02/22/12 St. Louis, Missouri – Well, the crazy things that have been going on with Japanese yen (JPY) finally seem to be unwinding… For anyone new to class, the Japanese yen has been one of the best-performing currencies the past couple of years, and not for strong fundamentals… The economy has been in a funk for over two decades, interest rates have been zero for so long now — I don’t remember when they weren’t zero — an aging population and government debt up to their eyeballs, but still the yen rallied…

But that appears to be over, giving credence that the only reason yen was so strong for so long was that it was still considered to be a “safe haven” currency. Well, with the latest agreement in the eurozone, I’m sure a lot of those “safe haven” trades into yen are being unwound, from the looks of it, I should say. So for the first time since July of last year, yen is trading with an 80 handle…

The euro (EUR) remains above 1.32 this morning… but has found the waters quite rough as it attempts a run at 1.33, and just like a couple of weeks ago, when we saw the euro bounce around 1.32-1.33 and never really climb past 1.33, the markets will grow tired of this trade, and soon the euro will begin to slide again. That is, unless it can get some strong legs and move past 1.33. Personally, I would be happy to see the euro remain around 1.32, for now, and see where the baby steps of stabilization for the eurozone go from here…

In the 1980s here in St. Louis, the world-famous rock radio station, KSHE, used to run a TV ad that had a father break into air guitar when the Stones’ song “Brown Sugar” would come on, and the daughter would get all freaked out and say, “Mom… he’s doing it again.”

Well, I told you all that to set up… “Pfennig readers, China’s doing it again.” China announced last night that they had signed a new member to their club of countries that have currency swap agreements to remove dollars from the terms of trade. This time, China signed an agreement with Turkey. Yes, China is being coy with these smaller — in terms of world trade — countries, but that’s how they are going to spread their wings, and gain a wider distribution of their currency. And again, I sit here and tell you, dear reader, that China has plans to remove the dollar as the reserve currency of the world.

And maybe it won’t be the renminbi (CNY) that takes over… maybe the so-called reserve currency is a basket of major currencies. The point here, and I can’t emphasize this enough, is that to have the reserve currency title stripped from the dollar would be devastating to our economy… To you, me, our kids, our grandkids… Think about this, dear reader… after World War II, the pound sterling (GBP) could no longer be the reserve currency of the world. Because of the debts the U.K. built fighting the war, the U.S. became the financier of the world, and was the only country that had the ability to act as “settlement banks” and use dollars in the terms of trade…

Then gloom, despair and agony fell on the U.K. economy. So this is what the Chinese have in mind for us… and why are they doing this? They believe that the U.S. has broken their promise to the world to keep the dollar strong, which they can no longer do, given the debts, deficits, economy, scandals, unfunded liabilities and on and on…

OK, I’ve got to go on, because this is really depressing me this morning!

This morning, the euro was dealt a bit of a blow by a worse-than-expected manufacturing index report for this month… remember, these manufacturing index reports are called “PMI.” So the eurozone PMI came in at less than 50, at 49.7. In addition, remember that any number below 50 represents contraction of the manufacturing sector. I find this report to be interesting, given that there appears to be a strong economy in Germany. But even with Germany representing the largest economy of the eurozone, there are many more countries in the eurozone that are not experiencing economic strength.

In the U.K., the latest Bank of England (BOE) meeting minutes showed that two members voted for additional bond purchases greater than what was implemented. I’m surprised at how the markets slammed the pound after the printing of this report… Silly markets… fickle markets… It’s just two votes… But the real point here is that we have to keep our eye on the ball, as I’ve explained several times over the past few years, and that is that what happens in the U.K. ends up on our shores about six months later… The BOE implemented another round of QE last month, so the clock has started…

The Aussie dollar (AUD) is still gasping for air, after having the wind knocked out of it by the RBA meeting minutes… We talked about this yesterday, but for those that missed class yesterday, the RBA added some wording in their latest meeting minutes that surprised the markets. The RBA kept their foot in the door of more rate cuts. Of course, they didn’t say they would cut rates, they simply said they “had the scope to do so, should the economy weaken”…

So as I said yesterday, we saw this same type of trading after a RBA rumor about three months ago, and it took the A$ a few days to get its wind back. I think it may get its wind back when the markets get a drift of the latest Wage Cost Index for the fourth quarter, which printed stronger than expected!

