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January 03, 2005

Are Gold Reserves the Only Way Out?
by Alex Wallenwein

A very simple case can be made to show that world central banks will soon be forced to return to a pure gold-reserve system.

If they want to save even a smidgeon of their former power, they really have no choice - unless they prefer that the whole ship go down before they change course.

Right now, international dollar reserves constitute the proverbial hot potato. Nobody really wants them, but no one can afford to drop them, either.

Best way to demonstrate the truth of this: a look at Asian central banks, especially those of China, Japan, and India.

They are awash in dollars, and they know that dollars are falling and will continue to fall. They also know that:

1. If they simply keep them, their value will rapidly decrease over time;

2. If they sell them, their value will decrease even faster;

3. If they buy more to keep the dollar and their export-based (rather illusory) profits from collapsing, they will only delay the inevitable and build themselves an even bigger problem.

There can be no greater argument than this to return to a system where gold is held in reserve instead of fiats - or any other country's financial obligations (government and agency debt, etc.).

Staying on a fiat-based reserve system simply is not an option. The more time is "bought" by these countries continuing to buy dollars to keep their own currencies low and the dollar system from imploding, the bigger the problem gets. All of the participants know very well that, eventually, a point of no return will be reached.

Right now, they are still waiting, hoping - against all better knowledge. But that will stop at some point in time, because it will become impossible to maintain.

The only hope they have right now is that, somehow, their tactics will enable another credit-fueled "boom" of the world economy - but they really know better. They know exactly that credit-fueled "booms" are what brought us all to this juncture in the first place. Any more of this, and this pressure cooker will simply explode. That's not the kind of "boom" they want.

The only viable alternative is the one thing they have collectively tried to abandon and have worked so hard to forever lay to rest. It will take some time to sink in, but sink in it will. Namely, only by exchanging dollars for physical gold reserves can they truly save their countries from this mess. Here is why:

The very same reason why the Asians can't sell dollars right now (their dollar-holdings' value would dramatically decrease, so they end up with huge losses) will eventually force them to abandon all pretenses at being able to run a world-wide monetary regime apart from gold, and it will force them to start buying gold with their dollars.

If they sell dollars for other currencies or productive assets, each time they spend dollars to buy these their remaining dollars will decrease in value and buy less, while any real assets they could buy with the proceeds will increase in price as the dollar sucks all currencies down that old competitive-devaluation sinkhole.

The same will be true of they buy gold with their dollars' of course. But there is one decisive difference.

If they buy gold for their dollars, then yes, the value of the dollar will decease just as rapidly - but the accompanying rise in the price of gold will more than compensate them for this loss. Why is that so? Because the "performance" of the gold they buy does not depend on the performance of any underlying economy where other real assets they might diversify into may be located.

As each additional dollar spent buys less and less, each additional ton of gold becomes more and more "expensive" in terms of dollars. As this process continues, their balance sheets will on balance be, well ... balanced.

Whatever downward pressure their fiat-sales will exert on the dollar, gold will make it up in a commensurate price-jump. Eventually, they will come to the realization that the dollar-price of gold (or whatever other currency price of gold) is nothing but a red herring, a ruse.

The real value lies in the gold, not in the dollar.

Instead of looking at the "price of gold", they will eventually begin to look at the price of fiat, and they will realize that its price - due to fiat's inherent worthlessness - is always too high. It doesn't matter which way you look at it. If you have any grasp on economic reality at all, you know that the cost of fiat is always too high.

Once this process starts, how much fiat do you think they will demand for their gold? How much fiat will they be willing to give for gold?

Eventually, other central banks will catch on to that, and will join in on the game, driving the price of gold ever higher and the value of the dollar ever lower.

Obviously, the central bank that begins this process first will get the most bang for its buck. (Take a good look at China.) The bank that joins last will lose out big - but such is life. It's called 'reality' - and reality, of course, cannot be ignored forever.

As each central bank buys gold with its surplus dollars, the price of gold will increase exponentially, but at least this way they end up with an asset that has proven its value - and especially its store-of-value function, throughout human history. Fiat, on the other hand, is now proving its ultimate uselessness and unreliability just once more.

