US Dollar Chart Watch - Update

A week ago we ran this article noting that the US dollar index as hovering just above a key support area at 93-94. The dollar index had fallen down to the 94 level twice and weakly bounced up a little as you can see on this chart. We wondered if the 94 level would hold. This week we get our answer as the dollar did not hold the 94 level and closed Friday just barely above 93. This has some added significance since this was both a weekly and monthly close. 

When you look at the chart linked above virtually every indicator is suggesting that the dollar index is headed a lot lower soon. It will have to stage an immediately sharp rally off 93 or else it is probably headed into a deeper dive. On this longer term chart you can see that there is not much support until the 80-82 area. A drop down to there will be a major event and will send gold, silver and oil prices higher. About the only positive you can find on the charts is that the dollar index is showing to be oversold, but if 93 does not hold, that will likely just continue to be the case for awhile longer.

Normally I don't monitor things like this on a daily basis, but in this case the dollar index is at a very key level from a technical standpoint. It must stage a stronger rally soon or we will likely see a drop (over 10% in a short time frame) that will get investor and media attention. Because we do know that governments and central banks do intervene in markets at times, it will be interesting to see if any effort is made to rally the US dollar index right here. If there isn't, it suggests to me that a decision has been made to let the dollar go for now or that market forces pulling the dollar down are too strong for attempted intervention to matter. Just keep an eye on it over the next couple of weeks and see if it rallies or breaks down into an even sharper decline. The chart right now suggests the later is more likely.

Added update 5-2-16: Here is a decent technical analysis that points out what we are saying about the dollar being at a very important point right now on its chart and the potential impact on precious metals depending on what happens next with the dollar.

New Article Proposing Using SDR to "Finance Global Reflation" Supports Jim Rickards Prediction?

Readers here know that we have followed the SDR story for quite some time here and covered it in depth. We started following this story because a few years ago Jim Rickards issued a prediction that another major financial crisis in the future will lead to the IMF issuing trillions of new SDR's in order to "reflate" the system after the crisis. In our research here, we have found evidence that this a plausible theory (although likely a gradual process absent a crisis) and have documented it here in articles with direct input from a leading expert in the world on SDR's, Dr. Warren Coats. 

Now we have a new article by Andrew Sheng (U. of Hong Kong) and Xiao Geng (U. of Hong Kong) that appears to be supportive of the idea that the SDR could be used in the future to reflate the global system. Below are quotes from this new article appearing on Project Syndicate and following that are some added comments including some by the former head of the SDR Division at the IMF (Dr. Warren Coats).

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How to Finance Global Reflation

"There is a growing awareness that, in today’s globalized world, financial markets are beyond the control of national policymakers. While a few economies do have the scale to shape interconnected global markets, they face serious constraints, political and economic. As a result, the global economy is stuck in a pro-cyclical financial cycle, with few options for escape.

As Claudio Borio (BIS) pointed out years ago, the global financial cycle is longer and larger than real economic cycles, and is closely associated with the fluctuating value of the dominant reserve currency, the US dollar. When the dollar is weak, capital flows from the United States to other countries, where it spurs growth through increased credit."

. . . . . . 

"With the US, the issuer of the world’s preeminent reserve currency, unwilling or unable to provide the liquidity needed to close the infrastructure investment gap, a new supplementary reserve currency should be instituted – one whose issuer does not have to confront the Triffin dilemma. This leaves one option: the International Monetary Fund’s Special Drawing Right (SDR).

Of course, the road to becoming a reserve currency is long, especially for the SDR, which currently functions only as a reserve asset, with an issuance size ($285 billion) that is small relative to global official reserves of $10.5 trillion (excluding gold). But an incremental expansion of the SDR’s role in the new global financial architecture, aimed at making the monetary-policy transmission mechanism more effective, can be achieved without major disagreement. This is because, conceptually, an increase in SDRs is equivalent to an increase in the global central bank balance sheet (quantitative easing)."

. . . . . 

"Consider a scenario in which member central banks increase their SDR allocation in the IMF by, say, $1 trillion. A five-times leverage would enable the IMF to increase either lending to member countries or investments in infrastructure via multilateral development banks by at least $5 trillion. Moreover, multilateral development banks could leverage their equity by borrowing in capital markets. Depending on the quality of the projects, in terms of governance and cash flows, they could subsequently be sold back to investors as asset-backed securities to fund new projects."

Click here to read the full article on Project Syndicate

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My added comments: This article clearly calls for a major expansion of the SDR and offers a proposal as to how this could be done by existing central banks. This proposal would not require another major crisis to move forward as it suggests the reserves created under this proposal could be used to finance global infrastructure projects. Jim Rickards immediately called attention to this article on his Twitter feed here. It should be noted that the authors of the article acknowledge that absent a major crisis "the road to becoming a reserve currency is long, especially for the SDR." This is also in line with what we have reported here. Willem Middelkoop writes a new blog post about this article here.

I reached out to Dr. Warren Coats (former head of the SDR Division at IMF) to get his reaction to the proposal in this article. Here is what he had to say about it:

Thanks Larry.

While the authors (of the "How to Finance Global Reflation" article) mischaracterize the operation somewhat, it is totally feasible under current rules.  They propose a large allocation of SDRs that countries would use to lend to the development banks for a large increase in infrastructure lending. This would not involve any increase in IMF lending contrary to what they state. While the SDR allocation would also relieve country reserve demand and the larger stock of SDRs would improve the resilience of the international monetary system, it would do nothing to improve the character of SDRs and how they are issued as I have proposed. 

