Rush to Gold as Global Banking Crisis Unfolds

By: Julian_DW_Phillips

This week saw the $ cross the $1.48 line to the € heading for $1.50 after the U.S. markets closed for Thanksgiving. It then bounced after the London market had opened on Friday. We do expect a bounce, but not for long as a secondary phase of the crisis comes into play. What crisis, you may well ask? It is the sub-prime crisis/credit crunch/$ crisis as it spreads into the global economy [as well as inside the U.S. of A.]

The first phase is the onset of the crisis, together with smoothing words to calm markets, but to no avail. The second phase is when there is public recognition that there is a crisis, followed by all involved coming together to give the impression that the crisis is being resolved. This phase precedes watching the system begin to actually break down despite the superficial efforts of global monetary authorities to the contrary. 

Are we there yet? The global credit crisis hit Asia like a tsunami hits the shore there for the first time this week, triggering a massive run for cover as investors fled their holdings of dubious fixed interest investments.

Another big Capital Tsunami hits

• Yields on three-month deposits in China and Korea plummeted almost 1% over this week, driven by hasty withdrawals from money market funds and credit derivatives. The crisis has flowed from the States and is beginning to paralyze the whole global economy.

• Korean and Chinese three-month yields have fallen from 4% to 1% in a matter of days. Asian investors appear to be opting for deposit accounts with government guarantees. Are investors now under the belief that Asian banks have yet to announce horrendous losses from the U.S. mortgage disaster?

• The Hang Seng index in Hong Kong fell 4.15%, while Tokyo's Nikkei tumbled to the lowest level in a year and a half. 

• This sudden “flight from risk” has led to a sudden unwinding of the $1,200 billion Yen "carry trade" as hedge funds and Japanese investors close risky positions. The Yen has roared back from Yen122 to Yen107.90 against the $ since early October, crushing the gains of those slowest to move out of these positions.

Then the capital Tsunami flowed back to Europe where : 

• The iTraxx index measuring default insurance on bank and insurance bonds hit an all-time high of 63.5. Bund-Swap-Spreads were going through the roof there. Spreads on low-grade European bonds had been jumping 10 basis points a day, for the last week. 

• Suddenly, in a startling move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads." 

• Abbey National today cancelled its sale of covered bonds, the third company to withdraw an issue this week. 

• Then there was an alarming spike in the "Ted spread" between commercial Libor and U.S. Treasury bills, now near 150 basis points. The London Interbank Offered Rate [Libor]] is now at a premium to T-bills not seen since the dark days of 1987.

And we are told to expect problems from this crisis could last for two more years as the real tragedy for the sub-prime mortgage holders. But now it is a $ / banking credibility problem threatening to engulf the entire global economy

Authorities overseeing the crisis are blithely raising their hands saying markets must find their own level. This is complete inaction, but is it a result of their powerlessness in the face of these massive waves of capital? 

The finger pointing at the suppressed Yuan is ducking the issue. The statement that the $ is not a problem of the U.S. is confirmation that the U.S. will not do anything about its weakness and why should the Fed ? It is to their advantage to see a weaker $. We don't expect the States to do anything about the weak $ now or in the future. From the perspective of the States, the $ is bedrock, so the problem lies with those dealing with the States. Not only is it in the interests of the U.S. to see a weak $, there is little that they can could do to rectify the $'s performance, until foreigners take action against it. But they are in a strong position to do so.

So the ball is in a foreign court. Until China and Asia are far less dependent on the U.S. it is not in their interest to see a $ collapse or even the buying power of the $ diminish. It is however in their interests to use the $ to buy up all the assets they can across the globe until they are spent. That would see a major rise in the power of China in the global economy. That is already well on the way and continuing at a frantic pace. 

There is little incentive to sell the dollars to lower their presence in national reserves, because this would lower the value of the remaining dollars in the reserves. Consequently we all have to live with a falling $, consequential rising global inflation, picking up speed as the velocity of the fall of the $ is diminished through market intervention, breeding more inflation still. The result has to be paper currencies across the world having to accept that to keep their economies healthy they must accept inflation, or see their international competitiveness reduce their own national growth.

Gold - as a result

In such a climate there is absolutely nothing to stop the price of gold in all currencies from trending higher and higher and higher still. 

The trigger to this rise is the awful loss of confidence in the banking system and the investments they have engineered. It is called “risk aversion”, but it is more serious than that. Harsh lessons are being learned from bitter experiences that have shocked even the most experienced of investors. Will the crisis go away we are told, not for some time to come? In fact, it could worsen as the structures on which confidence stands stumble under the doubts and fears.

Then it becomes simply a matter of prudence and wisdom for investors of all types in all parts of the globe to protect themselves against this turmoil in something that is not an obligation, a promise, something not dependent on the performance of people or any other hope. Where can they go? They need something they can know will not evaporate as quickly as a changing exchange rate, something they can grip in their hands, something solid that has proved itself in just these sort of times - gold.

With the global market so integrated, so informed, so fast and now so volatile, expect this relatively small market to get a great deal of attention to make it evolve into something totally different to what we see at the moment!

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By Julian D. W. Phillips
Gold-Authentic Money

Copyright 2007 Authentic Money. All Rights Reserved.
Julian Phillips - was receiving his qualifications to join the London Stock Exchange. He was already deeply immersed in the currency turmoil engulfing world in 1970 and the Institutional Gold Markets, and writing for magazines such as "Accountancy" and the "International Currency Review" He still writes for the ICR.

What is Gold-Authentic Money all about ? Our business is GOLD! Whether it be trends, charts, reports or other factors that have bearing on the price of gold, our aim is to enable you to understand and profit from the Gold Market.

Disclaimer - This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold-Authentic Money / Julian D. W. Phillips, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold-Authentic Money / Julian D. W. Phillips make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold-Authentic Money / Julian D. W. Phillips only and are subject to change without notice.

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