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US dominance is under threat from more than just China’s foreign-reserves hoard…

CHINA is the largest holder of the US Dollar in its foreign exchange reserves, notes Julian Phillips at the GoldForecaster.

But Beijing’s $2.45 trillion in US assets is an impossible number to trade on foreign exchanges. So they’re stuck with them, until they can spend them. As long as the US Dollar is the world’s sole reserve currency, these reserves are useful to buy any asset in any country. But it is vital that they retain their buying power.

Buying power is defined by its exchange rate value, and inside the United States relates to the inflation rate. A prime task of the Federal Reserve is to maintain price stability, i.e. buying power stability. So when China expressed concern over the value of the Dollar (and its buying power), we all became concerned. There are many reasons to be concerned about the future of the Dollar. We shall look at some of these in this article.

Quantitative Easing is a technique the Fed used to fill the holes that the credit crisis created. Writing down of assets is essentially a reduction of money in the system. The consequences of this in the banking system meant that money disappeared off bank balance sheets and reduced their lending capabilities. The actions of the Fed allowed the money that disappeared to reappear again. It works nicely if the banks keep on lending. But if they don’t the exercise is fruitless as they protect themselves by not lending, but investing back in government bonds instead.

That’s happening today, because instead of lending money, banks are investing in Treasury and Agency securities. Their holdings of such assets increased to $1.57 trillion at the end of July, up 40% from $1.12 trillion in mid-2008. The government is borrowing in a rush, to shore up its deficit, growing fast at the moment. The projected 2010 deficit of $1.47 trillion will be a record, and equivalent to 10% of the economy. China and most other people expect such a growing deficit will lead to a significantly weaker Dollar.

At worst, such a prospect has the potential to deter foreign investment in the US, shoving up interest rates. If the US Dollar Index falls below 80 (this Index measures the Dollar against a basket consisting of the Euro, Yen, the Pound Sterling, the Canadian Dollar, the Swedish Krona and Swiss Franc), the Dollar will fall quickly and heavily and further discourage investment in Dollar assets.

The longer the government delays in stimulating the US economy again, the bigger the amount of new money needed to reflate the economy. As an economy deflates, money velocity slows and consumer attitudes become more and more thrifty. This makes efforts to return the economy to growth harder and harder. A fair analogy would be to compare the situation to retrenching an employee. To bring confidence and hope back to previous levels, two employees must be hired. The longer it takes to fire up the economy, the greater the stimuli needed to do so. Experienced investors are expecting new stimuli to lead to explosive inflation because the change from deflation to recovery becomes more and more mercurially uncontrollable the longer it is delayed.

We do not expect to see a US trade surplus in the years to come, because of the structure of the US economy. Every deficit means that more Dollars were exported. To date the difference between a recessionary economy and a growing economy is either a $30 billion or a $60 billion trade deficit.

However, we do not think that US foreign suppliers will dump their Dollars, but we do expect them to accept only the amounts that relate directly to the value of their US trade in the future. Lowering the amount of Dollars they accept will allow them to reduce its role as the sole reserve currency over time.

Unless the US restructures its economy so that the trade deficit is eliminated, there is an immeasurable (but certain) time limit on its continuing as the sole reserve currency. As the power of the US wanes, the clock is ticking. There are two events that will precipitate this hasty decline. Each of these has the power to accelerate the role of the Dollar in the global economy.

Since Middle Eastern oil production began sales of oil have been priced in the Dollar. While there has been discussion on Dollar pricing, no change has been made to it. The Middle Eastern nations cannot afford to stand alone, they believe. The US has guaranteed their security and shown that they are committed to doing this as seen in Kuwait and in Iraq. Such commitment now protects these nations from terror attacks as well. The House of Saud would fall quickly were it not for the protection they get from the US.

Hence there is more to pricing oil in the US Dollar than meets the eye. Until this advantage is either lost or replaced there is little enthusiasm to accept other currencies in payment of oil. Of late, though, we have seen Saudi Arabia increase its gold reserves and expect the rest of the Persian Gulf nations to follow suit, in time. We see this as them buying a small amount of insurance against the dangers facing the US Dollar.