Moreover, the spending stimulus they propose comes totally from increased project funding by the development banks. This financing could come directly from member countries rather than by allocating and then investing SDRs in the development banks. The proposed approach probably avoids the need for national budget approval for increased funding of the development banks. The bottom line question is whether the development bank chosen and directed infrastructure lending by the development banks is the best way to go. I am skeptical.

Warren

note: Dr. Coats gave permission to quote his email comments.

additional added note: It is interesting that this whole idea of using SDR's in the future as a global reserve currency was virtually unheard of (at least in general media) when Jim Rickards first talked about it. Having followed this now for some time, it is noteworthy that you now see this mentioned more often in serious media articles (like this one linked above). I give Jim full credit for bringing this whole topic to my attention as I would not have known about it at all had I not heard him talk about it years ago. Also, my curiosity to learn more about this led me to Dr. Coats and others who I view as leading experts in the world. I feel this has benefited readers here who want to learn more about this topic.

This may seem like an off the radar subject now, but if the SDR is eventually seriously proposed as a global reserve currency to replace the US dollar, it will be very important for people to have the best information available. I think some of that can be found here thanks to Jim Rickards, Dr. Coats and others who have helped point the way to more accurate information.

added note from Willem Middelkoop: Willem posts this link on his twitter feed which goes to a 2012 Chatham House gold study group report on the idea of using gold to "anchor" the SDR at some point. The report looks at the idea, but says it believes it is unlikely to happen for reasons listed on pages 18-19.

Developments in the Gold and Silver Markets

I don't do many articles on the gold and silver markets here because the topic seems to generate a lot of emotions for some reason and this blog is trying to attract the interest of people new to the topics covered here. Constant controversy makes it hard to discuss issues with someone trying to learn about these topics for the first time.

With that said, the precious metals markets are a key part of what we do cover here. When we see sharply rising prices for gold and silver in terms of what they cost in US dollars, it is an important signal to keep an eye on. We have said many times that if we do get the kind of new major financial crisis that Jim Rickards and others are expecting, the potential for major systemic change that will impact all of us will greatly increase. A sharply falling US dollar and/or sharply rising prices in US dollars for gold and silver could indicate the conditions for such a crisis are in play.

Below is a bullet point list of some of the recent developments in the gold and silver markets and after that a few comments.

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- Deutsche Bank settles gold and silver price fixing litigation - the signifigance here is that DB not only will settle for price fixing, they agreed to point a finger at other major banks involved in price fixing in gold and silver. GATA views this news as partial vindication for their claims that the gold and silver markets have been manipulated. They still believe the major manipulation (gold price suppression) is done by central banks.Russia chimes in with this article in The Sputnik News.

- Opening of new Shanghai gold exchange - this news was mostly ignored in mainstream financial media in the west, but gold and silver advocates view this as an important change in the market for the future. Andrew Maguire talks about that in this interview. John Embry of Sprott Assets also talks about it in this interview. Money manager Stephen Leeb also talks about it here. These interviews will give you a feel for the importance that gold and silver advocates are placing on this event. It will be interesting to see if it has the impact these advocates are anticipating.

- The massive rally no one knows about (in the general public). It's always interesting to me how financial media will talk endlessly about the US stock market going up, but seems to completely miss gigantic moves up in the gold and silver markets when they do happen. If there were a stock sector that has gone up around 100% in about three months, would you be interested to know about it? I bet most people would be surprised to know that the HUI index that measures gold and silver mining stocks has gone up that much since January of this year ( doubled from 100 to 200 - see this chart as of 4-22-16). Meanwhile the Dow Jones index is up a little over 15% during the same time. Which one got all the media coverage?

- Silver moving to take the lead in the gold and silver market. While gold has made a strong move up so far in 2016, we are starting to see silver outperform gold quite a bit lately. This has resulted in the gold to silver ratio dropping from a high near 84 (84 ounces of silver to buy one ounce of gold) to around 72 as of 4-22-16 (see this chart). I expect to see this ratio continue to fall in the future meaning that silver would go up more in % terms than gold. Retail demand for silver eagles from the US mint also is on a record breaking pace this year so far. Other mints around the world are experiencing similar high demand.

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My added comments: Earlier this year I noted that it seemed as though the silver market may have bottomed out in late 2015 (see silver chart here). The upward trend this year is beginning to add confirmation to that possibility. What that means for the average person is that if you want to include some actual physical silver as part of an emergency cash reserve fund you may want to not wait a lot longer. I am NOT talking about trying to trade silver (or gold) short term. They are volatile markets at times and will go up and down all the time in the short term. A long term physical holding as part of an insurance emergency cash reserve is a completely different idea and is perfectly reasonable option for the average person to consider.

Added note 4-26-16: 40 year veteran precious metals dealer Bill Haynes is reporting very high retail demand for gold and silver which he says means prices will be heading higher. In the past Bill has demonstrated that he has a pretty good feel for how the retail market will impact prices so his comments are worth listening to.

The US Dollar - Chart Watch

One of the keys to watch is to see if the US dollar as measured by the US Dollar index (USDX) is getting stronger or weaker. A stronger dollar tends to hold back inflation and keep commodity prices held down (at least in terms of their price in US dollars). Conversely, a weaker dollar suggests rising prices in commodities. 

In January of this year, we noted that Ben Bernanke stated that he felt the US dollar rally was likely done for the time being (see this article in Bloomberg). We then noted that shortly thereafter the dollar started dropping. That trend as continued all year now as we can see in the USDX chart linked just below.

