Certainly there have been times over the last few months when nascent stock market and commodity rallies have been snuffed out early following a burst of initial optimism - notably in late October last year, following signs that Europe's leaders had arrived at a plan for restructuring Greece's debts. The situation is different this time, however, in that the markets are stating to adjust to the fact that the world's monetary authorities are not going to "deflate the bubble" (to coin a technical term).

Evidence in favour of this point has been steadily accumulating over the last few months - whether in the form of the European Central Bank's rapidly expanding balance sheet, the Fed-ECB swap lines announced last November, and the €489bn's worth of three-year loans the ECB made to European banks in December as part of its "long-term refinancing operation". A second LTRO is scheduled for next month.

In addition, the International Monetary Fund is also looking to bolster its bailout options, a move sure to generate political controversy in countries that are expected to contribute more of their taxpayers' money to the organisation. Already US Republicans are speaking out against American involvement in any eurozone rescue, though they've missed the boat slightly on this, as the increase in Fed-ECB swap lines was clear assistance for the eurozone (which avoided the obvious political risks the Fed would have run if it had engaged in direct purchases of European securities).

Similarly, the significance of any new IMF deal may initially slip under the radar screen of most politicians and a good chunk of the media, as it will be presented in the language of international bureaucray rather than plain English. Nevertheless, the IMF has been steadily laying the groundwork for greater involvement on its part in bailouts since the 2008 crisis, and increasing its issuance of "Special Drawing Rights" (SDRs) - a kind of central bank currency.

The world's monetary authorities will not go down without a fight, and it's foolhardy to question their determination to inflate.

Comex gold futures for February delivery gained 0.9% to settle at $1,678.30 per troy ounce. Silver for delivery in March gained 1.9% to settle at $32.27 per troy ounce - another solid day for the white metal, though it keeps banging up against selling resistance around $32.50.

Greece is once again the topic of market conversation this morning (surprise surprise), following the news that talks between eurozone finance ministers and private finance have again been brought grinding to a halt - with both sides disagreeing on how high the coupon should be on newly-issued Greek debt. The UK's Office of National Statistics also released data this morning showing that the UK's public sector net debt (excluding financial interventions such as bank bailouts) has passed the trillion-pound mark for the first time in the country's history. Alan Mattich has written an interesting article at The Wall Street Journal about the "zombification" of the UK economy that is well worth reading.

The debt picture for the UK is even worse when one considers that, as in the US, official public sector net debt disguises many off-balance sheet commitments. These include the likes of public sector pensions and Private Finance Initiative (PFI) projects. These off-balance sheet liabilities are worth another £1.1 trillion.

Meanwhile, the US dollar's reserve currency status continues to die a slow death. Last week saw the news that China has entered into a new currency swap deal with the United Arab Emirates, worth 35 billion yuan (US$5.6bn), a deal that will last for three years (though it's extendable) and that is designed to enhance bilateral trade, investment and financial cooperation. All of this is part of Beijing's slow move towards introducing the renminbi as a unit of account in international trade, and away from the US dollar.

Yesterday also brought forth the highly interesting news that India will use gold to pay for Iranian crude oil, while China is expected to follow suit. China and India combined buy around 40% of the 2.5 million barrels of oil Iran produces each day. Looks like the Chinese, the Indians and the Iranians didn't get Ben Bernanke's memo.

With negotiations still on-going between the Greek government and its private creditors and the situation in Hungary looking increasingly fraught, the World Bank has warned that developing nations should prepare for a slump in economic activity comparable to the 2008/09 downturn. Though the Bank’s chief economist Justin Lin stated that Europe’s sovereign debt crisis was “contained”, he stated that “the risk of a global freezing-up of the markets and as well as a global crisis similar to what happened in September 2008 are real." The ratings agency Fitch has now stated that it expects a default from Greece in March.

Meanwhile, the precious metals consultancy group GFMS reported yesterday that net central bank purchases of gold reached 430 tonnes last year – a more than five-fold increase on the previous year and the highest level since 1964. As reported by Dow Jones Newswires, in 2010, net demand from these institutions stood at just 77 tonnes. GFMS expects central bank buying to remain at an elevated level, with demand of around 190 tonnes in the first half of 2012 – a slight reduction on the 205 tonnes bought in the first half of last year.