As I look at the currency screens this morning, most of the currencies are moving in the wrong direction, but not by much, just an underlying bias to buy dollars this morning. And gold, which had a very strong performance yesterday, is off about $5 this morning, as it appears some profit taking has taken over.

The price of oil didn’t take a step back, though. The oil price is up another $1, to $105, and knocking on the door to $106… I stopped to fill up my gas tank this morning… and much as the way groceries, restaurants and so on are doing… I got less and paid the same… This way, most of us don’t really feel the inflation all around us, but it’s there… trust me. No wage inflation or home inflation, but everything else that touches our lives… and as long as everything else around us is going up in price or going down in the quantity at the same price (it’s the same thing), it would be OK to see some wage inflation, eh?

China also printed a weaker manufacturing index (PMI). The preliminary report from HSBC Holdings shows that China’s PMI was 49.7, again below 50. This is all a part of the “moderation” of the Chinese economy, folks… nothing to be really concerned about yet, so move along, these are not the droids you are looking for…

Well, it looks as if the U.S. isn’t the only country that didn’t experience a grand Christmas shopping season. Retail Sales in Canada too, came in much weaker than previous months… December Retail sales for Canada slipped 0.2%, following increases of 0.4% in November and 0.8% in October! So maybe everyone shopped early? December was the first drop in five months for Canada, and a look under the hood (pun intended) showed that motor vehicles were to blame for the drop. So let’s not write the Canadian economy off just yet…

One European currency, the krone, (NOK) that’s bucking the trend of following the euro today, and in my opinion, it’s about darn time! The Norwegian krone is rallying nicely this morning. You might recall me bemoaning the fact that the krone was following the euro, even though Norway had sterling fundamentals and should be held to a different standard. Well, maybe that’s happening, finally! The krone is the best-performing major currency this month!

After cutting rates in December, the Norwegian central bank, the Norges Bank, might just be sitting on its hands going forward, as speculation of another rate cut fades… All this fading speculation is really pushing the krone… I wonder how long this will last? Does it have legs? Is it on terra firma? I guess we’ll have to wait and see, but in my opinion, it should be OK! Of course, just because I say that, I need to make sure you understand that it’s just my opinion, and I could be wrong!

I saw a cartoon on Ed Steer’s excellent morning Gold & Silver Daily this morning… It shows the president holding a dollar bill that’s on fire, and he says, “Look, Green Energy!” If it weren’t so true, it might be funny, eh?

Not much in the way of data from the data cupboard this morning here in the U.S., just existing home sales for January… The thing to look for here is not the homes sold, but at what price? Did the median price decline as it has for a couple of years now? That’s what to look for…

Then there was this from The Economist:

“The European Union has lower government debt levels than America. Gross government debt in the 27 nations of the EU was 80% of the region’s GDP at the end of 2010; in America, gross federal debt at the end of 2010 was 94% of GDP. Furthermore, government debt is growing more slowly as a percentage of GDP in the EU than in America, because pretty much every nation in the EU is implementing austerity measures. The general government deficit in the EU-27 in 2010 was 6.6% of GDP. In America, the federal deficit in 2010 was 9% of GDP.”

I tell you this not as a “hey, they’re better than us” type of thing. This article caught my eye, because we’re going to hear over and over again during the election campaign that we are “becoming Europe” because of the debt. But if that were true, then we as a country would be cutting deficit spending, and implementing austerity measures… watch out for that!

