A very loud and uncomfortable groaning sound emerged from the depths of the international financial system last week. Actually, to be more accurate it was a nasty shredding sound as the prices of paper gold and physical gold began to go their separate ways.
It came out of nowhere, but it was decisive. The plunge in the paper gold price lit a fire under physical demand all around the world. If paper and physical have indeed gone their separate ways, expect more price falls in the coming weeks as players abandon the paper market.
As always, gold is the canary in the coalmine. We're not sure exactly what it means just yet, but last week's action was the canary getting a good dose of gas smack bang in the face...or beak. It's a harbinger...a warning sign. Gold has sounded its alarm. Now we wait.
And while we wait, we have G20 meetings to enjoy. These gabfests aren't always pure dribble and soothing press statements. The latest meeting in Washington on the weekend brought out some interesting divergences between the thoughts and policies of the world's major trading blocs.
It seems that China and Europe are on the same page, while the US and Japan are reading a different book entirely. Check it out...
German Finance Minister Wolfgang Schaeuble said:
'Fiscal and financial sector adjustments remain crucial to regain lost credibility and strengthen confidence. International cooperation remains crucial. At the current juncture, it is in particular the responsibility of the advanced economies, including Japan and the U.S., to follow through with ambitious fiscal consolidation over the medium-term to reduce public debt ratios which in several cases have reached unsustainable levels.'
And China's central bank Chief Zhou Xiaochuan said:
'Although unconventional monetary policies in major advanced economies have helped stabilize financial markets and foster economic recovery, it is necessary to re-evaluate the marginal benefits and costs of such policies after multiple rounds of monetary easing.
'Unconventional monetary policies alone cannot solve the structural problems faced by advanced economies, and should not become a substitute for structural policies.
'Prolonged easing could exacerbate the financial vulnerabilities and affect the stability of the international monetary system.'
Meanwhile, Japanese Finance Minister Taro Aso, doing his best doublespeak, had this to say on exchange rates:
'The commitment from G20 countries to avoid targeting exchange rates for competitive purposes, and to resist all forms of protectionism and keep markets open is a fundamental principle of economic policy management that should be respected by all IMF member countries.'
Not to be outdone, US Treasury secretary Jack Lew came out with a series of buzzwords that, when translated, meant 'we have to continue with our stimulus efforts, and Europe, you should be doing more to stimulate your economy too.' Here's what he actually said:
'This is not a time for complacency. Tail risks have receded recently, but global growth remains weak, and unemployment is still too high. Strengthening global demand is imperative and must be at the top of our agenda.
'Stronger demand in Europe is critical to global growth...There is a welcome debate in Europe on how better to support demand through an appropriate mix of macro tools, recalibrating the pace of fiscal consolidation, reducing financial fragmentation, and rebalancing.'
These few statements highlight the ideological differences between the world's major trading blocs. Europe has drawn a line in the sand. In order to maintain the long term viability of the euro, Europe's leaders have decided that austerity and structural reform is the only way to go. They are prepared to take short term pain (as in 5-10 years of it) for long term gain (as in 50-100+).
The US and Japan have a different take. Their ideology has always been short term stimulus. Go for growth now and the rest will take care of itself. In the US's case, it's a view borne out of imperial arrogance, coupled with the suffering endured throughout the Great Depression.
As a result, deflation is ALWAYS something to be avoided. And that aim is a lot easier to achieve when you have the world's reserve currency and can create as much of it as you think is necessary to cure your domestic economic ills. You know your trading partners must absorb the flow of dollars you emit. Otherwise their currencies appreciate too quickly, which will put them at a trading disadvantage.
And despite 20 years of evidence to the contrary, Japan takes the same view. That is, fiscal and monetary stimulus will eventually work and structural reforms, which upset powerful interest groups, can wait.
That Japan and the US are powerful economic allies should come as no surprise. The US, through General Macarthur, helped establish Japan's post WWII economy. Ever since the two have been inextricably linked.
But these policies don't suit the emerging power of China. A weaker Japanese yen threatens China's export markets. Loose US monetary policy increases the threat of inflation in China via the pegged USD/yuan exchange rate.
With China's economy increasingly vulnerable from its own credit boom, it will become ever more belligerent to those outsiders who threaten its internal stability.
Which is why the differing comments from the G20 are very interesting. Clearly, the US dollar centric financial system works for some (the US, and Japan's entrenched interest groups) but not nearly as well for others (Europe, China).
That why you've seen China steadily working away to position the yuan as a trade based currency, which cuts out the US dollar as the middleman in all international trade transactions. It's why Europe designed the euro, to lessen the power of the US dollar as a reserve asset.
Russia, an outsider in all this, is also working to lessen the influence of the US dollar as the world's reserve currency. Russia holds the Presidency of the G20 this year, and will host the main G20 gathering in St Petersburg in September.
The next meeting takes place in May in Istanbul. The working title for the conference is 'Global Finance in Transition'. Event organisers are the Turkish Central Bank, the 'Reinventing Bretton Woods Committee' and the Russian Ministry of Finance.
Reinventing Bretton Woods committee, huh? That sounds interesting...especially at a 'Global Finance in Transition' conference. What could the Russians be up to? We'll follow the story closely, and let you know what we find out.
It all sounds ominous though. And we keep thinking that gold knows something no one else really does. Could it be that in the process of systemic breakdown, gold breaks down first, undergoing the necessary pain of paper and physical markets separating?
for The Daily Reckoning Australia
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About the Author
Greg Canavan is a feature Editor at the Daily Reckoning Australia and is the foremost authority for retail investors on value investing in Australia. You can subscribe to The Daily Reckoning for free here. He is also the author of Sound Money. Sound Investments (SMSI). An investment publication designed to help investors profit from companies and stocks that are undervalued on the market.