GOLD WILL GAIN FROM BOTH 
THE LIQUIDITY SUPPLY 
FOR STABLE MONEY CREATION... 
AND TO PREVENT MONEY SHRINKAGE
Excerpts from GLOBAL WATCH:
THE GOLD FORECASTER
by Julian D.W. Phillips
August 31, 2007

Many, many times we have opined that the Fed would not fight inflation at the expense of growth and that proved true last week. This concept permits a measure of inflation and it permits the issuance of money headed overseas to promote world growth [paying for imports], called ‘stable’ money creation. But as we are all aware the over-issuance of money [supplying more than necessary to provide just the right amount of the medium of exchange to make the economy [global as well as local] function with stable prices, has now had a long history one likely to get longer too. If it were simply to facilitate global growth, there would have been no reason to doubt the value of money. But the temptation to print too much has caused the gold bull market to be steadily on the go since 1999. With recent events pointing to inflation and or uncertainty, it is set to continue for a long time. The issuance of liquidity should promote stable money expansion, but it has gotten out of hand.

Over issuance has set off two dangers: -

1)       Asset bubble bursts, where prices have over inflated, then burst sending asset values plummeting [equaling the disappearance of money].

2)       Deflation where prices drop [again equaling the disappearance of money].

If these are on a small scale the two can be coped with. But if they are on a large scale they threaten not only growth, but cause a slide down towards depression. This is where confidence in money and the Central Banks issuing it play a key role. 

Falling confidence can lead to consumers saving, not spending and that is deflationary. When consumer’s credit becomes suspect, then the institutions behind them become suspect in the eyes of other institutions as well. [A month ago professional finance people would have laughed at that possibility] When this second type of money deflation sets in Central Banks, defensively, have to issue money. The word defensively must be emphasized, because if they don’t deflation really takes off. Of course, such deflation feeds on itself, so when new money arrives to combat it, it causes prices to rises as well, prompting the need for an even greater supply of it. This prompts further price rises – greater need for money – price rises and so on until Central Banks have to allow runaway inflation eventually leading to hyperinflation or see a collapse [such as can be seen in Zimbabwe today] and was seen in the Weimar Republic after the first world war. [Subscribers – please ask for a copy of our essay on this]

Last week saw the beginning of the second type of liquidity supply, the overtly defensive supply by the Fed and the E.C.B. Unless they can restore underlying confidence in the system as well as the $, they will have to repeat such measures as the loss of confidence results in the starvation of liquidity. 

What makes this defense so critical is the concept of syndication. When a bank wraps up a parcel of dubious mortgages, collateralizes them [adding their name to it] and issues shares in them to their subsidiaries and clients, they lay off their bets [syndicate] by selling portions to several other banks. Eventually banking in this way becomes like a spiders web of shared risk. So a shock at one point sends waves throughout the banking system as we saw last week. So if more Fed/E.C.B. defense is needed it has the potential to actually break confidence and rocket deflation and loss of confidence in the entire structure of the economy. The delicacy of such confidence building makes this the most difficult task a Central Banker can face. 

If it precipitates the need to supply huge doses of liquidity supply, which are confidently accepted [if only out of relief] then the cycle will begin as we described above and growth may be maintained, but the threat of a depression will sit in the wings constantly. However, the task of fighting inflation will then become impossible. 

Global cost

In a local context such hyperinflation can be contained and stopped, because the government has full control of the situation locally. Additionally there is always an underlying reason that permits hyperinflation in the first place, but with the global economy fragmented by a host of separate national interests that make up the global economy, this is not the case, hence the greater danger. 

If excessive defensive doses of liquidity are injected, not just inside the States, it will have to be matched overseas as we saw in Europe when the E.C.B. also defensively issues Euros. As this happens surplus holding nations will seek to either quarantine themselves from the local impact of the $ [reverse capital control as we highlighted in last week’s issue where China is permitting $ proceeds to be kept offshore] or to switch out of them. They will also encourage international trade to be priced in currencies other than the $. Both moves spell disaster for the $’s role as the global reserve currency.

The impact on Gold and Silver

Well before such inflation takes off, the value of the $ will plummet. As it is the globe’s pivotal currency, on which all others are in some way dependent for the stability of their currencies, the infection will spread and undermine the entire global money system. This is where the meaning of gold and silver as “safe-havens” will be properly understood. It is in this climate as doubt and uncertainty grows that gold and silver investments really prosper. By this we don’t expect gold and silver to become “mediums of exchange”, but on the one hand, they will be preservers of value and on the other, confidence builders in paper currencies under stress [as important reserve assets].

Before that happens now, the dust has to settle on the present crisis, institutions have to take stock, re-strategize, then focus on the way forward [with precious metals in more favor than before]. 

Last weeks confidence crunch was the beginning of gold and silver’s rise, and it will go on as long as doubts are thrown at the monetary system and the global Balance of Payments.

© 2007 Julian D. W. Phillips
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