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India Buys IMF Gold, What Could It Mean ?

Commodities / Gold & Silver 2009 Nov 03, 2009 - 11:39 AM GMT

By: Michael_Pollaro

Commodities

Best Financial Markets Analysis ArticleThis flashed on the Bloomberg news wires this morning:

India Buys IMF Gold to Boost Reserves
India, the world’s biggest gold consumer, bought 200 tons from the International Monetary Fund for $6.7 billion as central banks show increased interest in diversifying their holdings to protect against a slumping dollar.


http://www.bloomberg.com/apps/news?pid=20601087&sid=aa6oc6Wz9Ftg&pos=5

This is no little thing.  China, now India, indeed all US creditor nations, who sit on top of huge USD reserves in the form of US Government IOU’s, are not just looking to diversify out of those USD IOUs.  They ARE diversifying out of those USD IOUs.   And it seems, with increasing intensity, they want gold. 

The fact that it was the Reserve Bank of India that stepped up here underscores the significance of this transaction, and the growing concern over the USD.  You see, notwithstanding the Indian population's interest in gold, the economic authorities in India have until now NOT been buyers of gold.  This from Reuters:

Although India is the world's biggest consumer of gold, primarily in the form of jewelry and investment among its billion-plus people, its central bank had given few signs of seeking to diversify its reserves pool into bullion.

The proportion of gold as part of its total foreign reserves has fallen from over 20 percent in 1994 to just under 4 percent….The latest purchase will lift its share of gold holdings from near 4 percent to about 6 percent…

http://in.reuters.com/article/economicNews/idINIndia-43625720091103?sp=true

Make no mistake, world USD holders are becoming increasingly concerned about the US government's fiscal position, getting more precarious by the month.   What worries them?  In short, default by the US government on its IOU’s, whether that be via an outright default or via a stealth default, through the Federal Reserve’s printing press.  As Steve Saville, proprietor of The Speculative Investor suggests, it’s likely a bit of both:

Under the current monetary system there is no limit to how much debt a government can take on, provided that the debt is denominated in its own currency. The reason is that the central bank stands ready, willing and able to be the bond-buyer of last resort, and the central bank's pockets are infinitely deep (there is no limit to the amount of new money that the central bank can create). As a result, if it chose to do so the government could continue to issue new bonds until the currency became worthless. At the point where the currency had lost almost all of its purchasing power the surreptitious default would essentially be complete because any debt denominated in this currency would be almost worthless.

But rather than continue the debt issuance and the associated monetary inflation to the point where the currency is worthless it could, at some stage during the process, become politically more feasible to default directly on a large chunk of the outstanding debt. The reason is that hyperinflation would destroy the economy as well as the currency, and would thus inflict large losses on almost everyone, whereas directly defaulting on the debt would only inflict large losses on the holders of government debt. In the US case it is not hard to envisage the Administration being faced in the future with the following choice: default on all Treasury debt except for the debt held by US government trust funds, or plunge into hyperinflation and wipe out the values of all bonds and all monetary savings. Given that the bulk of the aforementioned Treasury debt is held by foreign governments, a direct default will potentially be the natural choice of the politically astute.

The way things are going it will probably take less than three years for the US and many other countries to reach the point where it becomes necessary to completely abandon the pretense that the government's debt will ever be repaid legitimately (without inflating the currency into oblivion, that is). It will then be a matter of deciding on the method of default.

For now, clearly, the US has chosen the way of the printing press.

OK, why gold you ask, why not diversify into Euros or Yen?  Well, we are seeing diversification into Euros and Yen.  But we are also seeing something else.  For the first time in many years, the official sector is now a net buyer of gold.   Even the European nations, major sellers of gold in recent years, have been slowing their gold sales.  Perhaps it is not just USD holdings that concern creditor nations.  Perhaps it’s a concern about any holding in any currency of any debtor nation that seems to think the way out of its debt burden is resort to the printing press. And right now, it seems all debtor nations are resorting to the printing press.  And what’s the only currency that can not be debased?  Gold.

G7 nations have about 35% of their foreign exchange reserves in gold.  Non-G7 nations have less than 5%.  China has just 2%.  If China, India and other emerging nations want to protect their foreign exchange reserves, at least in a fashion similar to the big boys, than they have some catching up to do.

As an aside, gold bears, who have been pointing to the bearish impact of IMF gold sales on the price of gold for months now, have something more to think about today.  If G7 institutions like the IMF, that have had a want to sell off their gold holdings, want to sell gold, off-market, to Non-G7 nations like India or China, you know, the nations that are striving to become world financial forces, than I suspect there will be more of these off-market trades to come. 

Next up, the remaining 200 tons of planned IMF gold sales?

By Michael Pollaro

Email: jmpollaro@optonline.net

I am a retired Investment Banking professional, most recently Chief Operating Officer for the bank's Cash Equity Trading Division. I am a passionate free market economist in the Austrian School tradition, a great admirer of the US founding fathers Thomas Jefferson and James Madison and a private investor.

    Copyright © 2009 Michael Pollaro - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Michael Pollaro Archive

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