To recap… Yen finally surrenders to intervention and reduction of safe-haven flows. China signs another member to their currency swap club. Oil climbs further. Gold has strong performance yesterday followed by some profit taking today. The A$ is still searching for some wind, after having it knocked out of it by the RBA minutes on Monday, and maybe, just maybe, Norway is breaking the trend to follow the euro…

Chuck Butler
for The Daily Reckoning

I apply unconventional logic to economic issues.

Op/Ed|2/22/2012 @ 1:12PM

Panic is in the air as gasoline prices move above $4.00 per gallon. Politicians and pundits are rounding up the usual suspects, looking for someone or something to blame for this latest outrage to middle class family budgets. In a rare display of bipartisanship, President Obama and Speaker of the House John Boehner are both wringing their hands over the prospect of seeing their newly extended Social Security tax cut gobbled up by rising gasoline costs.

Unfortunately, the talking heads that are trying to explain the reasons for high oil prices are missing one tiny detail. Oil prices aren’t high right now. In fact, they are unusually low. Gasoline prices would have to rise by another $0.65 to $0.75 per gallon from where they are now just to be “normal”. And, because gasoline prices are low right now, it is very likely that they are going to go up more—perhaps a lot more.

What the politicians, analysts, and pundits are missing is that prices are ratios. Gasoline prices reflect crude oil prices, so let’s use West Texas Intermediate (WTI) crude oil to illustrate this crucial point.

As this is written, West Texas Intermediate crude oil (WTI) is trading at $105.88/bbl. All this means is that the market value of a barrel of WTI is 105.88 times the market value of “the dollar”. It is also true that WTI is trading at €79.95/bbl, ¥8,439.69/barrel, and £67.13/bbl. In all of these cases, the market value of WTI is the same. What is different in each case is the value of the monetary unit (euros, yen, and British pounds, respectively) being used to calculate the ratio that expresses the price.

In terms of judging whether the price of WTI is high or low, here is the price that truly matters: 0.0602 ounces of gold per barrel (which can be written as Au0.0602/bbl). What this number means is that, right now, a barrel of WTI has the same market value as 0.0602 ounces of gold.

During the 493 months since January 1, 1971, the price of WTI has averaged Au0.0732/bbl. It has been higher than that during 225 of those months and lower than that during 268 of those months. Plotted as a graph, the line representing the price of a barrel of oil in terms of gold has crossed the horizontal line representing the long-term average price (Au0.0732/bbl) 29 times.

At Au0.0602/bbl, today’s WTI price is only 82% of its average over the past 41+ years. Assuming that gold prices remained at today’s $1,759.30/oz, WTI prices would have to rise by about 22%, to $128.86/bbl, in order to reach their long-term average in terms of gold. As mentioned earlier, such an increase would drive up retail gasoline prices by somewhere between $0.65 and $0.75 per gallon.

At this point, we can be certain that, unless gold prices come down, gasoline prices are going to go up—by a lot. And, because the dollar is currently a floating, undefined, fiat currency, there is no inherent limit to how far the price of gold in dollars can rise, and therefore no ultimate ceiling on gasoline prices.

Federal Reserve Chairman Ben Bernanke uses a “core CPI index” that excludes food and energy to guide monetary policy. From Big Ben’s point of view, rising gasoline prices are not a problem. For the rest of us, they are becoming a big problem.

Over the centuries, gold has been “the golden constant”. Eventually, all prices equilibrate with gold. This is why gold represents the best available standard in terms of which to define the value of a monetary unit. Forty-one years ago, when the value of the dollar was defined in terms of gold at $35/oz, WTI was selling for $3.56/bbl.

Right now, the threat posed by rising gasoline prices is not just to family budgets. An even greater danger is that the government will use escalating oil prices as an excuse to do something stupid.

After President Nixon abrogated the Bretton Woods monetary arrangement in stages starting in September 1971, both gold prices and oil prices started to rise. The government responded by imposing wage-price controls. This made a bad situation much worse.

