though the gold market cannot provide a haven for such massive amounts the dangers posed by these monsters will ensure that the gold price will rise to much greater heights when any of these funds quake in crisis and send out financial tsunamis, as confidence in the system buckles yet again.

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