The point: However much or little gold they are able to buy with their dollars, they end up with something they can rely on, while even currencies, government debt, or even productive assets of other nations or economic unions are shaky at best (because the underlying economies are shaky and fiat-dependent) and will eventually lead to the exact same problem.

Look at the euro. If they buy those, euros will become super-expensive because the entire concept behind the euro is "price stability" - which in effect means limited printing. To counter that effect, the ECB would have to seriously dilute its currency by either printing more or lowering its interest rates, direct intervention buying other currencies, or all of the above.

The foundations of the EU are already cracking under the weight of its expensive currency. Talk of abandoning the price-stability mandate abounds in the constitutional debates. For how long do you think they can continue to operate on virtual recessions and deficits while supporting the international reserve role of the euro? For how long do you think the nations making up the union will go along with that? Once they break away - where is the euro?

Even if a basket of currencies centered around the euro is used as a currency reserve, the effect on the euro will be quantitatively less severe but still too much for the struggling euro zone to digest. They are complaining even now - while the euro hasn't come anywhere near the heights it will soar to when the dollar collapses.

Of course, most central banks will fight tooth and nail before admitting that they have screwed up with their little fiat paper experiment, but the day will come.

Let's say they will try to institute another basket-case policy and adopt a currency "basket" that contains gold among other currencies. Can you see purely unbacked fiat paper successfully competing with gold once gold has been officially elevated to "currency" status again by the IMF, the World Bank, and all other international reserve banks?

Ha! I can't wait for the day.

Watch their little experiment go up in smoke and see the high and mighty central bankers sit around their conference tables with soot from the explosion all over their faces like little kids who failed to heed the instructions on their first chemistry kit.

But, seriously, try as they might, gold is what will become the number one reserve asset again - one way or the other.

The problem is: where does that leave the US as the dollar's issuer? What effects will it have on the US economy if the all world sells dollars for gold? Will the Fed and Treasury join the gold-buying rush and in the process annihilate their own currency?

Or will some smartypants politicians (like past and current White-House occupants) step forward and tell us that, "for the sake of national security, and to prevent the clandestine financing of terrorism, blah, blah, blah ..." we all need to forget about cash-money and gold altogether and accept a convenient little tracking device under our skin that can function as authorization to use a new cybercurrency to buy and sell what we need?

Source: LibertyThink.com

This cybercurrency will of course exist purely in the imagination and on the computer screens of certain programmers. It will need neither currency reserves, nor central banks, nor commercial banks, nor wallets, nor safes, and that quality will be trumpeted as the salvation of the world economy. All it needs is one single, humongous computer database into which your entire life's record will have to be fed including mental health records and your innermost wants, dreams, and aspirations - only for you own protection, of course.

Which way will the world proceed? Judging from past (and current) experience, I'm willing to bet my life that the latter will be at least attempted. Whether it's successful or not depends in the final analysis on - you.

If you own and possess physical gold, at least you will have something to defend, something to fight for. If all you own is paper, and paper/computer claims to more paper, why should you care? Expect a witch-hunt of all gold owners, if that comes to pass.

BUT:

As hinted above: Take a good look at China. Interesting to note in all of this is that, of all places China - yes, supposedly communist China - is strongly advocating that its people own and save physical gold to hedge against currency risk. Thus quoth Zhou Xiaochuan, the governor of the Peoples Bank of China in a recent address to the LBMA.

If China will be the leader of the emerging post-dollar world order as so many expect, can we anticipate that private gold ownership will be an officially sanctioned policy world wide? Or, maybe only Chinese citizens will be allowed to own gold??

More time will have to pass before that call can be made with any degree of certainty.

In the meantime, take advantage of artificially suppressed, pre-dollar collapse gold prices, and stop complaining about gold price manipulation. It's a pure blessing for those who are wise enough - like the Chinese.

The motto? Don't fight it - take advantage of it! Its days are numbered.

Got gold?

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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