USDX Chart link

Readers can decide for themselves if Mr. Bernanke just made a lucky guess in January or not. Either way the dollar has absolutely headed down since his comments and the chart linked above shows very clearly that it has now reached a very key support level around 94. It has bounced up some off that support as we might expect. But if the 94 level does not hold, there is not much more support until the 80-82 level. That would be a very large drop pretty quickly if it does happen.

Whenever we look at currencies over time, it is always worthwhile to look and see how various major currencies have fared against gold. While they bounce up and down of course, over time gold does a lot better than many people realize. Here is a link to a chart of gold vs. the major currencies over the last 10 years. 

Chart of gold vs. major currencies for the past 10 years

I bet many people would be surprised to see how strongly gold outperformed them during this time (including the US dollar). This is even with gold having a major correction off its high reached several years ago.

Of course, it's no accident that gold and silver have started to show signs of life as the USDX has been falling this year. Watch the 94 level on the USDX over the next couple of weeks. If that holds and the dollar rallies well above 95, the uptrend for gold and silver will probably pause for awhile. If the USDX does not hold the 94 level, it is likely that we will see it pick up some speed downhill and provide more fuel to continue the gold and silver rally. That would also probably confirm that the years long downtrend for gold and silver bottomed out last December.

Added thought: When people talk about increasing the price of gold (or silver) to use it as a form of backing for the money supply that sounds strange to most people. Some may wonder if the government (or a central bank) can really just arbitrarily "set" the price of gold higher. The answer is yes they can. FDR did it once before in 1934 by increasing the price of gold 75%. He raised it from $20 to $35 an ounce. 

Using a more modern example, the Royal Canadian Mint produces silver coins of various kinds. One version they produce is a silver coin a little over 1/2 ounce in size (15.87 grams). What's interesting about this coin is that they stamp a $50 face value on the coin and sell it out to the public for $50 per coin. Just by stamping a $50 face value on the coin they raised the price of silver in that coin to around $90 per ounce. Here is one around one ounce with a $100 face value stamped on it. These coins are legal tender. See, it's not really that hard. If you were making a one ounce gold coin, just stamp $5000 on it if you want to and sell it for $5000. Problem solved.

Update 4-28-16:  The US dollar index is continuing to struggle to hold the 94 level actually closing below it today. If 93 does not hold, we can expect the decline to continue and pick up steam. Gold and silver are reacting to this as you would expect and showing increasing strength. 

Off Topic: Bluebonnet Time in Texas

This time of year we get to enjoy the blooming season for Bluebonnets here in Texas. Ennis Texas (about 35 miles south of Dallas) has held a Bluebonnet Festival for many years and I can recall taking our daughter several times when she was young. Got a chance to head back down there this past weekend (sadly without our daughter who is in college now). But we did get to take our little dog Bean with us. Below is a picture of him enjoying the day in the Bluebonnet field. The orange flower on the left is an Indian Paintbrush. Some years (like this year) they mix in with the Bluebonnets (see the background of the third picture below)

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(Indian Paintbrush is the orange section in the background)

What Can We Learn from the US Political Results So Far

We are now far enough into the primary election process to get a pretty good feel for what the general mood is among voters in the US. While this blog has no political agenda and is not interested in endorsing any candidates, we can learn some things about what the public mood may indicate in terms of the potential for major change to take place. Below are some observations along those lines.

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- the US public is completely divided and has now splintered into three main groups as I see it.

1) the establishment that prefers the status quo and elite control of government policy (this is probably the smallest of the three groups right now and would tend to vote for Hillary Clinton for President or John Kasich on the Republican side).

2) voters who are totally disgusted with the elite control of the system and do not trust government to solve most problems (or other agencies such as the Federal Reserve). This group is growing and very large now and would make up the voters now voting for both Ted Cruz and Donald Trump.

3) voters who are disgusted with elite control of the system who don't trust the current leaders to make the system more equitable and fair as they would see things. This is the group of voters now strongly supporting Bernie Sanders. 

-  Of course someone will emerge victorious from all this and will probably do so without actually having a majority of the country agreeing with them even if they win. This will make the job of the next US President extremely difficult no matter who wins.

- despite all the drama at the Presidential level, the Congress is likely to stay pretty much as it is now except it is possible the Democrats could retake the US Senate. 

- we can expect that the US will continue to have divided government and that we won't see much change from how things have been politically for the last decade or so. The public is so splintered now that even if one party happens to get a temporary advantage in one election cycle, it is unlikely they can hold on to it beyond that because there is not voting block coalition in the US that is anywhere near 50% on a consistent basis.

- all of this means that the most likely future scenario for major fiscal policy change is a continuation of the status quo meaning no real solutions of any kind for the unsustainable debt problem long term until some kind of crisis forces the issue. 

Bottom line: The US election cycle this year will probably create a lot of emotion and drama, but very little real change long term in regards to the big issues that can impact financial stability and monetary system change. The race for President will draw all kinds of attention and be like a circus for the public, but will not result in any meaningful change going forward after all the dust clears. Until a genuine financial crisis emerges that truly shakes the stability of the financial system, major change is unlikely. If we get something like that before this election in November, all bets are off and all kinds of change might take place.

Added note: Donald Trump is already on record saying the stock market is in a bubble. Now Ted Cruz joins in and says we will see a stock crash due to Fed policy and that we need to return to a "rules based system" that includes gold.

