Safe Haven | A Credit Crisis? No its a Confidence Crisis! What's Next for Gold?

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October 10, 2008

A Credit Crisis? No its a Confidence Crisis! What's Next for Gold?
by Julian D. W. Phillips

Events on the banking, credit and foreign exchange fronts are behaving in a startling and frightening way. Not only are equity markets crashing but currencies are worrisome especially now with what appears to be a strong $, but falling against the Yen. We saw a dropping € against the $, with the news from the Eurozone confirming it is infected with the same financial virus as the States. With both currencies weakening, their relationship to each other is losing relevance as they fall against gold. This is now confirmed as gold broke through the $900 barrier this week. Yes, as the currencies are falling against gold, it's not simply a credit crisis out there. Let's call a spade a spade; it's a confidence crisis!

Confidence in the banking system has been mortally wounded. This is contracting the global economies [maybe Asia can limit the decay in its own system?]. Central Banks are in danger of losing their own credibility as the crisis persists and as they slash interest rates. After all, it's not a matter of rates, but confidence in the entire system and its instruments. Investors are seeing their own wealth fall victim to the markets on a daily basis and are searching for something that can avoid that decay. If profits can be made from the decline in the market as well, it's a bonus! Therefore, gold is moving back into the spotlight.

Bankers don't trust each other!

The decay of confidence is moving with the speed of a contagious disease. The Fed is doing all it can to restore confidence not amongst the public, but within the banking community. Trained to examine creditworthiness, they won't even give credit to each other. Bernanke is saying in effect that the U.S. Treasury, no the U.S. itself, stands behind credit amongst you bankers to the extent that we will take the debt you have, re-package it with a government guarantee and put it back into the market. Foreign governments need that reassurance, as well as U.S., European and every other banker in the world too. The principle behind this is that bankers are supposed to realize that if governments go down, they are going down too, so why refuse government debt? But the high levels of LIBOR [London Interbank Offered Rate - the rate bankers lend to each other] continue at exorbitant levels. This bodes more ill for the financial world itself, regardless of Paulson's package. After all, if the package and lower interest rates do not work, it means that confidence is lost! The next move will leave disarray in currency markets.

The contagion is in Europe now and governments are falling over themselves to guarantee deposits as customers pull out deposits. Major surplus countries are staring in horror [major depositors in the global banking world], captured by the fact that they have so many deposits with the U.S. government [and others] that they can't afford to pull out. They are stuck with the $ and see little alternative to it as the € seems to be headed in the same direction now. It is unlikely though that they will just sit still and absorb losses. So what will they do? Could they begin to unload some currencies and retain some value?

These two global trading blocs have most other nations dependent on them for their own economic viability, towing them along through the ills affecting them. There is no way out of the situation for almost any economy unless they are relatively self-sufficient economies [such as China]. The only solution is the restoration of confidence.

This piece is not saying that the banking system will run to gold as money, because it would not be practical to replace gold where paper is right now. First, it would have to be taken into government custody. Then, as in 1935, it would need to be revalued so that it could be spread far and wide, with bankers, cap in hand promising not to print money to excess and while telling their customers, "live now, pay later". We're not there just yet, but are we headed that way?

No, until governments reform the financial system in a manner that can restore trust in banking, credit and savings, gold will remain where it is now, in individual's hands worldwide and in the vaults of governments wise enough to retain their holdings in the event of that inevitable 'rainy day'. That day is here!

Is gold immune to the confidence crisis?

As confidence wanes, will gold be pulled down with other assets? We believe that once the de-leveraging hemorrhaging has abated, investment funds moving into gold will take the reins. Gold will do its job of retaining value when other assets won't. After all, the net effect of inflation and deflation is the same; you have less value to buy goods with! Gold will hold on to the confidence it receives now with a very large number of investors coming across from other markets to it, taking it much higher.

With money being issued in seeming trillions, one quality of gold stands head and shoulders above the rest; gold is a limited edition item. It can be traded from Mongolia to Central Africa, Dubai to Denver and anywhere else in the world. It doesn't rely on government support, or handouts, or promises of payment. And that means everything at the moment.

The gold market is about to enter the final stage of its evolution. This stage springs from failing confidence in paper money, currently as bad as any pre-war situation and heads back into the investment world as an important component of responsible portfolios. If governments can accede to the disciplines that gold imposes on them, they will also start to buy gold. But this is the hardest leap for them because they have been fighting gold off from being relevant to the money world [and promoting paper money] for nearly 40 years [since Nixon closed the gold window in 1971]. Once they endorse gold by buying it, there will be a flood of funds looking for it.

Will governments turn back to gold?

It is possible, perhaps probable, that, as in 1933 - 1935, gold captures the attention of governments again. As we said above, if it does, they will want to hold it away from the public and for the same reasons. What has become starkly evident is that gold cannot be manipulated long-term, as it was over the last 30 years by governments. Too much confidence has been lost in the last year in the monetary system for a credible attack on gold to persist with the $ being held up as the alternative, so gold perhaps will be used to shore up that confidence, in some way. But this will not happen until the monetary system is almost in disarray. If they do return to gold, you will have no notice whatsoever, most likely on a Monday morning [since that seems to be the way of notifying you these days] and you will see it as a done deal. Will you be you sitting without your gold?

What price will gold rise to and when should it be bought?

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Julian D. W. Phillips
Gold-Authentic Money

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