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Gold, Silver and the Black Hole of Deflation

Commodities / Gold and Silver 2012 Jun 28, 2012 - 11:15 AM GMT

By: Julian_DW_Phillips


Best Financial Markets Analysis ArticleIn Part I of this series we looked at the decaying state of confidence and how this is assisting in the deflationary process that is slowly, inexorably, moving forward, with limited action from central bankers and very little action at all from politicians. We looked at Christine Legarde's comments that highlighted the need for value and measures of value to keep the monetary system under control. And then we looked at the loss of money velocity, deflation and the damage it's doing to the solvency of banks and nations.

Since then the process has moved forward with 28 Spanish banks downgraded by Moody's ratings Agency, while the Spanish government has formally asked for financial assistance from the E.U. Cyprus now makes the fifth E.U. member to put its hand out for a bailout. Italy's borrowing cost jumped to new highs too.

What are we really looking at in the Eurozone crisis? We ask this question knowing that this story is being played out in Europe first, to be followed by the U.S. then the rest of the world in time, as they are part of the same global monetary system. The Eurozone crisis is a confidence crisis among banks and nations, followed by asset and debt deflation, as the loss of confidence is priced in.

Filling Money Holes Isn't the Answer

A look back over the past five years shows that we have seen central banks and governments use quantitative easing in an attempt to stimulate economies while ameliorating the loss of asset value that started with the housing bubble bursting in the States, then mortgage linked securities losing huge value, dragging down the owners of those now-toxic debt assets, including banks, into bankruptcy.

The Fed has been careful to simply fill the hole left by the deflation and add no more new money than that. As it is, the Fed's intention was the business would then be as usual, but instead these banks did not lend to the economy, they lent back to the government. The same happened in Europe, but there some governments approached junk status as borrowers, sending interest rates for those nations rocketing to unsustainable levels. Thus the noble purpose of quantitative easing was perverted by prudence, caution and the need for self-preservation. Now we sit with a healthier U.S. banking system, but a barely growing economy. In Europe we see a far worse picture where confidence is sapping by the day.

Gold, Silver's Performance During the Last Five Years

During these last five years, what impact did this have on gold and its price? Firstly, after the initial impact of the 'credit crunch' hammered investor's abilities to invest and pulled the gold price down to $1,000 from $1,200. It then turned around and for the next four years soared up to $1,900, before correcting again in the face of a greater 'credit crunch' back to $1550, where it is close to now. The Eurozone crisis is that 'rose by any other name', a 'credit crunch'. And it is not being resolved, but worsening.

Silver, being the long shadow of gold, moved in a more spectacular fashion, moving in since 2005 from $6 up to a [false] peak of $49, before pulling back to a low of $26 today.

Gold, silver thus performed their age old role of broadly 'measuring' and holding 'value' during these tempestuous times and will do so in the future.

Not only did Christine Legarde, head of the I.M.F., refer to the need for value to be determinable at all times, but the head of the World Bank, Mr. Robert Zoellick, last year suggested that gold should be a value-anchor for the global monetary scene. We cannot stress enough the need for measuring rods that are reliable and beyond the ability of the political and monetary authorities to debauch. Without it there can be no stability or foundation for real growth and enterprise.

Mr. Zoellick and we suspect Mme. Legarde will be ignored by the central bankers of the world, except for those of the emerging world who started to buy gold in significant tonnages since 2009. Why haven't the developed world central bankers said anything with regard to gold? They don't need to because gold in the reserves of the leading nations in the world reaches as high as 70% of those reserves, with the E.C.B. requiring 15% of its reserves to be held in gold. It is higher now, because of the recent price rises of gold.

While silver is not a monetary metal in the eyes of bankers worldwide, it's considered a hedge against paper money by the poorer investors worldwide and has performed accordingly. It's also likely to stay off the central banker's radar screens until the monetary system reaches the brink of collapse. But expect it to rise alongside the gold price during that journey.