Continued on Pg. 2

The talking heads vary on their opinions on how this will affect the global gold market. Some claim it will bring massive shortages in the coming years as China acquires more tonnage in the coming decade. While others shake this off as nothing more than the Central Bank of China (CBOC) anomaly of shoring up its banking through its gold holdings.  We think that both are correct to a varying degrees. Yet, we tend to cling to the middle ground that China both privately & through the CBOC will continue to add pressure to the price of Gold based on demand.

Much like oil demand is greatly increased by the consumption of the growing Chinese industrial revolution. Gold will continue to see price pressure as demand ebbs and wanes in China. As no surprise to any, China is growing into a power-house economically that will continue to affect global markets, including Gold.

Chinese central bank governor Zhou Xiaochuan

Much like last summer when Gold rose and fell with every changing wind of the US Dept crisis, this winter Gold is clinging to every shift of the EU Debt crisis. In a not so surprising move China’s central bank governor Zhou Xiaochuan said on Wednesday, The People’s Bank of China has always maintained close cooperation and contacts with the European Central Bank, and we support each other in many policy aspects. The PBOC firmly supports the ECB’s recent measures to address the difficulties. In other words, China will continue to buy up cheap European debt as a continuation of their move to become the worlds debt collector.

China’s commitment boosted gold in early trading today pushing the yellow metal up 1%. Gold continues to trade in the $1,700′s and should continue to for the near future.  This makes gold a buy as it nears the $1,715 price and hold closer to $1,775.  The next major move in gold should come once any details are released after the finalization of the EU Debt agreement.

Still in the minds of most investors is the impending move by the Fed to start QE3 before the end of this election cycle. Over the last month Fed Chair Bernanke refused to rule out firing up the printing presses to fuel the downward trend of the Dollar. Bernanke may be getting nervous that the Dollar is strengthening too much during this current Euro crisis and will want to put on the brakes. All of this should send the price of gold higher in the coming months.

Now would be a good time to start or reinvest in your tangible asset portfolio, making sure you are at a conservative 10% to aggressive 20% of your net investments. This will provide the financial insurance needed to weather the coming economic storms on the horizon.

Published: Tuesday, 7 Feb 2012 | 6:15 PM ET

By: Daryl Guppy
CNBC Contributor

The gold price has been historically influenced by three main factors – currency hedging, jewelry demand and central bank activity. To these factors we add a fourth – the activity of Exchange Traded Commodity Funds.

The use of gold for currency hedging goes hand in glove with central bank buying activity. When fiat paper currencies are under threat then gold is the instinctive hedge. Investors worried about holding euros, and also worried about the weakness in the U.S. dollar start buying gold. The developing weakness in the euro, and the potential collapse or restructuring of the euro zone, is the main driver behind the current gold rally.

There has been an increase in demand for third party exposure to the market. This is provided by the Exchange Traded Commodity Funds. The Exchange Traded Funds now account for a significant proportion of gold trading activity and their investors are not motivated by the same concern as professional traders or gold industry participants.

Underpinning this investment behavior is the consistent buying by central banks as they seek to build reserves to protect their currency. In 2010 and 2011 central bank buying provided a firm foundation for the prolonged uptrend. There is no evidence to suggest that central banks will become sellers in the near term future so this up trend support remains in place. This combination of factors has created a strong and sustainable uptrend in gold.

The weekly COMEX  [GCCV1  1747.50    16.20  (+0.94%)   ]gold chart shows a strong trading channel. Starting in 2010 April the lower trend line defines the lower edge of the trading channel. The upper edge of the trading channel is confirmed in May 2010. The current rebound rally starting from near $1,570 uses the lower trend line as a rebound point.

Between May 2010 and July 2011 the gold price moved in a rally and retreat pattern inside the trading channel. The strong breakout above the upper edge of the trading channel developed in July 2011. After the peak near $1,924 in September 2011 the gold price developed a new downtrend. In October and November 2011 the upper edge of the trading channel acted as a support level. The rebound rally in October provided the anchor point for the new downtrend line.