You may well ask why haven’t they diversified their reserves into other currencies? Just as the Dollar is a reserve currency because of its ‘oil backing’, so oil in itself is instant international liquidity acting the same way as gold does. The need to have diversified reserves is lessened because of this. Consequently the dangers facing oil producers are not nearly as great as those who will have to rely on their gold and foreign currency reserves should they face a crisis. Gold buying by them is not for the benefit of the country, but for the sake of the reserves themselves.

China is up and coming and draining the power and wealth from the West. It is inevitable that a growing world won’t rely on a waning Dollar, but will set up a system that immunizes them from the ailments of the Dollar. We believe discussions are well under way to globally use a basket of the world’s main currencies as the benchmark for global trade. After all, the focus of US Dollar policy makers is on US economic performance, not on global economic performance.

A global reserve currency must reflect the overall global economy’s state not just one part. It must also have the flexibility to reflect changes in the performance of different parts of the global economy. The ‘basket’ idea suits this role well.

Finally, there’s the looming internationalization of the Chinese Yuan. While the Chinese banking system is not yet mature enough to be a large part of the global banking community, they are moving fast to get there. At the moment the heart of Chinese manufacturing (the Guanchou area) is allowed to use the Yuan internationally. It’s a bit like a movie maker trying out the popularity of a film in one town. Once they have systems that are tried and tested they will be able to go global.

The advantages of pricing Chinese goods in the US Dollar are huge, still. It’s a currency used all over the world and by managing the exchange rate, the Chinese export industry remains competitive internationally. In the process China gains a huge level of surplus Dollars needed for its development in future years. So long as the Dollar retains its buying power internationally this position is fine. But it is clear to all that the US Dollar may well not be able to retain its buying power at the current level in the not so far future. The day is already on the horizon when it would serve China well to gather the currencies of all its trading partners in its reserves rather than just the two main ones.

It will also serve the Chinese to have the Yuan become an international reserve currency, under their own management. Even as part of a global basket of currencies the advantages to China would become greater than they are in using the Dollar, particularly if they could buy oil in the Yuan too. The transition to an international Yuan would hurt the Dollar, but such pain may serve China better in the long run. After all if the Dollar did plummet, China would simply be another victim. We do not see them letting that happen and will act to forestall that. Even the Chinese see gold playing a part in the transition and beyond.

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Source:Buying Power in Dollars

There aren’t many times to favor Gold Investment over buying productive assets…

THEY FOUGHT the correction, but the correction won, writes Bill Bonner in his Daily Reckoning.

We refer to Bernanke, Summers, Obama, Geithner, Krugman – the whole lot of them. They added three trillion dollars to US debt in the last two years. In two more years the debt will be at 100% of GDP. Add in the debts they’ve guaranteed…from Fannie Mae, for example, and state and local debt implicitly backed by the feds…and you’re already at 150% of GDP.

Worse than Greece, in other words. And what do we get for it? A recovery? A healthy economy? A gold medal?

We’ll take the gold medal, thank you. It’s the only one that’s real.

The stock market was ready for a little bounce Tuesday. So that’s what it did…a little bounce – the Dow up 123. Gold kept climbing, however – up to a new record high above $1,250 an ounce.

If you had asked us 10 years ago which we’d rather have – stocks or gold – we would have said gold. Ask us now. Same answer.

Gold.

There aren’t many times when it makes sense to favor Gold Investment over productive investments. But this is one of those times.

Why? Because the world’s monetary system is heading for a crackup. And because the people running it have no idea what they are doing. Here’s Bloomberg:

Pimco’s Crescenzi Sees ‘Endpoint’ in Devaluations

June 8 (Bloomberg) – Nations have reached a "Keynesian endpoint" as exhausted balance sheets leave policy makers with few options to bolster economic growth, according to Anthony Crescenzi, an investor at Pacific Investment Management Co., the world’s largest bond-fund manager.

"Time, devaluations, and debt restructurings might be the only way out for many nations," Crescenzi wrote in an e-mailed note titled ‘Keynesian Endpoint’ that referenced the Great Depression era economist John Maynard Keynes. Debt-fueled spending programs aimed at combating the global financial crisis of 2008 are among policy tools now "being seen as a magic elixir that has morphed into poison."

