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Dying Fiat Currencies- Gold, Gossip and Russia's Tu-160 Bombers

Commodities / Gold & Silver 2009 Mar 18, 2009 - 09:16 PM GMT

By: Adrian_Ash

Commodities

Best Financial Markets Analysis Article"Germany in 1944 could buy materials during the war only with gold. Fiat money in extremis is accepted by nobody..." - Sir Alan of Greenspan, May 1999

FOR A WORLD-LEADING CLEARER turning over $60 billion per day, London's wholesale gold market sure spooks easy sometimes.


"I've just heard central banks have been selling. You hear anything?" asked one breathless contact of BullionVault on Wednesday...just before the Federal Reserve's $1.25 trillion shot in the arm gamed the gold price so hard, so fast, the perma-bulls at GATA should demand a Congressional hearing into Ben Bernanke's long Comex position.

More often than not, however, professional dealers get all aflutter about rumors of central-bank buying, not selling. In late 2008, it was supposed to be the Saudis. Last month it was the Russians – or so gossip claimed. Gossip that the Kremlin was only too happy to buoy.

Come mid-March, the People's Bank of China (PBoC) fired up the tittle-tattle – and again, as if on purpose – by forecasting that despite "safe haven" demand for the US dollar in 2009, gold prices would "fluctuate at high levels...possibly breaking through previous highs..."

Now this week a report by the oh-so-sexily-named Central Banking Publications says that out of 39 reserve managers controlling $3.2 trillion in official currency and bullion hoards – some 42% of the world total – well over one-in-two feels Buying Gold would make a smarter move today than it did this time last year.

So are the emerging powers hoarding gold today or not? What's a private citizen trying to look after his or her own to make of this chatter?

Well, as a rule, it means little or nothing for the price of gold day-to-day. And like GATA's claims – highly detailed, much derided – that Western governments regularly fix the gold market to cap its ascent, rumors of central-bank buying never prove quite as dramatic as central-bank action to either defend or debase the currencies against which it's priced instead.

Raise overnight interest rates to double digits, for instance – as the Federal Reserve's Paul Volcker did in the early 1980s – and non-yielding gold will tumble against high-yielding cash. Cut and hold rates at zero, in contrast...while creating, say, $1 trillion of fresh money in a 425-word statement, as Ben Bernanke did Wednesday...and you'll send Gold Prices higher, just as surely as the Maestro's apprentice strolling into London and buying 50 tonnes on his own account.

Investment-house analysts, meantime, are more focused on the possible 400-tonne sale mooted to help save the world-saving International Monetary Fund (IMF). Yet the really big driver so far this year remains mutual-fund managers buying paper-shares in Gold ETF trusts. Western coin buyers paying 10% mark-ups (or more...!) are meantime wrestling with Asian scrap-jewelry sellers as to who can tip the balance of apparent supply and demand.

Large-scale gold purchases by Beijing or the Kremlin would anyway come at the pit-head, rather than on the open market, as they look to "slow and steady accumulation" in the words of UBS's highly-regarded John Reade recently, quoted by the Financial Times . Buying gold direct from domestic miners was how South Africa more than doubled its official reserves in the late 1960s. China and Russia now stand first and fourth among the world's gold-producing nations. Why announce their intentions, sticking a premium onto their dealer's offer, by going through the open market?

But behind the dealing-room noise, howwever, the cold facts of Asian, Middle East and Russian gold hoarding point to a deeper trend – an ugly if grand historical shift that finds its last cyclical turn almost 10 years ago to the day.

In mid-1999, the Swiss, European and UK central banks announced gold sales that did indeed shake the market. Back then, the Gold Price had been tumbling for the best part of two decades – thanks first to those double-digit US rates, and then to the fast-growing number of high-return alternatives for investment cash that sprouted worldwide as interest rates began to fall back but remained well north of the rate of inflation.

Prompted by investment-bank advisors and analysts, the late 20th century's heavy selling by West European governments coincided not only with both a multi-year low in the gold price and a bubble in earnings-free tech stocks. It also came together with Francis Fukuyama's "end of history" and Tony Blair – the UK prime minister then guilty of neither bombing Belgrade nor Baghdad – declaring his to be "the first generation [in Europe] that may live our entire lives without going to war or sending our children to war."

Put Blair's cant to one side (if you're not retching). Why did Europe's central banks have so much gold to sell in the first place? As BullionVault has noted before, the continent's 30-year scrap between its big nation states was preceded and worsened by frantic gold hoarding amongst the major players. Because a government must trust in another's long-term survival when accepting its paper as payment. Whereas gold bullion, as former Fed chief Alan Greenspan famously said – and just before the UK announced its 415-tonne sales back in May 1999 as it happens – "still represents the ultimate form of payment in the world.

"Germany in 1944 could buy materials during the war only with gold. Fiat money in extremis is accepted by nobody. Gold is always accepted."