IMF Issues New Debt Warning

The IMF has continually had to redo economic forecasts for the global economy to reflect prospects for lower GDP growth than originally predicted. They continue that trend this week with new warnings about sluggish growth and issue a new warning the debt levels are continuing to rise. Below are some quotes from this Bloomberg article on the latest IMF warning.

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"Global policy makers need to guard against a self-reinforcing “spiral” of weakening growth and rising debt that could require a coordinated response by the world’s major economies, according to the IMF’s top fiscal watchdog.

Most countries are on a higher debt path than they were a year ago, the International Monetary Fund said in its semi-annual Fiscal Monitor report released Wednesday. Fiscal deficits in 2015-2016 in emerging economies are projected to exceed levels during the global financial crisis, as countries struggle with low oil prices, cooling investor sentiment and intensifying geopolitical tensions."
. . . . . . . .

"If a low-growth, high-debt spiral takes hold, the responses of individual countries won’t be enough. Major economies will have to quickly act together to combat the “stagnation forces” through measures to spur both demand and supply, said the Washington-based fund, which was created during the World War II to oversee the global monetary system."

“Our evaluation is that risks are at this point in time more considerable than they were, say, six months ago or one year ago,” said Gaspar, a former finance minister in Portugal. “The expression we use for the way we look at global developments at this time is a state of alert. We are on alert, we’re definitely not on alarm.”

Click here to read the full Bloomberg article

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My added comments: This article is in line with comments made by various officials as the IMF Spring Meeting this past week. The theme right now seems to be "we are on alert, we're definitely not on alarm."

It's interesting to watch the IMF and other officials continue to issue warnings but at the same time make sure they say that there is no sign of a crisis for now. Meanwhile alternative media sites continue to suggest that a major crisis is imminent. This week the recent secret meetings at the FED (and at the White House) along with the startup of the new Chinese gold trading platform that will price gold in yuan (instead of US dollars) has prompted all kinds of speculation that something (not good) is going on behind the scenes. In addition we have the Saudi threat to dump US assets if implicated in the 9/11 report and the Fed issuing a letter to JP Morgan saying their stress Plan B is not adequate. The top of page 11 of the Fed letter says that JP Morgan has risks that, "if not overcome, could otherwise undermine successful execution of the preferred strategy and, more broadly, pose serious adverse effects to the financial stability of the United States."

All you have to do is watch to see what happens in the next few weeks to see if there is any validity to the speculation. So far there are no visible signs that a sudden major crisis is about to emerge.

One thing to add. When we use the term "major crisis" here, we are not just talking about a few down days on the stock market or even a recession. We are talking about an event so severe that life as we know is disrupted in some way for a period of time. An event where we see the President address the nation concerning the crisis. An event where major markets are halted and banks are forced to close for some period of time due to extreme stress in the system.

The conditions for a crisis like this are present all the time due to high leverage in the system and the interconnected nature of the so called too big to fail entities. The letter linked above from the US Fed to JP Morgan clearly states that there are risks that could impact the  "financial stability of the United States" within JP Morgan. But so far, no such crisis like this has emerged. It could happen any time or it could not happen for a long time. It's impossible to know ahead of time unless you are inside the system and aware of the stress points in the system. No one inside the system has advised me that such a crisis in brewing behind the scenes, but who knows if they would even if they were aware of one. This new speech by William Dudley (NY Fed) does not suggest any signs of alarm for example. Of course, it's their job not to alarm the public and it's not as if they have not issued a ton of warnings for years now.

China Repeats call for broader use of the SDR at IMF Spring Meeting

This is basically just China repeating what they said earlier this year at the G20 meeting. But this article does add that the IMF agrees with China and will start a study on wider adoption for the SDR. Below are quotes from the article with some points I wanted to emphasize underlined in bold.

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Chinese central bank governor Zhou Xiaochuan on Saturday called for broadening the use of the International Monetary Fund (IMF)'s basket of reserve currencies to advance the reform of the International Monetary System (IMS).

"The IMS has inherent deficiencies and faces new challenges from globalization, financial innovation, and volatility in capital flows," Zhou said in a statement for the meeting of the International Monetary and Financial Committee (IMFC), the IMF's policy setting committee, on the sidelines of the spring meetings of the IMF and the World Bank.

"The SDR has the potential to resolve the existing deficiencies in the IMS," Zhou said, referring to the Special Drawing Right, an international reserve asset created by the IMF in 1969. The value of the SDR is currently based on a basket of four major reserve currencies: the U.S. dollar, euro, the Japanese yen, and British pound. The IMF decided last year to include the RMB in its SDR basket as the fifth currency, effective October 1, 2016.

"We can start now to gradually broaden the use of the SDR, including using it as a reporting currency in parallel with the USD and exploring issuance of SDR-denominated assets," Zhou said, adding that China has released foreign exchange reserve data denominated in the SDR in addition to the U.S. dollar starting from this month.

Zhou said China will also explore issuing SDR-denominated bonds in the domestic market and look forward to the IMF's further analysis on strengthening the role of SDR this year.

"We support the examination of the possible broader use of the SDR," the IMFC said Saturday in a communique after the meeting of the 24-member committee.

"The IMF will discuss the case for a general allocation of SDRs and the reporting of official reserves in SDR," the communique said.

Click here to read the article directly

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My added comments:

Please note that once again China talks about "gradually" broadening use of the SDR. What is new here (at least to me) is the IMF statement saying they support "examination of the possible broader use of the SDR." Now we have more than just China talking about the idea (see point #5 in official IMF communique).