GFMS notes “notably higher enthusiasm” from emerging market central banks for gold. Mexico was the largest official purchaser last year – buying 100 tonnes of the yellow stuff. Other notable official buyers include Turkey, Russia, South Korea, and Thailand. China is also acquiring gold at a rapid pace (around 350 tonnes a year), but its acquisitions are from mines in China rather than from open market purchases.

Cynics might argue that, given central banks’ generally-poor track records when it comes to economic forecasts and timing gold sales and purchases, that this burst of enthusiasm from these institutions might stand as a decent contrarian indicator that the best days of this latest gold bull market are behind us. This ignores the fact that – with the exception of South Korea – central banks in the developed world remain entirely absent from the buyers’ club. It was primarily developed-world central banks in countries such as Switzerland, Australia, Canada, the UK, France and Spain who were responsible for the bulk of official gold selling in the 1990s at prices below $400 per ounce.

The topic of central bank gold buying and selling deserves far greater examination in another article; as a parting note, another way of looking at this question is to ask: what could prompt central banks to sell gold? What alternative, high-liquidity asset could they own that would be a better long-term store of value than gold? US dollars? Euros?

To understand the debt crisis, you have to understand that in reality this is a “money crisis”. Let me explain this further.

Today, all money is created in the banking system. It originates from the central bank and is brought into existence by an extension of its balance sheet. This means that there it is a simple booking entry: new money on the liabilities side, and debt on the assets side. Yes that’s right: money is created through credit – which is nothing but a nice word for debt. In contrast to most of human history – where money has been a tangible asset with intrinsic value attached to it, such as gold and silver – today all dollars, euros, pounds and all other currencies are based on debt. This is taken on by governments, companies and private citizens all over the globe. Implicit in this is trust on the part of lenders that this debt will be repaid one day in the future.

So what's the problem? Let’s say you take out a loan for $100. The money you receive will be created from nothing once you sign the paper to take out the loan and you are then obligated to pay back $105 after say one year. Now here is the all-deciding question: Where is the interest coming from that you need to pay back the loan? At the moment the only money in circulation is your $100. The only way to solve this riddle is that somebody somewhere in the economy has to take out another loan to create the money that enables you to pay back the first loan.

This in essence is how our so-called “modern” monetary system works. It can only work if there are always people who are willing to take on new debt. This is because if people start paying down debt instead of borrowing more, then bank lending collapses – leading to drops in broad money supply measures such as the Federal Reserve’s M2 measure. (The Fed used to publish an even broader money supply measure, M3, but stopped reporting this number back in 2006). This will make it even harder for the remaining debtors to find the money they need to pay back their debts, because to recap: the interest is always missing and there is always more debt than money. This is what many call the “deflationary death spiral” in which more and more money (credit/debt) disappears leading to the insolvency of remaining debtors (which equals wealth destruction on the side of the creditors). This leads to a standstill in economic activity (companies fail, because falling prices halt consumption) and therefore skyrocketing unemployment. This is every politician and central bankers’ worst nightmare.

This is the reason why in our current system it is deemed politically impossible to reduce overall debt. There can be deflationary shocks – as seen in 2008 – but central banks will fight such deflation tooth-and-nail in order to prevent the aforementioned deflationary death spiral. In practice, this means buying lots of bonds (public and private) off of banks – purchases that are funded by newly created electronic money. In order to maintain debt-based growth and avoid short-term economic collapse, government debt must expand in order to compensate for the collapse in private debt growth. This also applies in reverse: the government can reduce its debt, but only if the private sector increases its debt, so that total debt and therefore the money supply doesn’t shrink.

So why can this debt based system only work for short periods of time? Think about what happens if we do not pay down debt. Due to compounding interest the amount of debt will keep rising automatically – and exponential. The current financial structure can therefore only be stable if economic activity increases along with the debt so that the debt is still backed by something (the labour of the debtor) and doesn’t turn “toxic”. This experiment has been going on for over 40 years now, ever since Nixon "closed the gold window" in 1971. We’ve come to the point at which economic growth can no longer hold pace with the unmerciful debt machine. Therefore the relative debt levels (debt to GDP) are constantly rising – a clear signal that should have anyone worried.

