ArabianMoney.Net

This is a rare interview on South African television yesterday featuring the gold uber-guru Jim Sinclair who is offering a $1 million bet that gold will reach $1,650 by January 14th 2011.

Here he explains the reason for his confidence in making this wager. He also predicts that November 4-27th this year will bring a severe challenge for the US dollar. Gold is a perfect currency and the safest of safe havens with no liability or nationality, he suggests.

Mr Sinclair could well be proven right again in his November dollar crisis prediction. This TV interview does not go into his reasoning so we can only speculate on his logic. However, let us say that the US stock market is being set up for another October crash with too much optimism about the non-recovery.

When that crash happens the dollar will have a final rally as stocks are cashed out and bond prices will rise. But what happens then? Surely the next call for traders will be to exit bonds and the US dollar which will have peaked, and be very vulnerable to inflation and devaluation from emergency stimulus packages.

And where will investors then put their money? Precious metals will be the only store of value left as a safe haven. That could well drive gold to $1,650 by 2011 and substantially higher by the current year-end.

US Treasury Secretary Timothy Geithner arrives in the Persian Gulf this week to reassure Arab states that their dollar assets are safe. Yet he will find himself largely preaching to the converted.

Arab central bankers are pragmatic folk, and the first question they ask about abandoning the dollar is what is the alternative. It is a fair point.

Alternative assets

Saudi Arabia has massive gold reserves. The UAE chooses to have none. There is an element of diversification into currencies like the euro, yen and pound in foreign reserves, but the major diversification is achieved in the sovereign wealth funds whose assets are broadly spread geographically.

It has to be said that short-term thinking often seems to predominate in Gulf banking circles and this again favors the dollar. The short-term horizon has the dollar as a safe haven asset whose strength was well proven in the financial crash of last autumn.

Indeed, in any further financial crisis – such as an end to Wall Street’s current secular bear market rally – then the dollar would strengthen further as stocks are turned into cash and bonds. The problems lie further out.

The US Government is going to have to borrow massive amounts of money to finance its public spending and trade deficits, and is already effectively printing money through its quantitative easing process.

All the history of monetary policy dictates that a higher volume of money in circulation must eventually result in inflation and devaluation of a currency. If you hold this money then you will lose out, big time.

Double-talking

Mr Geithner has to argue that black is actually white, and do it with a straight face. He will be closely listened to in the Arab World where personal relationships and judging individuals is often given more attention that facts, figures and analysis.

Of course, Arab countries have political agendas for supporting US monetary policy as well as purely economic objectives. The holder of the world’s reserve currency also holds a monopoly on military power.

However, it is more than that. If the Gulf States exchanged their dollars they would produce a devaluation of the US currency that would damage the value of their dollar assets that could not be so quickly liquidated.

Perhaps if we are all in the same boat nobody is going to pull the plug, but the problem is that it is sinking anyway. Quietly transferring more money into gold and silver would make obvious sense.

China has offset the impact of a huge collapse in its exports this year by indulging in frenzied domestic lending that all past experience suggests must end in a banking crisis similar to the recent US sub-prime mortgage lending disaster.

For June new Chinese Central Bank figures show total lending doubling from the previous month to $224 billion and running at five times the level of June 2008.

This massive acceleration of lending has fueled an 80 per cent rise in the Shanghai stock market from the low of last year, and allowed stockpiling of raw materials that has spiked commodity prices, including oil, sharply higher.

Sub-prime loan assessment

Such a rapid increase in lending would appear to be coming at the price of inadequate credit assessment by the Chinese banks which are repeating exactly the same error that produced the sub-prime mortgage crisis in the US.

Banking crises always have their origins in bad lending practices by bankers under pressure to loan money from higher authorities. China now just seems to be another example.

The reasoning is obvious enough. The nine months of falling exports, down a massive 23 per cent last month, is a huge hole in the Chinese economy which only fast action to grow domestic demand could fill.

But the problem is merely postponed. Further down the line lies a day of reckoning when a realization of bank losses from bad loans will cause a collapse in banking stocks and a systemic banking crisis like we saw in the US last autumn.

How long will shareholders keep bank stocks at their current heights? Some $170 billion from bank loans is estimated to have been invested in Chinese stocks in the first five months of this year, according to a government economist cited by China Business News.

Business loans

The same paper also reported that 30 per cent of these loans have gone to fund short-term working capital for business. So when a loan contraction comes it is going to strike at the heart of the Chinese economy, and not just the stock market.

Indeed, the more you think about these banking statistics it is apparent that China is actually just a year or two behind the cyclical downturn that has sent the developed world into its deepest recession since the Second World War.

The hope that China will be the motor to drag the developed world out of its recession is therefore a false hope, although in fact the Chinese economy never looked big enough to do the job in any case.