The Obama administration forecast a $1.6 trillion budget deficit, the most ever, in the current fiscal year that began Oct. 1.

You can fight a correction. You can delay it. You can distort it. You can make it bigger and nastier. But you can’t beat it. Eventually, mistakes have to be corrected…one way or another.

Usually, the mistakes take the shape of bad investments or bad loans. You can pretend that they’re still worth what you have in them. You can bail out the lenders and/or the investors. You can default and inflate. But somehow, someone, sometime is going to take a loss.

That’s when you need gold. Every other asset could have bad debt behind it…in it…or standing so close beside it that a blow-up would be damaging.

The correction that began in ‘07 was needed to address all the bad debt built up in the bubble years. The feds tried to stop it. Since they didn’t have any money they had to fight it by borrowing more money – that is, by increasing the level of debt!

We knew that wasn’t going to work.

And now, there’s bad private debt…and bad public sector debt too. And now we’re approaching a Keynesian "endpoint" when lenders are growing wary. They’ve already cut off Greece. They’ve warned the rest of Europe. And when they stop lending…then, all your props fall down…along with the economy…and the markets too.

Looking to make a solid Gold Investment today…?

Source:When You Need Gold

Subpar economic growth doesn’t mean flat-to-falling gold or Silver prices…

PHILIP SILVERMAN, managing partner of Wall Street’s Kingsview Management – a registered commodity trading advisor (CTA) and member of the National Futures Association – speaks here with Hard Assets Investor about the outlook for Gold Prices and the broader commodities market.

HAI: What is your outlook for the economy and commodities? The year’s off to somewhat of a flat start…

Philip Silverman: Well, our outlook is for subtrend growth. You know, we’ve had a bounce off the bottom in economic growth, as well as the markets. But we don’t think that that has very much legs. Not in any way calling for a collapse, but not growth rates that we would have been accustomed to in the last couple of decades.

HAI: So that 5.7% growth rate at the end of 2009 – that won’t be sustained?

Philip Silverman: We do not believe that will be sustained. You know, there was a lot of bounce-back from the crisis, a lot of inventory rebuilding. But to think that coming out of this crisis we’ll be able to sustain even a normal trend growth is a very optimistic outlook and one that I don’t think we can necessarily bet our money on.

HAI: Now, a 2% growth rate; how does that work out for equities, for commodities? Is it supportive?

Philip Silverman: I think certainly a general sideways price action is something we’re expecting. In stocks, it’s going to be a stock-picker’s market. Those companies that are able to thrive, have good products, manage their balance sheets very well and compete effectively in the marketplace are going to do well; value stocks will be able to do well.

But as a whole, I wouldn’t bet on very large advances any time in the near future. You know, we’ve made a large bounce off the bottom. A lot of money was reallocated into equities. And it’s going to be a tough time to see the market go up significantly. Like I said, I’m not looking for the bottom to fall out here, but we think you’re going to see a lot of sideways action.

HAI: How does the Fed play into the outlook? Recently we saw the Fed bump up the discount rate by 25 basis points…

Philip Silverman: Well, that is something you have to keep an eye on, because if they move too soon, they could choke off their recovery. But if they don’t get ahold of the stimulus, we’re going to see inflation coming down the road. Now, it’s tough because I wouldn’t expect to see any signs of inflation in 2010. We may not even start to see it towards the end of 2011. But typically, historically, when you’ve injected so much stimulus into the market, you will see inflationary pressures coming, tending to be three to five years out from where all of it began.

HAI: So, next year, basically, if it started in ‘08?

Philip Silverman: I would say we would be looking for it to really start to show up between ‘11 and ‘13. And it’s going to be very challenging for the Fed to get itself out of it without…in a smooth way. And I think to bet that they’re going to be able to do it is a pretty tough bet to make. I mean, they’ve not been able to get out of the way of inflation in the past. So we certainly think you need to have some assets in your portfolio that are going to be a benefit in this sort of a situation, whether it’s TIPS – inflation-protected securities – or the gold and Silver hard assets. And most likely we’re going to be seeing that, we believe.

