The World Gold Council has reported that the central banks of Russia, the Philippines, Kazakhstan and Venezuela have been buying gold, and Saudi Arabia’s monetary authority has “restated” its reserves upwards from 143m to 323m tonnes. If there is any theme to the bullion rush, it is fear that the global currency system is unravelling. Or, put another way, gold itself is reclaiming its historic role as the ultimate safe haven and benchmark currency. Words: 638

Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com, provides below further reformatted and edited [..] excerpts from Ambrose Evans-Pritchard’s (www.telegraph.co.uk) original article* for the sake of clarity and brevity to ensure a fast and easy read. Evans-Pritchard goes on to say:

The Economy Is In The Grip of Debt Destruction
It is not inflation that is worrying big investors – though inflation may be the default response before this is all over – but deflation.

1. Core CPI in the U.S. has fallen to the lowest level since the mid-1960s. Unlike the blow-off gold spike of the Nixon-Carter era, this rally has echoes of the 1930s. It is a harbinger of deflation stress.

2. Capital Economics calculates that the M3 money supply in the U.S. has been contracting over the past three months at an annual rate of 7.6%. The yield on two-year Treasury notes is 0.71%. This is an economy in the grip of debt destruction.

3. The ECRI leading indicator for the U.S. economy has fallen at the most precipitous rate for half a century, dropping to a 45-week low. The latest reading is -5.70, the level it reached in late-2007 just as Wall Street began to roll over and then crash.

4. David Rosenberg from Gluskin Sheff said analysts are once again “asleep at the wheel” as the Baltic Dry Index measuring freight rate for bulk goods breaks down after a classic triple top.

5. The recovery in U.S. railroad car loadings appears to have stalled, with volume still down 10.5% from June 2008.

6. The National Association of Home Builders’ index of “future sales” fell in May to the lowest since the depths of slump in early 2009.

7. RealtyTrac said home repossessions have reached a fresh record. A further 323,000 families were hit with foreclosure notices last month. “We’re nowhere near out of the woods,” said the firm.

8. Spain had to pay a near-record spread of 220 basis points over German Bunds last week to clear away an auction of 10-year bonds, roughly what Greece was paying in March. Spanish companies have been shut out of the capital markets since Easter. Given that the Spanish state, juntas, banks and firms have together built up foreign debts of €1.5 trillion, or 147% of GDP, and must roll over €600bn of these debts this year, this is a crisis unlikely to cure itself.

9. Fitch Ratings said it will take “hundreds of billions” of bond purchases by the ECB to stop the crisis escalating. Since Bundesbank chief Axel Weber has already deemed the first tranche of purchases to be a “threat to stability”, it is a safe bet that Germany will fight tooth and nail to prevent such a move to full-blown quantitative easing.

The markets, however, doubt whether the EU’s strategy of imposing wage cuts on half of Europe without offsetting monetary and exchange stimulus can work. Such a policy crushes tax revenues and risks tipping states into a debt-deflation spiral, as if everybody had forgotten the lesson of the 1930s.

*http://www.theage.com.au/business/the-us-and-europe-still-deep-in-the-mire-20100621-ysf5.html

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The inherent deficiencies in our system virtually guarantee that long-term implications of massive debt will be ignored. Unfortunately, the “long-term” may finally be upon us, and a dollar collapse of shocking proportions is increasingly likely. This Depression is just getting started. Words: 1011

In further edited excerpts from the original article* Moses Kim (www.expectedreturns.net) goes on to say:

The value of a currency is determined by a number of variables. In this article, I will focus on the dynamics of demand, supply, current account deficits, and aggregate government debt.

Demand for Dollars
The dollar has enjoyed a boost in demand and an exchange rate premium due to its privileged role as the world’s reserve currency. As a function of this status, world trade is, for the most part, transacted in dollars. However, recent developments on the periphery have slowly undermined the dollar’s dominant position in global trade.

World trade in dollars has been declining since the start of the decade. Recent currency swap agreements between countries, mostly involving China, have been used to bypass the dollar in global trade. Arrangements such as these threaten the dollar’s role as the global reserve currency, removing any support to the dollar’s value such an arrangement provided. This decreased demand is clearly reflected by a falling percentage of foreign reserves held in dollars.

Further, in a low interest rate environment, the dollar has become the carry trade currency of choice. Investors have long been waiting for a powerful countertrend rally in the dollar, but as the example in the yen shows, prolonged weakness in carry trade currencies can and do occur. Also keep in mind that alternative assets, such as gold, become much more attractive in an environment where yields are essentially 0%.

Massive Supply
It’s been well-documented that the Fed has embarked on a campaign of massive monetary stimulus. Unfortunately, it’s hard to quantify the extent of money supply growth, since the government has stopped reporting M3 money supply figures.

The real problem brewing under the surface are accumulating bank reserves, which can be thought of as a proxy for risk aversion. Once these reserves are deployed, expect inflation to increase significantly. Sooner or later, banks will have to focus on their core business, which is lending to consumers.

Current Account Deficits
Current account deficits are the quantifiable measure of a country’s profligacy and overconsumption. Current account deficits are historically a short-term solution to a nation’s underproductivity, which must eventually be settled through the balancing of capital and current accounts. As a nation continually funds consumption via debt, its currency naturally becomes less and less valuable as a medium of exchange.

Current account deficits as a percent of GDP in the U.S. have exploded to troubling levels, especially since President Nixon removed the last vestiges of our link to gold in 1971. Over the long run, the value of a currency is inversely correlated to the level of current account deficits. Persistent imbalances in current account deficits will weaken a currency without exception. The downward trend over the last decade in the dollar evidences the detrimental effect of long-term current account deficits. Gold, as an alternative to the dollar, has risen in response to rising current account deficits.

