In the Midst of Currency Confrontation, why are Gold and Silver Falling?


In the last week, gold and silver prices fell even as George Soros himself commented that conditions for gold looked perfect. Why? A look around at virtually all markets from Shanghai through Europe and back to the States fell. The media pointed to the potential for interest rates to rise, but that is an insufficient explanation when one considers that the declines were in the region of 5% across all the board. An event that touched the very structure of the global financial system occurred and is still happening right now was, we believe, the cause of the falls.

While the sovereign debt crisis in the Eurozone has been with us for some time now, it has developed into a more serious concern in the last week. The President of the Eurozone himself said that both the euro and the Eurozone were in danger of collapsing. Project this statement forward to an actual collapse, what would happen if it did collapse? What would happen if the Eurozone fragmented, or if Germany departed or if the southern nations of Greece, Portugal and Spain were booted out of the Eurozone? Chaos would reign in currency markets and amongst the banking system. The web-like nature of the global banking system would threaten a spread of the banking and sovereign debt crisis that would ravage investors in many markets.

So, what happened when gold and silver corrected nearly 20% a year and more ago, could happen to a lesser extent again. The result then was that investors withdrew to the sidelines. But this time, we’ve seen a repeat of this but temporarily and only to allow around a 5% fall in precious metal prices. Knowing what happened following the last correction, investors were able to react faster than before.

Right now, the recent rescue of Greece may not be as convincing as many hoped for as their tax revenues have fallen well below budget as tax evasion in Greece [rife for decades], now taints the success of that rescue. Ireland, although small, is unhappy to let go of any sovereignty, (even financial sovereignty) is hoping the EU and IMF will bailout their banks, who have yet to fully assess their property losses. This refusal of support could endanger the Eurozone itself. Sadly the very nature of bailouts in Europe and even the resolution of global currency problems appear to be more difficult than most thought. Why?

National interests dominate

Starting with the U.S. and its response to global annoyance at quantitative easing, we see that the U.S. has little choice but to follow its mandated path of using its money to stimulate growth inside the U.S. In turn, China feels that to maintain social order within its borders it must hold down the Yuan to keep its manufacturing sector healthy in the global marketplace. Following those examples, every other nation will frame its exchange rate policy on a similar basis, with the emphasis on internal price stability for the benefit of local employment. These are the rules of the currency game as well as the root of the potential failure of currencies to operate internationally.

In turn, banks are mandated to maximize profits for the benefit of their shareholders, not to look to the greater good of the countries where they offer banking services. These objectives leave no room for negotiation unless consistent with those objectives.

It is naïve of anyone to expect something different. When these objectives converge there has to be a clash, with the strongest imposing its will on the others. At the G-20 President Obama’s speech attempted to do just that. Having said that a healthy U.S. economy is good for the world, he emphasized his government’s course of QE for the benefit of the U.S. Later, he confronted China by saying they are holding their currency down, without mentioning that QE 2 would do the same to the dollar. This ended the currency cooperation between the two countries.

Now cross the Atlantic to the Eurozone where we find a similar clash of national interests. The richer northern nations, particularly Germany, enjoy being in the euro because it exports huge amounts within the Eurozone as well as overseas. Under the Deutschmark, the German currency would persistently revalue to reflect the economic strength of the country. Under one European currency, a fixed exchange rate and a single interest rate persists allowing German goods to dominate completely because of their high quality. Germany is not threatened by a revaluation anymore! Just as China is sucking wealth out of the West so inside the Eurozone Germany is drawing off capital from profitable exports to itself and other nations. It wants things to stay that way too. Meanwhile, Portugal and Spain and other poorer Eurozone nations are seeing the reverse happen. They do not have a national reputation for industriousness and essentially geared their economies to tourism and property. It was inevitable that there would come a time when sovereign debt crises would come. It is inevitable that the very existence of the euro would come under threat. That’s where we are today, with Ireland delaying acceptance of a rescue package from the E.U. and a ‘contagion’ effect threatening to go from Ireland to Portugal to Spain and likely exhaust the Stability Fund the E.U. has set up to cope with these crises. Ireland is not prepared to lose any political or financial sovereignty not just because of the nature of the Irish, but because the politicians responsible for rectifying matters are not prepared to lose their own political support.

