Paper Promises, Golden Hordes!

• Gold is signalling a coming currency crisis. We are already seeing it in countries like Vietnam. The Vietnamese populace have been buying up gold and driving gold prices to US$1,300/ounce internally. The Vietnamese Dong has weakened considerably. As more Vietnamese sell their Dongs to buy USD to buy gold, the Dong will be under more pressure.
   
• India and Sri Lanka are the 2 new additions, of central banks, who have publicly announced they are buying gold. What most people don’t realize is that it is a repudiation of the USD. Central banks around the world are increasingly worried about the fiat USD world reserve currency. We will see this trend continue and more countries will be settling their international trade in gold (ie not in USD). The major nail in the coffin will be when the Persian Gulf Oil countries abandon the USD in the oil trade. They will likely adopt a basket of commodities and gold.
   
• Gold is not so much an inflation hedge. It is more of an insurance policy against profligate government spending, financial crisis and monetary collapse. The Economist reports:
    
  TWO hundred metric tonnes of gold would occupy a cube of a little more than two metres on a side; it would fit into a small bedroom. But India’s purchase of that volume of gold from the IMF last month has had an outsize impact on the markets, helping push the price well above $1,100 a troy ounce.
   
  For bullion bulls, the implication is clear: central banks no longer trust the creditworthiness of other governments. And if they have lost confidence, private investors should do the same. The next step in this chain of reasoning is to assume a stampede (or at least a quick trot) by other central banks into holding the yellow metal. Gluskin Sheff, a Canadian asset-management firm, suggests that if China followed India’s lead, bullion could hit $1,400 an ounce.
   
  However, it is a big leap to assume that Asian central banks are abandoning the dollar. Even after the purchase, gold will be just 6% of India’s reserves. In any case a headlong retreat from the dollar would be counterproductive, since it would damage the value of Asian central banks’ existing holdings of Treasury bonds and bills. And those countries, like China, which peg their currencies against the dollar, are forced to buy large amounts of Treasuries as part of that strategy.
    
  It may be that, at the margin, central banks would like to increase the proportion of their reserves that are held in the form of bullion. The nature of reserves is that they insure against emergencies. And in an emergency gold is more likely to hold its value than paper money.
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  Some of the more pessimistic commentators see the recent credit excesses as the inevitable consequence of a system based on paper money and call for the return of the gold standard to prevent future crises. This column has argued that the current system is unsustainable. Debtor countries like America and Britain have huge fiscal deficits, but retain at the same time the ability to depreciate their currencies and offer near-zero interest rates on their short-term debt. This does not look like a good deal for creditors.
   
  A gold standard clearly protects the interest of creditors since it ties the value of money to a scarce resource. A government cannot create new gold. But the law of volatility applies. If you fix one part of the economic system, trouble has to show up elsewhere. When countries on the gold standard suffered a shock they had to let the real economy, rather than their currencies, take the strain.
     …….
  Given the Depression it is hard to see governments ever wanting to tie their countries to a gold standard again. But the result is that foreign creditors have a right to be more suspicious of debtor countries. Even if they do not resort to outright default, they can always achieve partial default through currency depreciation.
   
  Indeed, the law of volatility can be invoked again. Developed-country governments have attempted to control bond yields through quantitative easing and to support stockmarkets through ultra-low interest rates. But they cannot support their currencies as well without risking problems in the bond and equity markets. Gold’s surge may indicate that investors fear the next stage of the crisis will occur in the foreign-exchange markets.

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