The inflation trade is not dead. You can take your time to get there, but it’s coming. Gold and silver are the two that we like – silver because there’s a lot of industrial uses, technology-wise, and even in the medical field. So that it’s something that’s not as popular with investors, but offers essentially the same sort of price movement.

HAI: What if the Fed reacts, starts to raise interest rates? Is this not going to be negative for gold and Silver?

Philip Silverman: I don’t believe so. I think people will move to gold as a safety asset and a hedge against inflation. And at the same point, gold also is a little bit of a currency alternative. The currency markets are a very difficult place these days. The Dollar has rebounded significantly. A lot of that has been the "best house in a bad neighborhood". The EU is having a lot of problems. So that’s a currency that’s being moved away from. But the US has got a lot of problems with the fiscal deficit…

HAI: But so does Europe.

Philip Silverman: Well, absolutely. Europe is much worse than us. And that’s going to continue to put pressure on the Euro, which can mitigate the inflation outlook for the US if the Dollar continues to go up. But, the point is, unless we can get control of all of our financial house, there will not be a strong push to the Dollar. And the more it goes up, we will just see it getting more overvalued and an inability to have a lower-risk play on being short against the Dollar.

Everyone got short the Dollar this past year. It was the most crowded trade out there, carrying…short the Dollar, long other assets, which is one of the things we believe helped spring gold back recently. It got ahead of itself trading-wise.

HAI: Where do you think it’s going to go in 2010?

Philip Silverman: I think we could see a new high in gold, but I’m not calling for a huge move up to $2000. It needs to come at a more sustainable pace, nearer $1400 or $1500. What we saw before got a little parabolic at the end. And that scares a lot of traders out. And at the same time, with the Dollar bounce and the carry trade coming off, it pressured the Gold Price.

HAI: What do you see besides gold and Silver? What other commodities?

Philip Silverman: We actually have been watching oil very closely. It’s been in a sideways market for quite some time. So we don’t see any urgency to be getting in. But we do believe that the long-term outlook for crude, based on the idea that it is a limited resource, and there will be a continued demand for crude, out of Asia and South America that we believe that, if we start to resolve out of the range to the upside, it’s going to be a place that you’re going to want to be.

Getting back to the $150 that we saw is a little optimistic. We would be looking for oil…if we get above the low $80s – particularly the $85 level…to make its way up towards $100. If you start to get up towards $100, we’re going to need to have a much stronger economy. Because at $100, it starts to really have some effects on the end-users. And even the producers are starting to get nervous too at $100 too.

How best to Buy Gold and Buy Silver today…?

Source:Gold at $1400, Oil at $100

The age of de-leveraging is upon us. Bad news for the US economy; good news for gold…

FOR THE PAST 60 years, corporate debt has grown faster than the economy, writes Chris Mayer in the Daily Reckoning.

The volume of corporate debt has swollen by 4.1% annually, compared with only 2.7% for the economy as a whole. In short, more and more debt went toward producing each Dollar of GDP growth.

What if this 60-year trend reverses?

In fact, I think that is the likely scenario. The deleveraging will take some time…and it won’t be fun.

"Today’s overleveraged assets will become tomorrow’s underleveraged assets, and vice versa," QB Partners, a hedge fund, explained in a recent letter to shareholders.

What will this new world look like? More people will save more money. And they will focus more on preserving that wealth than on making a big score. We’ve been here before. Michael Farrell, the chairman of Annaly, says the psychology of people will change as it did for those of 1930s, as he discussed on his company’s first-quarter conference call.

Exhausted by the uncertainties of the 1930s and 1940s, the older generation just felt lucky to be alive and they settled into a time of saving, preservation of capital and lowered expectations as consumers.

If that kind of financial orthodoxy takes root, then leveraged assets like real estate and bank balance sheets face a long period of stagnant returns as they continue to deliver – that is, as borrowers and lenders ratchet down the debt on these things. (I find it ridiculous that government officials want us to believe that the US banking system is OK at 25-to-1 leverage. The banking system’s insolvency will become more apparent as it continues to take losses from bad debts made during the bubble.)

