Developed World in Financial Decay – How Long Before Money Collapses?

 

by Julian D. W. Phillips - Gold Forecaster
Published : September 14th, 2012

The Current Scene

Since 2007 and the start of the “credit-crunch” the developed world’s money system has been under stress. As a consequence, there has been an economic downturn that government and bankers have not been able to stop, convincingly, in the last five years.

The developed world has decayed to the point that it can’t handle another major crisis such as an oil price well into the $100+ area.

• · Food inflation now threatening, must not be allowed to take off because consumer/voter reaction will undermine government and money still further. 

• · As it is confidence in both the euro and the dollar is at a low ebb. Yes, it is still the only means of exchange and it can be forced onto citizens, but general confidence in the economy, the monetary system and a broad range of markets is suffering as never before.

There are bright sparks of hope, such as the Dow Jones Index returning to the highs it saw in 2007; however, this is by no means in the same investment climate as before the credit-crunch. Fear and instability pervades most markets as faith declines.

Daily we see another Eurozone crisis unfold casting doubts on the continuance of the euro and the financial credibility of its weaker members. Overall, on both sides of the Atlantic, consumer confidence continues to fall after so many efforts by central bankers to resuscitate their economies.

Why is so large a burden being put onto the central bankers, who should only really support governments’ actions? Because the U.S. government is mired in political gridlock, it cannot achieve the vigorous action needed to do all it can to restore growth and confidence, and doubts now remain as to whether it’s too late for any government to do so.

[Forecasts of a dollar decline are seen daily as its debt levels mount to new unacceptable highs. With the impending ‘fiscal cliff’ on the horizon and promises of a heated political battle, consumers and companies expect a savage tax blow around year’s end, further damaging consumer confidence. Will we see a recession in the States next year? It seems likely. Its timing could not be worse.

In the Eurozone, we daily see discord between citizens of the financially stronger nations and the weaker ones. Government discord is constantly apparent. Growth is proving even more elusive in the world’s biggest trading bloc as it stands in a mild recession already.

Hope springs eternal, but today, realities keep hope on the run.

Can the Money System Collapse?

The thought seems unrealistic to people because it’s what we use every day. But the money we use is entirely reliant on government and its central bank. If their performance does not meet the criteria required by money then confidence in that money will collapse eventually. It’s clear that all currencies are not performing well at the moment as the balance sheet of most nations (except China) gets weaker and weaker. If most nations were individuals, then they would have been bankrupted by now.

A look back in history shows that not one paper currency system has lasted throughout the centuries, with the exception of those based solely on gold and silver which remain as money assets all the way.

Not today, you may well answer! We say oh, yes, today too. Despite all the rhetoric since 1971 gold remains in the bulk of the world’s leading reserves for that rainy day when something else is needed other than the currency issued by the nation’s central bank.

How Does Money Collapse?

Look back at Argentina in the 1990’s and you see it using the U.S. dollar, but the economy of Argentina could not support the use of the dollar so it reverted to the Peso after savaging its citizen’s dollar savings in exchange for that Peso. That was a ‘collapse’ of their currency. If the Greeks return to the Drachma or the Spanish the Peseta, we will see a similar scene; it will be a collapse of their currency (the euro) inside their nation.

Can the dollar collapse? Because it’s a government-controlled money system, the dollar will remain the means of exchange it is, even in a collapse.

A collapse will be expressed in several ways:

· Its exchange rate against other currencies can fall heavily. In the case of the dollar as the world’s foundation, un-backed currency, this is unlikely as it supports the un-backed currencies across the world indirectly. Its trading partners will try to pull their currencies down with it so as to protect their trading with the U.S. The same applies to a greater or lesser extent with the other main trading blocs of the world such as the Eurozone and China. You will have noted the narrow trading range of the € & the $ between $1.21 and $1.45 over the last few years. This is because of the mutual support between the Fed and the ECB by way of currency swaps.

• It can collapse inside the country, as its buying power declines rapidly. This is monetary inflation usually caused by the over-issuance of a currency.
  