Why else did the Nazis march straight to seizing the central-bank vaults on reaching Vienna, Prague and Warsaw? Why else did the United States grow its hoard from 500 tonnes in 1900 to almost 20,000 by the eve of World War Two...nationalizing privately-held gold on pain of a $10,000 fine or imprisonment when F.D.R. took office at the depths of the Great Depression? ( See Hoarding for War, Vaulting for Victory for more... )

Now, two generations later, China's official gold reserves remain unknown and unknowable to outside observers. But it has become the world's No.1 gold-mining state thanks to the collapse in South African output. And the fresh deluge of US money debasement only confirms why Beijing's bankers " hate you guys " as one policy-maker, Luo Ping – director-general of the China Banking Regulatory Commission – put it last month.

"Once you start issuing $1 trillion or $2 trillion," he said to the Financial Times , five weeks before the Fed issued...ummm...$1.25 trillion of new cash..."we know the Dollar is going to depreciate.

"So we hate you guys but there is nothing much we can do. Except for US Treasuries, what can you hold? Gold? You don't hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option."

Further west (but only a little, politically), Russia's official gold reserves have swelled by one-half this decade on the IMF's data , with new purchases peaking in August 2008 – just as the 58th army rolled into Georgia to defend South Ossetia's illegal, breakaway republic.

Under Vladimir Putin, the Kremlin said it wanted gold to grow from 2.5% to fully one-tenth of its foreign currency reserves, meaning four-fold growth of its bullion hoard if not a collapse in its paper assets. Just last month, the central bank stated that it was buying gold. On the available data, it had already added 109 tonnes to its hoard in the 15 months starting Jan. 2007 at a cost of some $27 billion.

Oh sure, that's peanuts compared to the total $4 trillion-worth of gold now thought to be above-ground at today's prevailing prices. But the vast bulk of that gold is held as jewelry, not monetary units like coins or bars. And according to Tsar Putin himself back in 2007, before this burst of gold-hoarding really got started, the ratio of Russian government debt to its national gold reserves was already stronger than for any other state in Europe.

Never mind how wide of the mark that metric was; Putin's claim shows how much Gold Bullion matters to Russia's political confidence – a confidence only called into use when debt and foreign currencies slide into crisis. And then this week, the current Kremlin incumbent, Dmitry Medvedev, goes and announces that he's "rearming" Russia, using the very word – "rearmament" – that Europe fretted over and feared all through its short 20-year peace between the first and second world wars.

Specifically, "[I will] increase the combat readiness of our forces, first of all our strategic nuclear forces," Medvedev declared Tuesday, piling historical weight onto Monday's more Cold-War-style news that Roscosmos, the Russian space agency, is planning a manned lunar mission for 2015.

Oh, and then there was the overnight news from Venezuela that socialist crackpot Hugo Chavez says Russia's long-range Tu-160 "Black Jack" bombers – each capable of carrying 12 nuclear warheads – are welcome to use the Caribbean island of La Orchila. You know, just for re-fuelling, cleaning the windscreen, emptying the ash-trays...but not ever as a permanent base.

So this isn't the Cuban missile crisis. Not yet at least. But the Kremlin's new saber rattling must still have caused a shock at the White House – just as it shocked anyone not tracking Russia's fast-growing gold reserves. Either that, or Team Obama is so smart, they were expecting some kind of pre-emptive strike ahead of the Fed's nuclear blast in the T-bond market.

"Foreign demand for long-term Treasuries has disappeared over the last few months," writes Brad Setser – an ex-US Treasury and IMF official, former economist for Nouriel Roubini's doom-and-gloom funsters at RGE Monitor, and a visiting or associate fellow pretty much everywhere worth having deep thoughts on big subjects.

Studying the latest official data (released Monday) in his blog for the Council on Foreign Affairs , "It is striking that for all the talk of safe haven flows to the US, foreign demand for all long-term US bonds has effectively disappeared," he explains.

In particular, "Over the past three months, almost all the growth in China's Treasury portfolio has come from its rapidly growing holdings of short-term bills, not from purchases of longer-term notes...and it is also still selling [mortgage] Agency bonds."

All told, China continued to buy US Treasury debt; it is "the only option" for China, Russia and everyone else at this stage of the game, as Luo Ping wailed to the FT last month. But of the $12.2 billion China purchased in January, fully 95% were short-term bills. "Russia also, interestingly, added to its holdings of short-term Treasury bills," Setser says.

And then, with the latest Treasury fund-flow data revealed... BOOM! The Federal Reserve prints $300bn to buy 30-year US debt, plus another $750bn to buy mortgage-agency bonds.

Someone's got to buy this stuff, and the forced buyers of this decade-to-date are starting to tire. They might just be looking to Buy Gold for much more than "portfolio diversification" as well.

There. How's that for rumor...?

By Adrian Ash
BullionVault.com

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2009

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

Adrian Ash Archive

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