The rebound rally that has developed from the December 2011 low near $1,560 has two important features.

The first feature is that the rally has moved above the upper edge of the trading channel near $1,720. The second feature is that the price has also moved above the value of the downtrend line, which also has a value near $1,720.

This breakout above two important resistance features is very bullish. The first upside target is near $1,800. This is the peak of the November 2011 rally and it is a weak resistance level.

The width of the trading channel is calculated and this value is projected upwards to provide the second breakout target. This is near $1,860 but there is a high probability the price will use the previous resistance level near $1,880 as a target level.

The long established pattern of trend development inside the trading channel suggests that any breakout towards $1,800 and $1,880 will have the characteristics of a rally rather than a sustainable trend. This provides short term trading opportunities. In the longer term the gold price may return to trading inside the trading channel.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com . He is a regular guest on CNBC’s Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

CNBC assumes no responsibility for any losses, damages or liability whatsoever suffered or incurred by any person, resulting from or attributable to the use of the information published on this site. User is using this information at his/her sole risk.

© 2011 CNBC, Inc. All Rights Reserved

Philip Coggan

We don’t often have video or audio links on this blog but both of these interviews are worth listening to. This is a warning that should be shouted from the mountain tops!

The following links are two separate interviews on the book:

NPR Morning Edition: Amid Debt Crisis, A Trail of Broken ‘Promises’

The Economist: The Debt Crisis – Philip Coggan on ‘Paper Promises’

By JAMES B. STEWART

Published: February 3, 2012

Meet Mr. 102%.

James Ross, 58, is a founder and managing member of Rossrock, a Manhattan-based private investment firm that focuses on commercial real estate and distressed commercial mortgages. “I realize I am very fortunate, and in fact I am a member of the 1 percent,” Mr. Ross wrote in an e-mail. His résumé is studded with elite institutions: Yale, Columbia Law School and stints at the law firms Cravath, Swaine & Moore in New York and Holland & Hart in Denver. Since his company fits the category of private equity, he even has carried interest, the kind of incentive compensation that enabled Mitt Romney to pay such a low tax rate.

Yet Mr. Ross told me that he paid 102 percent of his taxable income in federal, state and local taxes for 2010. “My entire taxable income, plus some, went to the payment of taxes,” Mr. Ross said. “This does not include real estate taxes, sales taxes and other taxes I paid for 2010.” When he told friends and family, they were “astounded,” he said.

In the midst of a national debate over tax rates and policy, I lifted the veil last week on my income tax rates for 2010, a year in which I paid 37 percent of my adjusted gross income (total income minus things like retirement contributions) in federal, state and city income taxes and 74 percent of my taxable income (after deductions like state and local taxes).

I was dismayed by the comparison to Mr. Romney — who paid 13.9 percent of his adjusted gross income of $21.7 million and 17.5 percent of his taxable income of $17.1 million — as well as by the possibility that I paid a higher tax rate than just about anyone. So I invited readers to send me e-mails disclosing their tax rates and circumstances.

I was deluged with submissions, including many people who pay a higher rate than I do. But at 102 percent, Mr. Ross was in a category of his own.

That doesn’t mean Mr. Ross pays more in taxes than he earns. His total tax as a percentage of his adjusted gross income was 20 percent, which is much lower than mine.

That’s because Mr. Ross has so many itemized deductions. Since taxable income is what’s left after itemized deductions like mortgage interest, charitable contributions, and state and local taxes are subtracted, it will nearly always be smaller than adjusted gross income and demonstrates how someone can pay more than 100 percent of taxable income in tax. Mr. Ross must hope that his interest expense will pay off down the road and generate some capital gains.

Still, all of Mr. Ross’s itemized deductions are money out of his pocket, which is why he’s had to draw on his savings to pay his taxes. Robert Willens, a tax expert and New York attorney, made the argument that taxable income, therefore, may be a better basis for measuring the tax burden.

