Dollar crunch

Gold trades inversely to the US dollar. Typically, if not always.

In its 41 year history as the world's reserve currency, we have seen gold:

1. Soar against a dollar crisis (witness the 1970s)
2. Decline against perceived dollar strength (witness the 80s and 90s)
3. Rise once again with the longer-term dollar crisis commencing in 2001.

Gold has a historic role as international money - a money incorruptible, the kind that can't be created at will or out of thin air by Governments. When people lose confidence in the Government's money system, they will typically turn to tangible assets such as gold, silver and commodities.

So what's driving the current dollar crisis?

Forget QE, not that that's unimportant. The dollar's real problems lie in the US' growing current account/trade deficits, fiscal deficits and exploding national debt. Now in the red by $15 trillion, the US Government is dependent on foreign creditors for 40 cents of every dollar spent.

Crucially, there are no signs on the horizon that the politicians are doing anything to address this unsustainable development.

Can the cheap credit last forever?

No. Slowly but surely, America's creditors are turning away from the dollar.

Consider China, the USG's largest creditor, with holdings of $2 trillion of US Treasuries/ dollar-denominated securities. Recognising the dollar's fundamental weakness, it has taking steps to diversify away from it and into the open arms of gold. Not only has its central bank been dramatically increasing its net buying of the yellow metal, it has liberalised its domestic banking regulations on gold imports and even encouraged its own citizens to buy through through the newly-formed Gold and Silver Exchange.

With interest rates at 0%, more debt and QE on the horizon, there is no reason to think the dollar will reverse course any time soon.

The day will come when an event will occur. A 'psychology event', as I like to call it. An event which will fundamentally change the way people think about the dollar and its paper promises. In turn, this event will lead to a 'currency event' and the collapse of the dollar in world markets, followed in turn by domestic ones.

The event I speak of will trigger the final phase of the gold bull market - the 'blow off' top witnessed in other such run-ups as the Internet stock and real estate manias.

Watch for the pulling of the trigger:

1. China finally dumps US treasuries on global currency markets;

2. China and Russia agree to dump the dollar and start using a new global currency;

3. A famous dutch bond dealer suddenly decides US Treasury 'safe-havens' no longer look so safe.

4. A no-show at a US Treasury auction leads to sky-rocketing borrowing costs.

Thanks to Jim Rickards and the National Inflation Association for some of these examples.

In short, fasten your seat belts folks and hold onto your hats!