New Money a 'Cure'?

So to understand this entire process properly, we have to understand the 'cure' put forward -namely replacement of value by additional sums of newly-printed money. The principle applied was that, if the loss of value was replaced in bank's hands, then the problem would be solved, provided some adjustment was made to the regulations governing banks. The banks subsequently recovered and prospered but they did not carry on business as usual, within the broad economy.

On both sides of the Atlantic they took the new money and pushed it back to government and did not send it out into the broad economy. On both sides of the Atlantic growth stalled and while a recovery was trumpeted, it was a hormone-free recovery that is barely recognizable as such, five years on. Many nations are in recession if not depression and in the best of the developed world have a recovery that can barely keep up with population growth. Please note that the central bankers have done a good job, but one that could never succeed without the governments supporting that efforts by driving the economic growth. They haven't and as is the wont of people today, they are targeted for blame by politicians, who have done an abysmal job of promoting growth.

Quantitative easing has certainly stopped an economic collapse, but has not produced growth. Growth is needed if the developed world economies are to truly recover and there is little sign of true growth. Yes we see money growth but that isn't the same as the broader economy will tell you. It's on-the-ground-production that gives growth. Money growth should produce that but if government-generated Q.E. is where the growth is coming from then it is serving merely to mask a slow, osmotic, shrinkage of the economy and economic confidence. We're seeing a 'stalling' of economic growth in the U.S., a recession in the U.K. and several national recessions in the Eurozone. A much better measure of growth comes in the form of such measures as factory capacity usage, employment figures, disposable income expenditure levels and the like. These define growth in the broad economy down to the consumer.

If a bank balance sheet is healthy but they are reducing lending out into the broad economy that is a sign of economic shrinkage, which leads to a compounding of that shrinkage. This's what happened to all that new money added to the system through Q.E. It's still in the banks and in government bonds and bills.

It has not reached the on-the-ground producer of wealth, the consumer. In the U.S. it is the consumer that accounts for 70% of the economy. He is still struggling with the loss of wealth in his house and his business and getting little help from the top. While the government and banking industries are looking relatively sound, they are unlikely to contribute effectively to the broad economy for years to come. While the objectives of government and finance are so separate, this won't change, it's structural.

Political Solutions

It is with amazement that the vaunted political systems on both sides of the Atlantic have failed to produce united governments capable of producing economic growth that would have resolved the money crises of the last few years.

  • The U.S. has been mired in a political gridlock that has emasculated government throughout its present term and promises little more in the next term.
  • In Europe, the political nationalism of each member has shown a degree of disunity that prompt and effective solutions have evaded all their attempts to rectify their debt crises.

There is little in the somewhat bureaucratic actions in both blocs that inspire sufficient confidence that can steer the developed world back to economic prosperity. Meanwhile, confidence continues to decay alongside the monetary systems at banking and sovereign levels.

We feel that the path forward is more loss of confidence and value for national assets and currencies, until it gets out of control and turns into the "Black Hole" of deflation that this series is about.

Gold Forecaster regularly covers all fundamental and Technical aspects of the gold price in the weekly newsletter. To subscribe, please visit

By Julian D. W. Phillips
Gold-Authentic Money

Copyright 2012 Authentic Money. All Rights Reserved.
Julian Phillips - was receiving his qualifications to join the London Stock Exchange. He was already deeply immersed in the currency turmoil engulfing world in 1970 and the Institutional Gold Markets, and writing for magazines such as "Accountancy" and the "International Currency Review" He still writes for the ICR.

What is Gold-Authentic Money all about ? Our business is GOLD! Whether it be trends, charts, reports or other factors that have bearing on the price of gold, our aim is to enable you to understand and profit from the Gold Market.

Disclaimer - This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold-Authentic Money / Julian D. W. Phillips, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold-Authentic Money / Julian D. W. Phillips make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold-Authentic Money / Julian D. W. Phillips only and are subject to change without notice.

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