Fiat currencies are not retaining the value or credibility they once did. It is easy to understand why fiat currencies are losing their credibility given the record debt expansion and relentless printing of money by the world's largest nations. At some point there is going to be a reset or return to sound money. Gold will be fundamental in bringing the world back to sound money and our team believes this is one of the most important Volumes we've ever released on the subject.
Reuters reported earlier this year that "Banks are already preparing for the full implementation of gold's dominance as the new first class security for banking."
Central banks are accumulating gold as a monetary unit once again. Gold hasn't seen this kind of interest from central banks in almost half a century.
Countries issue hundreds of billions of dollars in debt every month and no one blinks an eye. Germany recently announced it had sold 4.2 tonnes of gold, equal to only $229 million (at $1700 an ounce), and the financial world went into shock. Germany was getting called out by every news reporter and pundit in the finance industry, demanding to know why it would sell any gold in a time like this. The Germans wasted little time and immediately put out a rebuttal, explaining that the sale was "intended solely for producing commemorative coins". This is something Germany has done routinely in the past, and actually sold more (roughly 4.7 tonnes) in October of 2011 for the same reason. However, there was no backlash in 2011. So what has changed and why was Germany scolded for selling gold this year?
Germany was scolded because gold has now become the world's only trusted currency.
The World Embraces Gold
Effective January 1, 2013 gold will be considered currency by an important group for the first time in over 40 years. Behind this move is a highly private, almost secretive, group which sets banking rules for the entire world. This group is known as the Basel Committee, based in Basel, Switzerland.
When the Basel Committee makes an announcement, central banks around the world listen. Since its inception in 1974, the Basel Committee has only advised the global banking community three times. In 1988 the committee issued Basel I. In 2004 they issued Basel II and just this year, issued Basel III. In Basel I and II, gold was considered a 'tier 3 asset' and accepted as reserves for loans (collateral) on a 50% basis. In other words, it was considered a risky asset and inferior to cash. US Dollars were the ultimate currency and coveted by nations and individuals around the world. Amidst the current global currency war, with debt proliferation running at the utmost extreme, the USD, among other currencies, has been losing purchasing power against a title wave of inflation. The recently issued Basel III has made some critical changes that impact gold, which explains the record accumulation by central banks.
In Basel III, gold was moved from Tier 3 to Tier 1 capital and is now considered a 100% loan-backed reserve. It is classified in the same regard as cash and bonds. This is the first time since 1971 that gold will be considered as good as cash by the Basel Committee. These rules come into effect January 1, 2013.
The World Gold Council revealed net central bank purchases in 2011 exceeded 455 tonnes (or over 14.5 million ounces) - the largest amount since 1965. It has been reported that central banks will purchase nearly 500 tonnes in 2012 alone. This is the beginning of a trend (or race, depending on how you look at it) to acquire gold as global money supply (fiat currencies) continues to recklessly skyrocket. Central banks are preparing for something big.
Last week we explained why gold was not even close to being classified as an asset bubble about to burst (click here to read our report). Take a look at the Gold vs. Forex Reserves chart below. Notice the massive decline in gold holdings as a percentage of FX reserves. This is a staggering drop-off over the last 30 plus years.
The only potential asset bubble we can see is in bonds, both government and corporate, and of course in fiat currencies. Few charts explain gold's under-supply in relation to fiat currencies over-supply better than the one above.
Since Nixon took us off the gold standard in 1971, gold has appreciated from $35 to a high of over $1900 an ounce. Nixon first did this to allow for a period of increased spending, both domestically and abroad. When the USD came off the gold standard he effectively prevented foreign governments the ability to exchange their dollar reserves for US held gold. Keep in mind, foreign governments were exchanging dollars for gold at a rapid pace in 1971, due to a serious lack of fiscal discipline in Washington.
Jim Rickards, the bestselling author of the book, "Currency Wars" is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street.
* We recommend reading Currency Wars by Jim Rickards if you have time over the holiday season.
On November 13th 2012 he commented that, "Once the chaos hits, which I would define as a complete loss of confidence in paper money, social unrest and riots, when that sort of things starts to break out, governments will have to do something and they'll have to regain trust. And the easiest, fastest way to regain trust is by going back to a gold standard. So as I say, they won't want to do it but they will do it out of necessity."
What does he mean by this?
At some point the dollar is going to collapse. Whether the US continues making interest payments to its debtors by printing a few trillion in paper money every year or not, time is running out. The US national debt will clear $20 trillion in a few short years, highlighting the fact that the current system is unsustainable and the debt is now mathematically impossible to pay off.
The Federal Reserve has historically maintained roughly a 40% partial gold reserve against the base money supply. In early April 2011 that ratio was about 17.5%. It has since fallen further as more than a trillion dollars in debt has been added to the US balance sheet alone in that time.
Looking at the global monetary system in 2012, Rickards has some shocking revelations at where the current price of gold should be, if and when chaos arrives and governments are forced to return to sound money. Before we get into Rickards' calculations we must define some of the terms he uses.
Investopedia explains 'Money Supply':
The various types of money in the money supply are generally classified as "M"s such as M0, M1, M2 and M3, according to the type and size of the account in which the instrument is kept. Not all of the classifications are widely used, and each country may use different classifications. M0 and M1, for example, are also called narrow money and include coins and notes that are in circulation and other money equivalents that can be converted easily to cash. M2 included M1 and, in addition, short-term time deposits in banks and certain money market funds.
Flexible Gold Standard Factors (as of April 2011)
Jim Rickards explains:
- US M1 money supply with 40% gold backing - Implied Price of $2,590 per ounce
- US M0 money supply with 40% gold backing - Implied Price of $3,337 per ounce
- US M1 money supply with 100% gold backing - Implied Price of $6,475 per ounce
- US, China, ECB M1 money supply with 40% gold backing - Implied Price of $6,993 per ounce
- US M0 money supply with 100% gold backing - Implied Price of $8,342 per ounce
- US M2 money supply with 40% gold backing - Implied Price of $12,347 per ounce
- US, China, ECB M2 money supply with 100% gold backing - Implied price of $44,552 per ounce
Global money supply has expanded to ridiculous levels. There is no other asset which can be used to stabilize or control monetary expansion better than gold.
The US still has the largest gold reserves by far. Its gold reserves are more than double the amount of the second largest holder (Germany) and more than 8 times of what China holds. If there is a global currency collapse and the system is reset, those who hold the most gold will come out on top as the revaluation of currency will favor them greatly. China has bought over $3 trillion in US debt and the US could be setting them up for one of the biggest falls ever.
Bloomberg recently published a comment made by Gao Wei, an official from the Department of International Economic Affairs of Ministry of Foreign Affairs:
"China needs to add to its gold reserves to ensure national economic and financial safety, promote yuan globalization and as a hedge against foreign-reserve risks."
Gao Wei made that statement in the China Securities Journal.
As the US and EU continue to spend with reckless abandon, one has to wonder if a bigger story is unfolding, with gold at the very heart and soul of a new, stable monetary system.
All the best with your investments,