In any event, by either measure Mr. Ross pays a higher rate than Mr. Romney.

“I had no idea I was paying such a high rate,” he told me when we spoke this week. “I had trouble believing this was possible. I called my accountant, and I said, ‘Do you realize I’m paying every penny I have in taxable income? I’m dipping into savings to pay my income tax.’ He said, ‘It’s unfortunate, but at your income level’ ” — with high earned income and large itemized deductions that Mr. Ross can’t take advantage of — “ ‘that’s just the way it is.’ ”

Mr. Ross’s plight illustrates something that came through in nearly every response and cuts across nearly all income levels: the disparities of the tax code don’t just pit rich against poor or middle class. It taxes people within the same income brackets at grossly unequal rates. “I cannot help but reflect on the unfairness of the current tax regime,” Mr. Ross wrote. “Why should I pay 102 percent of my taxable income in taxes when others, with far greater wealth than mine, pay a fraction of that?”

I asked Mr. Willens if such a thing were possible, and he said it was. “It’s entirely within the realm of possibility,” he said. “I can’t recall any clients quite that high, but I’ve had people come close.”

How could Mr. Ross pay so much? I thought I was the victim of a perfect storm of punitive tax policies, but Mr. Ross’s situation is worse.

Like me, he lives and works in New York City, which all but guarantees a high tax rate. Nearly all of his income is earned income and thus fully taxable at top rates. (He said that’s not always the case, but given the recent dire condition of real estate, in 2010 he had few capital gains and his carried interest didn’t yield any income.) Unlike me, he can’t make any itemized deductions, which means his adjusted gross income exceeds $1 million, the level at which New York State eliminates all itemized deductions, except for 50 percent of the value of charitable contributions. Mr. Ross said he gave 11 percent of his adjusted gross income to charity.

That means Mr. Ross can’t deduct any interest expense on the money he borrows to finance his real estate investments, which is substantial, nor can he deduct any other expenses or other itemized deductions except for part of his charitable contributions. This means he pays an enormous amount in state and local taxes. Since those are among the deductions that are disallowed when computing the federal alternative minimum tax, Mr. Ross is in turn especially hard hit by the A.M.T.

Continued on pg. 2

This morning Fed Chair Ben Bernanke went before the Congressional Committee on the Budget and made them aware of some shocking new events in the economy. Bernanke brought to the committees attention unemployment’s drag on the current economic slow-down,   Particularly troubling is the unusually high level of long-term unemployment: More than 40 percent of the unemployed have been jobless for more than six months… Shocking! Captain ‘Obvious’ Bernanke apparently just woke up from his Van Winklian slumber  to bring this to Congresses attention.

In further breaking news he commented on the Debt Crisis, Of even greater concern is that longer-run projections, based on plausible assumptions about the evolution of the economy and budget under current policies, show the structural budget gap increasing significantly further over time and the ratio of outstanding federal debt to GDP rising rapidly. This dynamic is clearly unsustainable.  Say it ain’t so Ben!?!

He went on to further sound the alarm against debt, Having a large and increasing level of government debt relative to national income runs the risk of serious economic consequences. Over the longer term, the current trajectory of federal debt threatens to crowd out private capital formation and thus reduce productivity growth. To the extent that increasing debt is financed by borrowing from abroad, a growing share of our future income would be devoted to interest payments on foreign-held federal debt. High levels of debt also impair the ability of policymakers to respond effectively to future economic shocks and other adverse events.  In laymen terms: US Debt is going to turn us into Greece in the coming years.

Then in a stroke of brilliance Bernanke gives us the solution to all our problems & sets the world right. To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time. Attaining this goal should be a top priority. 