• Another form of collapse could include a bond market collapse where the markets push interest rates up so high as to make it impossible for governments to repay debt. This level is generally set at 7% and we have seen it in the P.I.G.S. nations of the Eurozone over the last three years. If these countries had separate currencies, they would have collapsed, but inside the euro we see that that final collapse will be expressed by exiting the Eurozone and returning to past currencies.
  
• In a nation where there is still a working economy, a collapse can also be expressed by the imposition of Capital and Exchange Controls, restricting the flows of money in and out of a country to protect the capital inside its borders. Its citizens usually bear the brunt.

Can the Global Monetary System Collapse?

We’re of the opinion that even if the system is hobbling along, it will continue until global economies collapse. This was the case in Zimbabwe in the last decade. The Zimbabwe dollar continued in use because the government enforced its use inside its borders. But to all intents and purposes, it has collapsed long before then. In the case of Zimbabwe, the U.S. dollar became the currency in use in the country and in what’s left of its economy. This is still the case today.

Before any such collapse occurs, we are certain that each individual developed world economy would cooperate with each other to take whatever measures are available to them to shore up the monetary system. These measures will prevent the system from a total collapse, keeping it staggering on all the way. We believe that they will fully harness gold then.

The questions remaining are how and when?

source :  http://www.24hgold.com/

Is Central Bank Buying Just a Driving Force Behind Gold or Much More?! – Part II

by Julian D. W. Phillips - Gold Forecaster 

Basel III Discussing Lifting the Accepted Value of Gold on Commercial Banks Balance Sheets from 50% to 100%Part of the side-lining of gold from the monetary system was through either taxation on its sale (in some countries) or by undervaluing it as an asset.

When the 2007 credit crunch hit hard, the loss in value of so many paper assets forced the sale even of those assets that did manage to retain both value and liquidity. Individual investors often sold gold, silver, and the like to cover margin requirements that screamed to be topped up in the hope of retaining assets that were losing value. That’s why asset values on so many fronts declined so markedly. Even assets whose market fundamentals remained solid were sold down only to recover when the storm passed. Gold and silver were among those.

At banking level, the pressure to go against investor logic was due to the regulations of the system. With gold a Tier II asset in bank’s balance sheets, only 50% of its value could be credited as an asset to that balance sheet. So its real market value could only be given meaning when it was sold. By selling gold and using the proceeds to buy Tier I assets, such as Treasuries, the bank ensured that their balance sheets benefitted fully from its value. Even when the gold price fell 20% it was worth selling, so that at least 80% of its former [$1,200] value could be credited to the bank’s balance sheet instead of just 50% [or 40% at the value after a fall in the price of 20%].

As the value of assets of various governments and potentially U.S. bonds are threatened by over-indebtedness, commercial banks are left little recourse except changing the situation by changing the rules for the banks. Hence, the current discussions on its definition in the bank’s balance sheets. If gold is redefined as a Tier I asset, then when any future loss of asset value of paper assets occurs, there will be no need for banks to sell gold to compensate for such falls. And, as gold has amply demonstrated, the gold price is more than likely to rise in such situations, proving to be a ‘counter to all paper assets’ on the bank’s balance sheets.

Such a change will do a great deal to remove the shock to the solvency of so many commercial banks in credit crunches and the like.Will the change happen? We believe so and expect this to take effect on January 1st 2013.

Why Clearing Entities Are Accepting Gold as Collateral

LCH.Clearnet is a clearing house for major international exchanges and platforms, as well as a range of OTC markets. As recently as 9 months ago, figures showed that they clear approximately 50% of the $348 trillion global interest rate swap market and are the second largest clearer of bonds and repos in the world. In addition, they clear a broad range of asset classes including commodities, securities, exchangetraded derivatives, CDS, energy and freight. The development follows the same significant policy change from CME Clearing Europe, the London-based clearinghouse of CME Group Inc., announced recently that it planned to accept gold bullion as collateral for margin requirements on over-the-counter commodities derivatives. Both C.M.E. and now LCH.Clearnet Group have decided to allow use of gold as collateral from 28th August. It is likely that they too have the same concerns about the possibility of another ‘credit crunch’ and the danger forced asset sales can have on liquidity. They too see the benefits of treating gold as money and collateral.