The impact of Quantitative Easing

Quantitative easing increases the money supply, incites inflation, accelerates the velocity of money and persuades savers to spend rather than earn zero interest on depreciating savings. Hopefully, if it can be controlled, it will invigorate the U.S. economy, but at the expense of the internal value of the dollar. The Fed believes it can control this process, enliven the U.S. economy and retain the greater bulk of the dollar’s value. Fear of their ability to achieve this and a breakdown in confidence in the dollar is palpable. Many expect deflation to impose its overweight force on the U.S. still further. Many fear that once out of the bag, inflationary pressures will grow beyond the control of the Fed to rein it in. Even the Fed admits it is in uncharted waters. U.S. citizens and businesses are not reflecting confidence in its monetary authorities. The huge flaw in the policy is that much of the money, currently in the hands of the investment and banking communities, is not being injected into the U.S. economy. Able consumers, with any benefits from this policy, are buying carefully and prudently, which favors the cheaper imports, such as those from China, thus benefiting the Chinese economy. In the banks, the money they receive travels into Treasuries or overseas into securities that offer higher interest rates than can be found in the U.S. alongside capital gains as the currencies invested in appreciate, pumping up foreign exchange rates at the expense of the dollar. This is spawning angst in those countries as well as occasional imposition of Capital Controls.

Can global monetary harmony be achieved in the future? To answer this some structural realities cannot be ignored.
No matter whether it is in a Democracy or otherwise, leadership can only be held so long as it suits those led. Any leader that ignores this fundamental principle will, sooner of later be toppled. In a Democracy this is even truer and usually comes with a relatively short time limit. Voters will place in power those that do their will.

Consequently, the prime directive of any leader is to place national priorities over international priorities. Failure to follow this directive will lead to loss of support of voters then to the leader losing his job.

A nation’s international policies can only succeed only when they have the support of the nations electorate then international support.

This is sometimes tempered by a major nation exerting such an influence [through forceful domination or economic need] that national interests of one nation over another is well served. Pax Romana was a case in point. Today we see Canada supporting the U.S., nations surrounding China benefiting from its growth, the Eurozone supposedly benefiting from each other. This sort of relationship can only hold so long as the electorate is happy with the inter-national relationship. Even China, without democracy is keenly aware of the need to keep the Chinese population happy, so they can stay in power.

These principles extend to the global monetary system. The monetary system is global but is being strained by national interests. The quantitative easing we now see is intended to benefit the U.S. economy. The collateral damage inflicted on the nations influenced by it has to be ignored if it is to succeed. The holding down of the Yuan has to continue, if China is to reach its full potential. The E.U. has to rescue financially delinquent nations within itself, if it is to remain in existence. Germany has to support the rescues of the poorer nations, if it is to enjoy a low but fixed exchange rate and fixed interest rate within the Eurozone [which has allowed it to grow far more than it could were it not for the Eurozone].

Once national benefits are lost because of international cooperation, everything changes. The currency world is the first point where we see such changes. The Gold Standard worked when it did, primarily because all nations subscribed to its values. The Bretton-Woods system worked while there was global growth and while all nations agreed to it. When Nixon essentially brought that system down in the early seventies, oil priced in the U.S. dollar became the cohesive ingredient that then and now continues to hold the global monetary system together as far as it is held together. This is now changing.
The monetary system and particularly the world’s foreign exchanges can only function fully and properly when currency movements and changes are acceptable to other nations in the world. Once they are not, such as with the dollar and the yuan at present, then confidence in the system is sapped. Indeed, unless there is global harmony over exchange rates, conflicts of interest will arise. This is happening and threatening a fragmentation of the global monetary system.

Once the global monetary system leads to the loss of confidence in individual currencies to express ‘true’ value, the credibility of the entire global system fades.

How is it good for gold and silver?
Markets have a habit of going the way they want to. If there is no global monetary harmony, markets will feel that there are dangers. So will central banks. When there is no reliable internationally used currency, acceptable assets are chosen in their place. Nationally, assets such as land or industrial property can serve as was the case in 1923 in Germany when the Rentenmark came to the rescue. For such an asset to be internationally acceptable it has to be free of Jurisdictional restraints and mobile. To date only gold has served this purpose, but that has come with flaws.
When one weighs gold against currencies, currencies will always win out, so long as there is global growth, global monetary and economic harmony and strict controls over the issue of money. When this is not the case something apart from people, considered dependable, steps in. Gold has done this over most of man’s monetary existence. Gold has shone in this way particularly in the extreme times when mankind has been in conflict with each other. In itself gold has no real value except in its qualities as a metal. Its monetary value lies in the fact that mankind considers it valuable when man fails to respect other men. It is because of this persistently present danger that central banks keep gold in their vaults for that particular rainy day. And the weather is clouding over now.

How long will the gold price rise and how far?

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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 Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina 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 Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

Julian D.W. Phillips
November 19, 2010