Big Ben is obviously smarter than a 5th grader, and in closing he pays homage to all children with a tear in his eye, Although we cannot expect our economy to grow its way out of our fiscal imbalances, a more productive economy will ease the tradeoffs that we face and increase the likelihood that we leave a healthy economy to our children and grandchildren.

Bernanke is the Fed Chair, we have placed our economic present and futures in his hands. Yet, when he over-states the obvious with no real working solutions it should make you run screaming to your financial adviser begging to have all your investments placed in Doomsday mode. Throw out all the rules and dive in head long to upwards of 50% of your net investments in precious metals & rare coins until further notice. I may be over-reacting a bit… OBVIOUSLY!

I write primarily on China, Asia, and nuclear proliferation.

1/29/2012 @ 4:46PM |142,725 views

This month, the Hong Kong Census and Statistics Department reported that China imported 102,779 kilograms of gold from Hong Kong in November, an increase from October’s 86,299 kilograms.  Beijing does not release gold trade figures, so for this and other reasons the Hong Kong numbers are considered the best indication of China’s gold imports.

Analysts believe China bought as much as 490 tons of gold in 2011, double the estimated 245 tons in 2010.  “The thing that’s caught people’s minds is the massive increase in Chinese buying,” remarked Ross Norman of Sharps Pixley, a London gold brokerage, this month.

So who in China is buying all this gold?

The People’s Bank of China, the central bank, has been hinting that it is purchasing.  “No asset is safe now,” said the PBOC’s Zhang Jianhua at the end of last month.  “The only choice to hedge risks is to hold hard currency—gold.”  He also said it was smart strategy to buy on market dips.  Analysts naturally jumped on his comment as proof that China, the world’s fifth-largest holder of the metal, is in the market for more.

There are a few problems with this conclusion.  First, the Chinese government rarely benefits others—and hurts itself—by telegraphing its short-term investment strategies.

Second, the central bank has less purchasing power these days.  China’s foreign reserves declined in Q4 2011, falling $20.6 billion from Q3.  The first quarterly outflow since 1998 was not large, but the trend was troubling.  The reserves declined a stunning $92.7 billion in November and December.

Third, the purchase of gold would be especially risky for the central bank, which is already insolvent from a balance sheet point of view.  The PBOC needs income-producing assets in order to meet its obligations on the debt incurred to buy foreign exchange, so the holding of gold only complicates its funding operations.  This is not to say the bank never buys gold—it obviously does—but there are real constraints on its ability to purchase assets that do not provide current income.

Apart from China’s central bank, there is not much demand from the country’s institutional investors for gold.  There are industrial users, of course, but their demand is filled from domestic production—China is the world’s largest gold producer.  Most of China’s gold demand from foreign sources, therefore, is from individuals.

So why are individuals now buying gold?  The easy answer is that the demand is only seasonal, as Jeff Wright of Global Hunter Securities believes.  The Chinese traditionally buy gold presents in the run-up to the Lunar New Year, which started a week ago.  Yet gift-giving does not begin to explain the surge in gold purchases that started as far back as July.  November was the fifth-consecutive month of China’s record gold purchases from Hong Kong.

A better explanation for the gold-buying binge of Chinese citizens is that they are using the shiny commodity as an inflation hedge, as the Financial Times recently suggested.  Yet the buying of gold has increased while inflation has eased.  And that means there must be another explanation.  The best explanation is that individuals in China are using gold as a substitute for capital flight.

Continued on pg.2

Investing | 1/30/2012 @ 5:43PM |2,051 views

Adrian Ash, Contributor

After the Fed’s latest zero-rate promise pushed gold back to the financial front pages, it’s worth asking who’s buying in bulk, and why?

There’s plenty of noise, for instance, about Chinese households buying gold during last week’s New Year holidays.

Away from the massed decisions of private investors and savers, gold holdings amongst the world’s central banks have quietly risen to a six-year high, according to data compiled by the International Monetary Fund.

