As currency devaluation is becoming a new goal for countries, central banks in the global economy are losing trust in each other.
The notion followed by central banks is that if they devalue their currencies, the prices of their goods become competitive in the global economy. Unfortunately, this may work in some situations, but right now this strategy is questionable. Why? Because to achieve their objectives of devaluating their currencies, central banks are printing money like never before.
Now with all this, think about what happens when central banks increase the circulation of their own currency while the value of their reserves starts to go down as well.
Let me explain…
Most central banks have the U.S. dollar as their main reserve currency. But, as the greenback is also depreciating in value, central banks need to replenish their reserves. And central banks are starting to look elsewhere to top up their reserves. For many central banks, gold bullion is the only option for sound reserves.
The activity of the central banks in the gold bullion market has increased since 2009 when they collectively became net buyers of gold. As I have mentioned in these pages before, central banks will not say when they are going to buy gold bullion or how much they are going to purchase, as they often want to keep their purchases under the radar.
At the World Economic Forum that is going on in Davos, Switzerland, right now, the First Deputy Chairman of Russia’s central bank, Alexei Ulyukayev, said, “We are buying metal and will continue to pursue this course.” He also added, “This is a course of asset diversification in a situation when investing in securities or deposits remains risky.” (Source: Reuters, “Update 3-Russia central bank to keep buying gold – Ulyukayev,” January 24, 2013.)
According to the International Monetary Fund (IMF), Russia’s gold bullion holdings increased by 8.5% in 2012.
Russia is not the only country buying gold bullion; other central banks are doing the same. For example, the Kazakhstan central bank’s gold bullion holdings increased 41% in 2012 over 2011.
Now consider this: Russia, Turkey, Kazakhstan, South Korea, and Brazil are only few of the central banks making headlines about their recent forays into gold bullion buying. What happens if other countries jump in and buy gold bullion?
Just look at the Bank of Canada, the central bank of Canada. Its reserves consist of only $184 million worth of gold bullion versus U.S. dollar holdings of $35.75 billion and other currency holdings of $19.43 billion! Imagine what would happen if a country like Canada (one of many countries whose holdings of gold bullion are minuscule compared to their U.S. dollar holdings) decided it needed to diversify into metals?
The stock market is near a high. The prices of senior and junior gold mining companies are near a low. I know where the best opportunity exists when comparing the two.
Michael’s Personal Notes:
Mark my words: the U.S. budget deficit will continue to increase and it won’t be too long before the national debt soars to $20.0 trillion.
And if the federal government’s deficit isn’t a big enough problem unto itself, my concerns grow when I hear stories about cities and sates struggling with their deficits.
Take the City of Detroit for example. Detroit has run out of money, as the city continues to post an annual deficit, because spending outweighs revenue. The city council has been working to make spending cuts so that the city’s finances won’t be taken over by the state.
During a public hearing, the Detroit City Council President, Gary Brown said, “We’re in a crisis, and if we do nothing to save $90 million, the state’s going to come in and do it and it’s going to be a lot worse with respect to our employees.” (Source: Reuters, “Detroit council approves cost cuts to stave off state takeover,” January 16, 2013.)
Similarly, Illinois has troubles of its own. The Standard & Poor’s credit rating agency just slashed Illinois’s credit rating one notch lower to a credit rating of A-. The main reason for the credit rating cut: the unfunded public pension of its cities. (Source: Reuters, January 25, 2013.)
Minnesota’s government employee public pension is unfunded by $16.7 billion, $4.0 billion more than its shortfall in 2010. Out of 12 state public pension funds that are open for new members, 11 of them have deficits, meaning they don’t have enough money to pay for what they have promised. (Source: St. Cloud Times, January 24, 2013.) The pension funds with the largest gaps include those of state troopers, local police and firefighters, and public safety workers.
If states and cities continue to suffer at this rate, at one point down the line, they will not be able to cope with their deficits and they will need bailouts from the federal government. Will they get their desperately needed bailouts? That’s another question. (I still remember the 1970s and President Ford telling troubled New York citizens that they couldn’t count on Washington for a bailout and that they needed to figure things out on their own.)
The federal government bailing out states and cities will result in our national debt rising significantly, because our government will have to borrow more as it increases its own budget deficit. We have already seen one credit rating downgrade for the U.S. economy; if Washington starts bailing out cities and states, get ready for another credit rating downgrade.
Where the Market Stands; Where it’s Headed:
It’s quite remarkable. The stock market goes up almost daily, while revenue growth at the S&P 500 companies comes crashing down to the low single digits after years of double-digit growth. I have to give credit to the Federal Reserve; it has certainly created another bubble within the stock market. We are inching closer and closer to a top for the market. And when it comes down, it won’t be a pretty sight.
What He Said:
“I see the coming recession being deep and difficult because U.S. consumers do not have the savings to spend their way out of the recession. The same thing happened in Japan. The Japan example proved that when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.” Michael Lombardi, Profit Confidential, August 23, 2006. Michael began talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.