Added note: Here are two more articles on China's call for more use of the SDR:

BRICSPOST - PBOC Calls for Broader Use of SDR

South China Morning Post - China's Obsession with IMF's Accounting Unit (SDR)

Some quotes from the South China Morning Post article just below:

"The SDR, a weighted average of various currencies, was created half a century ago as an alternative medium to the US dollar for governments and central banks to use to hold international reserves, but it never really gained momentum.

Now, with six months to go until the yuan is included in the IMF’s basket of currencies – alongside the US dollar, the euro, the British pound and the yen – China is reviving the earlier attempts."

. . . . .

"Measuring foreign exchange reserves using SDR could reduce valuation fluctuations and strengthen the role of SDR as an account unit, China’s central bank said in a one-paragraph statement. Alan Wheatley, an associate fellow of international economics at the British think tank, Chatham House, said the central bank’s move showed two things.

“First of all, they are playing the game as a serious member of the IMF, and secondly, it underlines, perhaps, that it is now tracking the basket, rather than the dollar.”

The idea of China issuing bonds denominated in SDR was “very interesting and potentially significant”, he said. “The SDR has been a failure – the SDR never took off as a private sector asset … but if China is doing that, then it could be different.”

David Marsh (OMFIF) on Why China is Promoting the SDR

David Marsh of the OMFIF writes this new commentary on why China would like to see broader adoption of the SDR. As we have noted here, he says the process will take some time. Below are some quotes from his new commentary. This article is further confirmation that we can expect change to take place gradually unless a crisis were to speed things up.

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"China’s utterances over the years on the International Monetary Fund's special drawing rights confirm the Beijing authorities’ delphic reputation for long-term thinking. The mystery is starting to look a little less obscure. China is embarking, pragmatically but steadily, towards enshrining a multicurrency reserve system at the heart of the world’s financial order.

Although it accepts that many years will elapse before the dollar can be dethroned from its No.1 role, Beijing favours a ‘4 plus 1’ system: the euro, sterling, yen and renminbi, co-existing with the dollar. These are the five constituents of the SDR, which the renminbi formally enters in October, following a US Treasury-endorsed IMF decision in November.

Beijing has upgraded the role of the IMF’s composite currency by starting to publish its foreign reserves total (the world’s biggest) in dollars as well as SDRs. As the People’s Bank of China said on 7 April, this ‘help(s) reduce valuation changes caused by frequent and volatile fluctuations of major currencies, hence providing a more objective measurement of the overall value of the reserves.’

. . . . . . . . 

"The statement was prefigured a few days earlier by Zhou Xiaochuan, the PBoC governor, in Paris reporting that Beijing had decided to publish the SDR reserve data, and intended issuing domestically orientated SDR-denominated bonds, promoting the composite currency’s capital markets use.

Among other initiatives, we can expect SDR pricing for some commodities, bond issues by governments outside China, and improved clearing and settlement for SDR currencies, where Beijing may co-operate with the Belgium-based Society for Worldwide Interbank Financial Communications (Swift) network."

Click here to read the full article by David Marsh

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Added note: Here are two more recent articles on SDR's that you might find of interest. The first sent to me by a reader here.

The IMF's Special Drawing Rights, the Renminbi, and Gold

This article notes that the SDR has lost over 80% of its value over time against gold.

SDR Does not stand for Secret Dollar Replacement

This article states the case that the recent statement from China about broader adoption of SDR's is more PR than real substance.

These articles continue to suggest that any replacement of the US dollar by the SDR would most likely be a very slow and gradual process unless another major financial crisis unfolds. The article comparing gold versus the SDR over time suggests that some form of asset or gold backing might be necessary to gain public confidence if the SDR was eventually put forward as a replacement for the US dollar as the leading global reserve currency.

The "New Case for Gold" Stirs Old Debates and Offers up New Ones

Best selling author Jim Rickards is at it again with a new book on gold. For some reason gold seems to stir up debate and emotional reactions in people for and against it as a form of money. In "The New Case for Gold", Jim takes on the age old criticisms against gold and offers a new reason why people need to consider owning some gold today. 

Below are some questions related to gold that Jim answers in the book.

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- Is gold really money?

- Why did the gold standard go away?

- Is it possible to return to a form of a gold standard today?

- Isn't there too little gold in the world to use it as backing for currency?

- Isn't there not enough new gold mined to allow for an expansion in the money supply?

- What price would gold need to be in order to back the money supply currently?

- What is the "Shadow Gold Standard"?

- What future monetary event could lead to increased demand for gold for wealth protection?

- Why are Russia and China buying so much gold?

- What is a new reason people need to own some gold in a modern technology world?

- What is the best way to own gold in a portfolio and how much is enough?
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Jim explains why he wrote this book in this video

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My added comments: If you want to look into the subject of gold without being bombarded with emotional arguments for and against it, this book will be for you. Jim provides a fact based analysis in support of gold as form of wealth protection without any hype. Since Jim does not sell precious metals, he can approach the subject in a purely analytical way. Readers can do their own fact checking and decide if Jim makes his case.

I will add that one question I get here is what the average person can do who might want to follow Jim's advice on acquiring gold, but cannot afford gold. I would say that you can apply much of what Jim says about gold to silver. There are differences in that silver is less regarded as a monetary metal and is also viewed as an industrial commodity more so than gold. However, in a crisis situation like Jim is predicting, silver could certainly function somewhat like gold for those who cannot afford the higher priced metal.