U.S. Government Debt and the Treasury Market
Moving forward, the Treasury market will inordinately dictate major moves in the dollar. Before I explain why, I want to briefly overview the relationship between treasury debt, inflation, and the value of the dollar under the Maestro, Alan Greenspan.

The “great moderation” in the Greenspan years was facilitated by the recycling of dollars into our capital accounts such as stocks, treasury debt, and agency debt. This meant that inflation was temporarily stifled as dollars were sterilized in debt instruments, while asset prices received a jolt from the attendant low interest rates. Furthermore, the tremendous demand for U.S. capital products proved to be supportive of the dollar. If there ever were a period of getting “something for nothing” in America, it was during this era of massively inflated asset prices, and moderate consumer price inflation.

Now what happens when our debt grows to a level that forces the government to become a major player in the bond market? Foreign actors will start unloading their treasury debt, especially on the long end of the yield curve, to an increasingly overburdened government. As demand for Treasuries falls, yields will rise, which makes the burdens of servicing debt greater.

The monumental and ever-increasing level of debt the government has directly taken on through its program of quantitative easing is troubling. The reason is simple: in an inflationary environment, the Fed will be inhibited from containing inflation by selling bonds in the open market, and thereby, soaking liquidity from the system. Due to the sheer size of our program of monetization, any move to sell treasury instruments will likely be met with panic from foreign investors. This is something to keep in mind moving forward.

Total Debt Including Unfunded Liabilities
Now we come to the elephant in the room: aggregate government debt, including unfunded liabilities. Decades of kicking the debt-can down the road in Ponzi scheme entitlement programs, like Social Security, has created a behemoth of debt that is quite literally unpayable. Absent a growth miracle, and a bigger miracle of fiscal austerity by our government, there is no way we can fund these accruing liabilities through our dwindling tax base… If recent government actions are any indication, our government will attempt to mask insolvency through the printing press.

A weaker dollar poses tremendous complications for Americans. For one, it makes imports more expensive, which is effectively inflation. Ultimately, this means a standard of living lower than what we have come to expect. If confidence in the dollar totally erodes, then things will really get ugly.

*http://expectedreturns.blogspot.com/2009/09/case-for-depression-part-4-dollar.html

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The Bank for International Settlements says Britain needs a primary surplus of 5.8pc of GDP for a decade to stabilise debt at pre-crisis levels, given the ageing crunch as well. The figure is 6.4pc for Japan, 4.3pc for the US and France. It warns of “unstable dynamics”, posh talk for a debt spiral. Words: 620

In further edited excerpts from the original article* Ambrose Evans-Pritchard (www.telegraph.co.uk) goes on to say:

Belt-tightening is the oppressive fact of 2010-2012 for half the world:
- Hungary, Ukraine, the Baltics and the Balkans are already under the knife.
- Latvia’s economy may contract by 30pc from peak to trough as it carries out an “internal devaluation”, ie wage cuts, to hold its euro peg.
- The eurozone’s fiscal squeeze is well advanced in Ireland.
- Brussels has told Greece to cut by 10pc of GDP in three years, Spain by 8pc, Portugal by 6pc.
- Britain must slash soon, or face a gilts strike.
- American states face a shortfall of $156bn in fiscal 2010.

While belt-tightening is indeed required cutting too fast would tip the West back into slump and kill tax revenues, solving nothing – a risk that austerity priests rarely acknowledge. Pacing is everything.

The West risks a slow grind into debt-deflation unless central banks offset fiscal tightening with monetary stimulus (i.e QE) to keep demand alive. Yet the Fed and the European Central Bank are letting credit contract:
- Bank loans in the US have fallen at a 14pc rate this year, caused in part by Basel III rules pushing banks to raise capital ratios.- The M3 money supply has fallen at a 5.6pc rate since September, 2009.
- The Fed’s Monetary Multiplier dropped to an all-time low of 0.809 in late February, 2010.
- The contraction of eurozone bank credit to firms accelerated to 2.7pc in January, while M3 fell by a further €55bn. – Japan’s GDP deflator has dropped to a record low of -3pc.

These are epic warning signals, with echoes of 1931 yet the Fed has just raised the Discount Rate. It is winding up liquidity operations, and preparing to reverse QE, even though the housing market has tipped over again. New home sales fell 11pc in January to 309,000 units, the lowest since data began, and 24pc of mortgages are in negative equity.

Fed chairman Ben Bernanke told us in his 2002 speech “Deflation: Making Sure It Doesn’t Happen Here” that:
1) Japan’s slide into deflation was “entirely unexpected”, and that it would be “imprudent” to rule out such a risk in America;
2) “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted”;
3) that a “determined government” has the means to stop deflation, if necessary by use of the “printing press”.

Yet here we are, facing exactly that risk, unless you think one good quarter of inventory rebuilding has conjured away our debt bubble. The one-off inflation blip caused by a doubling of oil prices is already fading, revealing once again the deeper forces of deflation. Core prices fell 0.1pc in January. They plummet from here.

So why has Bernanke begun to flirt with disaster by tightening too soon? Has he lost control to regional hawks, as in mid-2008? Have critics in Congress and the media got to him? Has China vetoed QE, fearing a stealth default on Treasury debt?

Don’t go wobbly on us now, Ben. If the governments of America, Europe, and Japan are to retrench – as they must – their central banks must stay super-loose to cushion the blow – otherwise we will all sink into deflationary quicksand.

*http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7338857/Dont-go-wobbly-on-us-now-Ben-Bernanke.html

Editor’s Note:
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given.
- Sign up to receive every article posted via Twitter, Facebook, RSS feed or our Weekly Newsletter.
- Submit a comment. Share your views on the subject with all our readers.
- Buy the book below from Amazon. It’s pertinent to this article and inexpensive too.