During the last deflationary shock in 2008 the world’s major governments stepped in to prevent the system from collapsing by rescuing many bankrupt institutions. By doing so they have become insolvent themselves – as is becoming more and more apparent in Europe. But all developed economies are to one extent or another facing the same problem. The fiat money system is in dire need of somebody still able and willing to take on debt to keep everything running. But we’ve reached a point of debt saturation. And even if we were to find new debtors this would only buy us a bit more time – and a greater altitude – before the inevitable fall.

By mathematical certainty the debt money system must and will collapse. Either through the described deflationary collapse or through ever-larger "rescue packages” (a euphemism for money printing) whereby the public is forced to take on the toxic private debt by devaluing the currency. As people lose faith in fiat currencies, a resulting hyperinflation will produce the same result as the deflationary collapse. Promised payments from debt instruments will implicitly or explicitly be defaulted on.

To sum up: In a debt based fiat money world there will always be debt for if there was no debt there would be no money. Since debt is not paid off, the compounding interest on it forces us to grow at the same pace. Since this experiment has failed we are now facing the collapse of this debt system. Prepare yourself accordingly by diversifying into tangible assets such as gold and silver, and by educating yourself and your loved ones about the nature of the economic challanges they are likely to face in the years ahead.

Improving macroeconomic numbers from the US are being seen by some economists as the first signs of accelerating inflation, especially given the rise in key energy and agricultural commodities, while others are playing the “green shoots” song again. Meanwhile the Chinese slowdown, exemplified by the Hang Seng Index’s 9 month and 25% drop, has sparked increasing concern over whether the Asian giant will see a soft or hard landing, and how that will affect the world economy. Both Japan and China will be less enthusiastic buyers of US sovereign debt, unless of course it is done with newly printed money and for currency manipulation purposes.

The demoralizing end of year drop in the price of gold spooked many gold bugs, however, “If you can keep your head when all about you, are losing theirs…” and take a few minutes to look at the fundamentals, you will see the wisdom of holding onto your gold, and perhaps even deciding to buy some silver, which at under $30 per troy ounce is looking like a real bargain. As long as the long term bullish trend is undisturbed and the fundamentals remain in place, the best plan is quiet, steady and methodical accumulation. Emotions are always the enemy of prudent investment and saving.

Spain’s announcement today that the budget deficit will overshoot 8% (when the official target was under 5% just a few months ago), casts a long shadow over the euro. We are well past the point where the euro-periphery trembled but could hope to be bailed out by the euro-core.

In the US the primaries, starting with the Iowa caucuses today, will see foreign policy compete with the fiscal crisis for the spotlight. Whatever the outcome, precious metals will remain the only store of value that do not depend on someone else’s promise and that cannot default.

As explained by Ambrose Evans-Pritchard at the Telegraph, and mentioned in a previous GoldMoney News article, European banks will now be able to borrow unlimited amounts from the ECB for up to three-years at 1%. The ECB has loosened the collateral requirements on these loans, meaning that banks are free to buy higher yielding eurozone sovereign debt – yielding 5-6% – and use these bonds as collateral for 1% loans from Draghi’s ECB. These “long-term repo operations” (LTROs) will thus allow banks to earn an easy 4% spread – bolstering their balance sheets and (it’s hoped) increasing demand for distressed eurozone sovereign debt. The ECB has also lowered reserve requirements in the hope of freeing up an additional €100 billion for bank lending.

As with the moves a fortnight ago by the world’s central banks to increase dollar swaps with the US Federal Reserve, this LTRO move is essentially a camouflaged form of quantitative easing. Though as with all these measures, the plain English phrase “money printing” is as ever conspicuous by its absence from media reports on this development; “new liquidity” is the euphemism of choice. Initial reports suggest (unsurprisingly) strong demand from banks for these loans, with €489bn lent where analysts had expected just €300bn.

Thus, we get another demonstration of the lengths central banks will go to in order to keep the financial system inflated. As famed American investor Richard Russell puts it, central banks must “inflate or die”. Certainly, anyone who still harboured any illusions about the ECB’s “hawkishness” should have been disabused of such notions by now, with the British think tank Open Europe releasing a report yesterday analysing the ECB’s growing “exposure to struggling eurozone economies.”

Open Europe notes that “contrary to popular opinion, the ECB is already heavily intervening in markets… its exposure (to peripheral eurozone debt) now stands at €705bn, up from €440bn in early summer – an increase of over 50% in only six months, raising fresh questions about its credibility, independence and possible losses it may face in the case of future sovereign defaults.”
Author: The GoldMoney News Desk