We have long said here on this blog that precious metals should be viewed like an insurance policy and that the emotional reactions surrounding gold seem silly when looked at in this way. "The New Case for Gold" seems to take the same approach.

Added notes:

CNBC Interview with Jim Discussing The New Case for Gold

In depth discussion of gold and the new book with Greg Hunter

Followup on SDR's: Dr. Warren Coats Says the World Needs a Reserve Asset with a "Hard Anchor"

Our article featuring the video discussion about the future potential for the SDR as a global reserve currency has generated a lot of interest and some good questions from readers around the world. Some readers here are advocates of a monetary system backed by gold so they wonder why the world would be better off using the SDR as a global reserve currency as Dr. Coats has proposed.

These are all good questions and encourage me that this blog is reaching one of its goals. A goal here is to present a variety of credible views on the important issues that relate to future potential monetary system change. In this case we have featured a presentation on how the SDR might eventually replace the US dollar as the world's global reserve currency and thoughtful readers raised some questions about why Dr. Coats thinks this is a good idea (see example here).  

In this followup article we will direct readers to a paper written by Dr. Coats where he explains in more detail why he thinks his proposal would make things better. Below I have pasted in the Conclusion section of his paper titled "Why the World Needs a Reserve Asset with a Hard Anchor". It may provide more insight into Dr. Coats thinking for readers here. Of course, you need to read the full paper to get the proper context. You can download the full paper here. Items that are underlined below are points I felt should have extra emphasis.

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from the Conclusion section of "Why the World Needs a Reserve Asset with a Hard Anchor":

Conclusion 

Since the collapse of the Bretton Woods/Gold standard system, the impressive growth of cross border trade and finance has been restrained by costly exchange rate volatility. An expensive industry has developed to hedge the related risks. Exchange rate manipulation, if not out right currency wars, have created political tensions and produced large international payments imbalances. Given the size of the U.S. economy and the depth and breadth of its financial markets, the use of the dollar has remained and even grown as the world’s primary reserve asset. But the continued failure of the U.S. government to address its unfunded liabilities, the traditional lack of concern by the Federal Reserve for the monetary needs of foreign users of the dollar, and faltering American leadership of the post WW II world order have increased discontent with and reduced confidence in the current arrangements. While gaining the exorbitant privilege of borrowing abroad in its own currency and the seigniorage from foreign holdings of its currency, the U.S. incurs the cost of deindustrialization caused by the chronic balance of payments deficits needed to supply the world’s demand for its currency, and the entire world incurs the cost of weakened monetary and fiscal discipline and hard to predict exchange rates. 

A much better system would replace national currencies for pricing and settling cross border transactions with an internationally issued currency, whose value was anchored to a small basket of real goods, and to which the exchange rates of all or most national currencies where firmly fixed. In 1969 the IMF created the Special Drawing Right (SDR) to supplement or replace the U.S. dollar in international reserves. Initially its value was fixed to gold but after the closing of the U.S. gold window, its valuation was fixed to a basket of key currencies. The Second Amendment to its Articles of Agreement obligated Fund members to make the SDR “the principal reserve asset in the international monetary system” (IMF Article XXII). 

However, the SDR suffered from several deficiencies and never caught on. The initial failure (since corrected) to charge interest for using SDRs (and to pay interest for holding them) tainted the SDR as a development aid instrument rather than a reserve asset. More importantly, the regulation of the supply of SDRs via the approval of periodic allocations to all members in proportion to their IMF quotas made it very unlikely that their supply would match their demand at their officially fixed value (based on a basket of key currencies). This necessitated administrative rules for their use, which seriously undercut their attractiveness as a reserve asset. 

While many simple and practical steps can and should be taken to promote the use of the existing SDR as proposed by one of us in many earlier articles and by Governor Zhou in his speech in 2009, we believe (along with Governor Zhou) that the SDR could be made a much better (and less political) unit of account by replacing its valuation basket of currencies with a basket of goods. All of this could be done under the IMF’s existing Articles of Agreement. 

However, with an amendment to the Articles of Agreement that replaced the allocation of SDRs with issuing them under currency board rules, the attractiveness of SDRs could be dramatically transformed. Rather than buying and selling SDRs for the items in its valuation basket (ala the gold or other traditional commodity standards), the IMF would sell and redeem these “real SDR” for the basket indirectly (against government or other AAA financial assets of equivalent value). Such an SDR, with a relatively constant real value, is likely to be adopted as the anchor currency for fixing the exchange rates of many if not most national currencies and to augment or replace the U.S dollar and Euro in countries’ foreign exchange reserves. The entire existing stock of central bank FX reserves could be swapped (substituted) for real SDR in one go.

So why haven’t such reforms been embraced? The United States is thought to want to hang on to the seigniorage it earns from supplying its currency to foreign holders while indulging in its exorbitant privilege despite the instability of its exchange rate as capital flows in and out in response to Federal Reserve monetary policy and world developments plus the growing risk of a Triffin Dilemma like loss of confidence. We argue here that the U.S. has not given enough weight to the cost of supplying its currency in the form of deindustrialization nor the cost in the form of global financial instability from excess leverage encouraged by unanchored monetary policies.

Claudio Borio and Piti Disyatat “have argued that the fundamental weaknesses in the international monetary and financial system stem from the problem of “excess elasticity”: the system lacks sufficiently strong anchors to prevent the build-up of unsustainable booms in credit and asset prices (financial imbalances) which can eventually lead to serious financial strains and derail the world economy. Reducing this elasticity requires that anchors be put in place in the financial and monetary regimes, underpinned by prudent fiscal policies.”  Our real SDR currency board proposals could remedy this excess elasticity. 

