Why Are the World's Central Banks Allowing Gold to Trade with Global Immunity?

Almost four and a half years ago, G7 (major industrial nations) central banks established a new monetary system (July 1, 2002)-a dual-reserve currency monetary system. G7 nations sold gold reserves into gold market rallies to allow the euro to gain the confidence of prospective users. This encouraged skittish buyers concerned about currency value to move to a stronger paper currency rather than to gold.

Gold, in recent months, is moving up with diminishing overhead resistance. It seems G7 no longer supports its dual-reserve currency monetary system with gold sales. If this proves to be true, why then did G7 abandon what appears to be a longer-term monetary policy?

China-centric: America's Dependence on Cheap Imports

The recent dollar rally was in part a reaction to a corporate dollar repatriation tax break, as well as surmounting pressures on dollar value caused by massive Congressional spending and lowered tax rates. As the dollar begins to weaken, China (which is estimated to have $800 billion in foreign reserves) will suffer a huge loss in the value of its reserves.

Selling dollar reserves would prove counterproductive. Dollar sales would expedite the downward pressure on dollar value. This would cause China to lose a huge share of its export sales (goods shipped to the U.S.) because it would now take more dollars to buy Chinese products, thus allowing domestic counterparts a competitive edge.

China, vigilant over the U.S./China relationship dynamic, will buy gold (rather than sell dollars) in an attempt to thwart damage caused by U.S. action. China will still be mandated to sanitize its huge trade surplus against domestic inflation (another reason why only recently the Chinese government is allowing its citizens to own gold).

A higher gold price impels buyers, particularly domestic ones, to buy gold with excess currency, further stemming China's inflation rate increase. Moreover, it allows China to slow the purchase of dollars (a strategy used to sanitize its trade surplus).

Therefore, Congress cannot afford a 27.5 percent tariff on Chinese imports. Although China presents a capitalist image, its government is still a totalitarian regime. Domineering governments who exercise power and authority through fearful and aggressive competition are likely to strike back at those who threaten their stability (i.e., the U.S.). China was recently named one of the top ten despotic nations. Like a snake when provoked, China could strike against the U.S. by selling a considerable amount of its dollar reserves.

Consequently, longer-term U.S. interest rates would move higher. And if China decided to really poison the U.S. economy, it could sell enough dollars to push U.S. interest rates high enough to send the economy into a recession. However, this would be counterproductive for China because the Chinese would lose 30 to 40 percent of their export market.

What can America do?

The investment winners in this scenario are the euro, Swiss franc, gold, and gold mining shares. Nevertheless, U.S. dependence on China to support its excess debt will pressure our nation in two ways: first, the Fed will be forced to facilitate a lower dollar value in order to slow China's surplus growth, and second, the U.S. will have to find ways to encourage China to buy gold and euros (rather than gold and dollars).

China purchasing gold with euros or yens rather than dollars will help buoy dollar value. This dollar support will benefit China in that it will allow it to maintain a greater share of the U.S. market.

The U.S. strategy to sell gold, in order to discourage investor buying, appears to be void of any benefit to central banks. In fact, the opposite appears to be taking place-investors are purchasing gold at an incredible rate with little to no opposition from central banks.

Therefore, I recommend investors to buy gold mining shares, as well as coins. Let us not forget silver. Silver is "poor man's gold" and will move up at a rate proportional to that of gold. For more information, look for mining share phases in the Mining Shares Index of Kenneth Coleman's Investment Tracker (the upcoming February issue).