LCH.Clearnet Group Ltd. said it will accept ‘loco London’ gold [0.999 or 0.995 quality gold] as collateral for margin-cover requirements on OTC precious-metals forward contracts and on Hong Kong Mercantile Exchange precious-metals contracts starting Aug. 28. ‘Loco London’ gold is London ‘Good Delivery’ Bars (roughly 400-ounce or 12.5 kilograms gold bar) held with LBMA members within the London bullion clearing system. The clearing house has already been using gold bullion as collateral since 2011 but now will accept ‘loco London’ gold as collateral.


Additionally, Intercontinental Exchange Inc. too has allowed the use of gold as collateral. LCH.Clearnet limited the amount of gold that could be used as collateral to no more than 40% of the total margin cover requirement for a member across all products and at a maximum of $200 million, or roughly 130,000 troy ounces, per member group. David Farrar, Director, LCH.Clearnet said at the time that “market participants want greater choice when it comes to assets that can be used as collateral. Gold is ideal; as an asset it typically performs well in times of financial stress, remains liquid and has a well-established pricing mechanism.”

Thus the commercial banking system is and has prepared to treat gold as full-bloodied money because of its invaluable liquidity virtues and its acceptability even under pressure.

We believe that the markets have yet to catch up to what’s going to happen. But the current gold price breakout is not because of this aspect of gold; it’s because of both Technical and seasonal factors. When gold is a Tier I asset and commercial banks appear in the market place, then the gold market will also see a new driving force behind the gold price. There is still a considerable distance to go before the gold price really does discount these potential changes.

In summary, the banking system, overall, is moving toward where gold will be an active, confidence-building monetary asset.

Will ‘Powers that Be’ Continue to Allow Citizens to Own Gold?

With gold moving back to such a pivotal position in the monetary system, won’t the private sector interfere with the ‘stability’ of the gold market, chasing its price up just as the Hunt Brothers tried to do in the days of yesteryear? This is possible, but this time the gold price will not be at a fixed price as it was under the gold standard. By ‘floating’ the gold price, every time it rises in price, it will benefit bank’s balance sheets and liquidity levels, countering volatile markets. The reverse is true if the gold price falls and other assets rise in value as the markets seems to believe will be the case.

Overall there will be a ‘value anchor’ as Mr. Zoellick, the last head of the World Bank, advocated last year.

If these changes are instituted, there is a danger of interference in the gold market price by the public, but on the upside not the downside. After all, it will be in the interests of the monetary system to see higher gold prices rather than lower prices that the powers-that-be appeared to want between 1985 and 2005. But they will want to see a level of stability consistent with that of currencies and other monetary assets in that situation. Their desire for this can be overwhelming, as we saw in 1933 when U.S. citizens were banned from holding most forms of gold in the interest of the nation’s monetary system. It was not until 1974 that they were again permitted to do so; however, this permission came with the proviso that owning gold from then on was a “privilege, not a right” as though to warn us all that things could change again. Even though governments attempted to write gold out of the system, they made it clear that they considered gold as part of their domain.

This is a real danger and one that should not be overlooked by us all in all the nations of the world. Any government that feels it is in their interests to take their citizen’s gold will do so even if it means changing their laws.

Julian Philips' history in the financial world goes back to 1970, after leaving the British Army having been an Officer in the Light Infantry, serving in Malaya, Mauritius, and Belfast. After a brief period in Timber Management, Julian joined the London Stock Exchange, qualifying as a member. He specialised from the beginning in currencies, gold and the "Dollar Premium". At the time, the gold / currency world exploded into action after the floating of the $ and the Pound Sterling. He wrote on gold and the $ premium in magazines, Accountancy and The International Currency Review. Julian moved to South Africa, where he was appointed a Macro economist for the Electricity Supply Commission, guiding currency decisions on the multi-Billion foreign Loan Portfolio, before joining Chase Manhattan the the U.K. Merchant Bank, Hill Samuel, in Johannesburg, specialising in gold. He moved to Capetown, where establishing the Fund Management department of the Board of Executors. Julian returned to the 'Gold World' over two years ago and established "Gold - Authentic Money" and now contributing to "Global Watch - The Gold Forecaster".