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My added comments: 

If you are interested in getting a better idea for Dr. Coats thinking you can do so by reading his papers written over the years which you can find here. Also, we have covered Claudio Borio (BIS) that Dr. Coats mentions above here on this blog. Readers might find this paper by Mr. Borio of interest as well.

Repost: Dr. Warren Coats Answers a Blog Reader's Questions on SDR's

One of the goals of this blog is provide the best quality information we can find for readers representing a variety of credible viewpoints. The article we published this weekend with the video presentation on the potential future for the SDR has generated a lot of reader interest and some great questions. One reader sent me three questions he would like to ask Dr. Coats about the video. I asked Dr. Coats if he would be willing to provide answers to the questions and he was happy to do so. 


Below I have posted the questions sent in by email by reader John Y. Below that is Dr. Coats email reply he sent me listing the three questions and his answer to each one. This is great information for readers here and it helps this blog serve the purpose I intended for it. A big thank you to both reader John Y. and Dr. Coats for the questions and the answers!

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First, here are the questions as I received them in the email from reader John Y:

"Larry, thank you for posting the video on the SDR discussion at the IMF. I watched it last night and found it very interesting. I'm hoping you can help clear up something that Dr. Coats said during the discussion. Around the 42:02 mark, the moderator asks whether the reforms needed to implement the SDR as a global reserve currency would tie the Feds hands in terms of monetary policy. Dr. Coats responded (42:18) that this would happen "only if the Fed, in its great wisdom would decide to fix the US dollar to the SDR." Do you think Dr. Coats was sincere and honestly meant the Fed should peg the dollar to the SDR or that this was more of a tongue-in-cheek, sarcastic respond? At first I thought he was sincere, but after re-watching it a few times, I'm thinking he was being sarcastic. What do you think? 

The reason I'm asking, is because if he was sincere then I think this would come into conflict with the Impossible Trinity concept, and I would like to ask him about this conflict. In case you're not familiar with the Impossible Trinity, it basically states that a country can't have free capital controls, an independent monetary policy, and an unpegged, free-floating exchange rate all at the same time. Long-term, you can only have 2 of the 3."

This is the second email with the last two questions:

"Along those lines,two other questions arose from watching the video. If you think they're worth passing along and/or posting, then please do so.

1. During the initial discussion of the SDR and why it should take on the role of global reserve currency instead of a national currency, I think both Dr. Coats and Dr. Krueger (sp?) were alluding to the idea of Triffin's Dilemma. Is that correct? Does this paradox help support their reasoning for why the SDR should take on a larger role in the international financial system?
2. When Dr. Coats talked about private SDRs, how exactly does a bank set them up? So if I'm a bank and want to start issuing SDRs, what are the steps that I need to setup in order to do so? Do I start accumulating reserves (assets) in whatever currencies (US Dollar, Pounds, Euros, Yen, Yuan) that make up the SDR basket and then loan out SDRs (liabilities)?"

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Below is the reply Dr. Coats sent me with the three questions listed and his answer to each one:

Question: Should the U.S. fix its exchange rate to the Real SDR and would that violate the impossible trinity?

Answer:  I have attempted to lay out gradual steps toward what I think is the optimal international monetary system. Replacing national currencies (the U.S. dollar) in international reserves with an internationally issued currency (the SDR) would be a very major accomplishment.  National central banks would be free to fix the exchange rate of their currency to the SDR or not.  However, the fully optimal system in my view is one in which all central banks fix the exchange rates of their currencies to the SDR. This would essentially be the one world currency we had under the gold standard of the late nineteenth century.  So yes, I would like to see the U.S. dollar fixed to the SDR.  That would mean (as indicated by the impossible trinity, which the questioner misstated) that the U.S. could not have an independent monetary policy.  The money supply would always be what ever the public wanted to hold at the official value of the SDR following currency board rules.

Question: Is there something similar to the Triffin Dilemma supporting the argument for replacing a national currency in international reserve with an international one?

Answer:  The Triffin Dilemma was that under the gold standard, when U.S. dollars were redeemable for a fixed amount of gold, increases in international holdings of dollars could grow so large that its redeemability for gold would loose credibility, causing something like a run on the bank.  The dollar is no longer redeemable for gold or anything else at a fixed price, but as international dollar reserves are generally held as U.S. treasury securities, the size of the U.S. government’s public debt could grow so large that foreign owners of that debt could loose confidence in the ability of the U.S. government to repay it (or even service it) thus causing them to dump the dollar.  This is similar to the Triffin Dilemma, which could be avoiding using an internationally issued currency (SDR).

Question: How would a bank create private SDRs?  What are the steps?

Answer: Where no private SDRs exist, a bank customer (e.g. the AIIB) would ask its bank to credit the SDR equivalent of a dollar (Euro or whatever) deposit to a new SDR deposit account of the customer.  The bank would determine the SDR amount applying the official SDR exchange rate to the currency presented and record that amount in the customer’s SDR account.  That creates SDR deposits.  The next issue is what assets would the bank keep against these SDR deposit liabilities?  It could hold assets (loans, securities, etc.) denominated in the national currency the customer brought if it was prepared to accept the exchange rate risk of a mismatch between its assets and liabilities (a so called open FX position).  Or it could balance its exposure by converting the dollars into the appropriate amount of each of the five currencies in the current SDR valuation basket.  Or if there are financial assets denominated in SDRs it could acquire and hold those, or denominate its loans in SDRs etc.

