Has the G-20 Saved the Financial World? Is the Gold Bull Market Over?
The G-20 has authorized $1 Trillion in Funding for the I.M.F. The Trade package and the beefing up of the I.M.F. were achieved how? Through the synthetic currency of the I.M.F. the S.D.R. [the Special Depository Receipts] and additional U.S.$ to boost the body internationally. This new money is being freshly printed. Yes, they are 'created'. Just as "Quantitative Easing" relies on newly issued dollars, so does the international funding the G-20 has issued. The difference is that this policy is an international issue of money so will not be seen in any national context.
Will the Plan work?
It may well salvage international trade, just as new bank financing will salvage banks and it will. But we hear you ask, "Will this de-base money in general". Well, not yet. The credit Crunch is estimated to have wiped away 45% of the world's wealth. This new money is intended to simply replace that so that no damage is felt and toxic assets are neutralized in the system. Once health is restored to the banks, it is hope that the 'toxic assets' will have a higher value and can eventually have their sting taken from them. We fully expect the markets in general to rebound on this news regaining a great deal of the 45% of the lost wealth the credit crunch caused. At that point the central bankers of the world hope to be able to suck out excess money as markets recover. Technically this sounds reasonable. The problem is that the world has been sensitized to such an extent by the credit crunch that any attempt to raise interest rates or reduce money supply will hurt confidence quickly and deeply. As Alan Greenspan stated in a recent article, "We have never successfully modeled the transition from Euphoria to fear". And so it will be in the future should any attempt be made to reduce liquidity in the system before an even stronger level of confidence is achieved than we saw pre-credit crunch. And it is from this base that we will see inflation soar, once a visible recovery is underway.
To date the markets reacted in such a way as to tell us that they believed U.S. stimuli will work and so far that the G-20 plans are a success. In fact there are only two ways ahead for the global banking system.
Either, the schemes will fail, in which case financial mayhem will break out worldwide and we will move into a Depression, as bad, and if not worse than the late twenties and thirties of the last century.
Or the scheme will succeed. This will clean up bank Balance Sheets. Thereafter the quantitative easing must have been so great that it will not pay banks to hoard funds and restrain lending. Until there are signs that the housing market is trying to turn up we cannot accept a genuine recovery is underway. This will re-establish confidence in the system, we hope.
The moment global confidence is threatened [and it will be fragile and skittish] it will collapse far faster than it did before. So Mr. Bernanke et al, have to follow a very delicate process to remove inflation if he is to attempt it at all. We believe that the consumer is not so simple, making the task of sucking inflation out of the system a decade long experience.
G-20 saves the World?
With the loud cheering going on at the moment it would be easy to think that gold should be dumped because all is well now having been saved by the G-20. From Monday onwards, as the euphoria subsides, clearer eyes will look at what's happened. It is, after all, more than a simple matter of confidence levels. Confidence in the banking system and the housing markets will have to accompany confidence in the monetary system. Yes, the world has no other option than to use the monetary system, but as to confidence in it, with such a new issue of money, this may prove to be a more delicate matter? Today is different from when the credit crunch first struck, in that if the plan does stumble, there won't simply be a recession or a manageable currency crisis [attended by more new money issuances through currency swaps], there will be financial mayhem on a scale not seen for generations. The trust in hallowed financial institution [para-statal ones in particular!] will also sink and as for international institutions they could become a mockery.
So is the plan G-20plan so believable as to knock the gold price off its upward trend and out of the Bull Market?
Gold going forward?
We think not! The last few months have seen a deflationary environment and gold has risen in that climate. Gold has two remarkable qualities one of which was responsible for this. It is a form of cash, of money! This has so far provided protection in the deflation we have suffered. Secondly, it is an inflation hedge because it is an asset as well. The scheme of President Obama's Administration is without doubt massively inflationary, requiring a move from cash to assets if wealth is to be preserved. This will add to gold's qualities for gold will still be attractive whether the coming financial climate is good or bad. As history has shown, whether in deflation or inflation gold gives protection from both and preserves wealth.
There is a strong case to be made for inciting inflation on purpose, for debt is a bigger threat to the system than savings right now. Inflation whittles away debt [as well as savings] and encourages a quick increase in the velocity on money. This is needed to prevent hoarding by banks and savings by consumers. So, strange as it may sound, the system needs inflation. This will lead to money pouring into assets for protection, away from deposits. Cash and interest returns from cash, becomes a bad investment. Spending spurs production recovery and in turn, a revival in manufacturing overall. A strong manufacturing sector is a prime sign of a healthy economy. The recovery will then gain traction and the consumer will be back in the driving seat going right back to where we were before the credit crunch.
And then? A permanent disability caused by the credit crunch will be its dependence on the consumer and on his confidence in the system. He has been wounded badly and will be very careful not to fall into the hole he is in now. This means that inflation will be part of our lives for the next decade or more. Whether Mr. Bernanke succeeds in controlling inflation or not, he will live with it as an inherent part of the system. This keeps gold in the limelight.
As attitudes turn from the desperation of deflation to the recovery of banking and the advent of inflation, gold may pause in its rise, briefly but will then rise again in inflation. Certainly it has garnered a great deal of confidence in the last few months and earned its place in portfolios of all kinds.
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