“There’s a perception perhaps that gold is no longer a crucial part of the financial system in the way that it was under the gold standard before 1970, 1971,” as Marcus Grubb of the World Gold Council put it in an interview last week. “But in fact that’s not really true because even with the ending of the gold standard, gold remains as an asset held by the world’s central banks.”

A good chunk of this weaving is due to official reserves. As our chart shows, central banks control a shrinking proportion of what’s been mined from the ground. A far greater tonnage of gold again is finding its way into private ownership, and it’s having a greater still impact on how money and finance work.

First, private individuals have led the rediscovery of gold bullion as a financial asset, rather than the decorative store-of-value it had become by the close of the 20th century. Institutional finance has caught up, however, and gold is now in front of the Basel Committee on global banking, proposed as a “core asset” for banks to hold and count as a Tier 1 holding for their liquidity requirements.

Turkey’s regulators already acknowledged physical gold as a Tier 1 asset for its commercial banks starting in November, with the cap of 10% worth some 5.5 billion lira ($2.9bn) according to Dow Jones. Also, a growing number of investment exchanges, meantime, as well as prime brokers, now accept gold as collateral, posted as downpayment by institutions against their commodity and other leveraged positions. Just on Friday, London market-maker Deutsche Bank was added to the CME’s list of approved gold custodians.

Gold pays no interest of course. But in our zero-yielding world, that only puts it ahead of where the capital markets are being herded by central-bank policy anyway. Nor does gold have much industrial use (some 11% of global demand in the 5 years to 2011), a fact which highlights its unique “store of value” attributes. Being physical property, gold is no one else’s debt to repay or default.

Being globally traded, it’s deeply liquid and instantly priced. Turnover in London’s bullion market, center of the world’s gold trade, is greater at $240 billlion per day than all but the four most heavily traded currency pairs worldwide.

And being both rare and indestructible, it couldn’t be any less like “money” today.

Scarcely a lifetime ago, gold underpinned the globe’s entire monetary system. Outside China, which tried sticking with silver, the compromised and then bastardized gold standard which followed first World War I and then World War II still saw the value of central-bank gold reserves vastly outweigh the paper obligations which those banks gave to each other.

Even three decades ago, 10 years after the collapse of what passed for a gold standard post-war, central-bank gold holdings still totaled some three times central-bank money reserves by value. Look at the decade just gone – the 10 years in which gold investment beat every other store of value hands down. Pretty much every currency you can name lost 85% of its value in gold. Yet the sheer quantity of new money pouring into central-bank vaults saw their gold holdings only just hold their ground.

Gold’s rise, in short, has been buried under wood-pulp. To recover its share of central-bank holdings as recently as 1995 would now require a further doubling in value. To get back to the 1980s average would require a 15-fold increase. Or, alternatively, a 93% drop in the value of foreign currency reserves relative to central-bank bullion holdings.

Such a trend is not yet in train, neither on the charts nor the fundamentals. The US Dollar remains the biggest reserve currency, weighing in at 62% of stated reserves according to IMF data, down from its peak above 71% in 2001 but more than equal to its share in the mid-1990s. Even so, as former FT columnist and current ButtonWood at The Economist Philip Coggan writes in his latest book, Paper Promises:

“If Britain set the terms of the gold standard, and America set the terms of Bretton Woods [in 1944], then the terms of the next financial system are likely to be set by the world’s biggest creditor, China. And that system may look a lot different to the one we have become used to over the last 30 years.”

Coggan rightly notes that China isn’t the only large creditor, and nor does it hold anything like the dominance which the U.S. held at the end of World War II. Whether this switch starts today or only starts to show 10 years from now, the risk of such a change of direction can hardly be discounted to zero.

Repudiation of government debt, the form which most foreign currency reserves take, will only begin with the Greek bond agreement, perhaps leading first to a rise in U.S. dollar holdings but also highlighting the ultimate risk of holding paper promises. And that fear, of having to write off money thanks to default or devaluation, is clearly driving the rise in gold demand from central banks already.