Deleveraging puts pricing pressure on leveraged assets. Banks must raise capital, diluting their shareholders and hurting their stock prices. Real estate owners must sell property to raise capital to defend other properties, thus putting pricing pressures on real estate assets. And so on…

So as an investor, it will pay better to stick with the unlevered assets, which face no such head winds. After all, there is no pressure to sell an asset with no debt, no ticking clock. "What are the most underleveraged assets?" you ask. QB Partners gives the answer: hard assets and natural resources.

The ultimate unlevered hard asset may be humble old Gold Bullion.

In fact, something important is happening in the gold markets right now. All through the 1990s to the present day, the world’s central banks were net sellers of gold. Europe’s central banks, for instance, have sold 3,800 tonnes of gold in the last 10 years. According to the Financial Times, this move cost them $40 billion, and that was with gold at $900 an ounce.

Well, too bad for them. But suddenly, that recent habit of selling gold is changing. Last year, central banks sold only 46 tonnes, which was the lowest amount in 10 years.

As the FT reports: "Sales in Europe have slowed to a crawl and fresh demand is emerging elsewhere and the financial crisis has helped to highlight gold’s value in turbulent times." In fact, we may soon see central banks flip to net buyers of gold.

China has doubled its holdings of gold this year and is now the world’s fifth largest holder of the metal. China is likely to be a buyer of gold for years because its gold holdings are still very small relative to the size of its total reserves. Gold represents only 1.6% of China’s reserves, versus a global average of nearly 11%. To further diversify its reserves – just to get to average – would require significant amounts of gold.

In a post-2008, deleveraging world, it is the unleveraged assets that will outperform against those saddled with debt. It’s another plank in the case for gold, which just seems to get stronger with each passing month. "A new chapter has begun in the gold market," the FT opines. Indeed, it has.

The International Monetary Fund, never known as a wise handler of money, is selling a bunch of gold. India bought half of it. A number of emerging market central banks are also upping their gold exposure. Maybe these CBs are onto something.

Russia’s gold holdings now make up 4% of its foreign reserves, compared with only 2.2% at the beginning of the year. Smaller central banks are also being crafty. Ecuador’s gold holdings have more than doubled since the start of the year – to 54.7 tons, from only 26.3 tons. Gold now represents 32% of that country’s reserves. Even Venezuela is Buying Gold. Gold now makes up 36% of its reserves, compared with only 23% in 2009.

So who is the sucker here?

Perhaps central bankers see more clearly than most what the effect of all their money creation will be. In recent months, we’ve seen a truly unprecedented boom in bank reserves. Bank reserves drive money creation. More money means money buys less – and the Gold Price should rise.

Then there is this chart of the Shadow Gold Price. In the old days of the Bretton Woods Agreement, countries had to maintain certain ratios of gold against their currencies. The Shadow Gold Price aims to replicate this discipline. So for the US, the Shadow Gold Price is Federal Reserve Bank liabilities (bank reserves) plus money in circulation divided by US gold holdings. Also on the chart, you can see the spot price of gold.

The important thing here is that you see how massive amounts of money creation have barely made an impact at all in the Gold Price – so far. Gold is fundamentally cheap compared with all the money added to the system in recent months.

As Paul Brodsky and Lee Quaintance of the hedge fund QB Partners write:

"If one allows for even a small probability of a future monetary system that reflects more honest/tangible money, then a quick glance at the graph above makes it easy to conclude that spot gold is fundamentally cheap. Even if this is too far a stretch for market participants skeptical of such a radical change in monetary policy, it is reasonable to conclude that the prices of spot gold and the Shadow Gold Price should converge somewhat over time."

They note that the spot Gold Price has never been so cheap compared with the Shadow Gold Price. For parity to set in, gold would have to trade for $16,000 per ounce! No one is predicting $16,000 per ounce gold. In any case, it shows you the risk of holding paper – and bonds – on the eve of a massive devaluation of the Dollar. Maybe the central bankers of Russia, Venezuela and Ecuador understand all of this better than they let on and that’s why they are buyers of gold.

It seems pretty obvious to me that if you create a lot of money, you are going to destroy the value of that money. And in that case, you want to own something other than that money.

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Source:Good Cause to Buy (More) Gold