Repost: IMF SDR - An Emerging Global Currency? IMF Officials Discuss on Video

We featured an interview with Dr. Warren Coats here on the blog in January. Dr. Coats has a proposal designed to encourage adoption of the SDR used at the IMF as a true global reserve currency. In February Dr. Coats and current IMF official Dr. Thomas Krueger were the featured speakers at a presentation on SDRs sponsored by the Chicago Economics Society in Washington, DC. You can watch the presentation on the video embedded just below. Following that is a brief summary of the contents of the presentation.

This presentation along with the Q&A session that followed with the audience has a wealth of important information about the prospects for the SDR some day becoming a true global reserve currency that could even replace the US dollar. This is a must see video for readers here and anyone you know who may have interest. Also, please note the quote Dr. Coats provided us to use for this article below.

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Here is a brief summary of just some of the important information covered in this video:

- introduction to IMF official Dr. Thomas Krueger who works with SDRs currently

- introduction to former IMF Head of SDRs - Dr. Warren Coats

- some history and background on SDRs

- an explanation of the distinction between official SDRs used at IMF and "private SDRs"

- Dr. Krueger talks about some realistic ways SDRs could be more widely used while also noting some of the factors inhibiting broader use of them (mainly the dominance of the US dollar)

- Dr. Coats reviews his "Real SDR" Currency Board proposal to explain how the use of private SDRs could expand the role of SDRs as a global reserve currency

- both speakers discuss the process in detail of various ways the SDR could gain broader adoption both within the existing IMF rules and with some changes to those rules

-the potential timing for adoption of the SDR as a global reserve currency is discussed (the time frame may surprise you)

- Dr. Coats notes that some changes to increase adoption of the SDR just require the "political will" to make some changes. He hopes that China might be willing to look at broader SDR adoption by issuing SDR bonds in the AIIB. Looks like China was paying attention in this Wall Street Journal article.

- The speakers (Dr. Krueger and Dr. Coats) were followed by a very interesting Q&A session with the audience where some excellent questions were raised and answered

- In the Q&A session (around the 1 hour mark in the video) Dr. Coats notes that Donald Trump is attracting support in his campaign by expressing concern over the offshoring of US manufacturing jobs. He adds that perhaps public concern with the loss of manufacturing jobs could lead to more interest in the future in the US for an international reserve currency. Dr. Coats feels that the loss of these jobs is tied in part to the US dollar being the global reserve currency (leading to payments imbalances globally over time)

-at around the 57 minute mark in the Q&A session they are asked what "event" could trigger the use of the SDR as a global currency. In the answer Dr. Coats explains how the issuance of private SDR's by banks could be done. Both Dr. Krueger and Dr. Coats agree that a major crisis involving the value of the US dollar (and loss of confidence in it) would have to take place for the SDR to step forward as a viable alternative

In addition we asked Dr. Coats if he had any thoughts on this presentation and any progress he sees towards broader adoption for the SDR as discussed in this video. He offered us this comment:

“In this presentation we were able to outline why it would be a good thing to replace national currencies as international reserves with an international one such as the SDR and to outline some steps toward that goal. It is generally believed that only an international financial crisis will precipitate a change in the international monetary system. Perhaps, but if so it is important to have a strong SDR waiting in the wings to take on that role when the crisis hits.”

Added notes: Dr. Coats answers some questions on this video presentation from a blog reader here.

Dr. Coats explains why he thinks the world needs a reserve asset with a "hard anchor" here

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My added comments:

Having covered SDRs here on this blog now for quite some time we know that there are a couple of huge questions in the minds of people all over the world on this topic. They are:

1) Will we get another major financial crisis worse than 2008 as predicted by Jim Rickards and other credible analysts in the next few months or years?

2) If we get the crisis, will that event lead to a more prominent role for the SDR in replacing the US dollar as the leading global reserve currency.?

I feel we have covered these questions here on this blog as well as any media publication on earth. We have dug into everything we can find to help readers learn more on this. Our search has led us to some of the leading experts in the world bar none. Included is Dr. Warren Coats featured in this video. This video will provide you with answers to many questions directly from an IMF official who works with SDRs currently (Dr. Krueger) and the former head of the SDR Division at the IMF (Dr. Coats). 

There is simply no better information available on this topic anywhere in our view here. It is important that more people learn about these issues and gain an understanding of the SDR because it could play a much more prominent role in the global monetary system in the future. Especially if we do get another major crisis. We have said that here on this blog for quite some time primarily based on Jim Rickard's work on this topic along with the work of Willem Middelkoop. (Dr. Coats mentions Jim Rickards at around the 59:30 mark in the video above). 

Now we have direct confirmation from a current and a former IMF official who are experts on SDRs related to what we have been covering here (see Dr. Coats quote he provided us above). Please take time to watch this video and encourage anyone interested in these issues to do so as well. It is loaded with valuable information.

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Below is a picture of a theoretical 100 SDR currency note used as a backdrop at the SDR discussion meeting. No such notes actually exist at this time. During the discussion Dr. Coats explained the difference between official SDRs issued at the IMF and private SDRs. This is a complex topic and it's hard to find high quality information on it anywhere, especially from experts like these.

One other added note: China gets a mention of the SDR into the recent G20 communique as this Wall Street Journal article notes. They call for broader use of the SDR.

SDR talk/UC alums Dr. Krueger & Dr.Coats w/@pdacosta Career trek, connecting to Alums @ChicagoHarris #ChicagoHarris