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Was That the Top?

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Precious metals give some important clues.

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The precious metals market is declining just as I mentioned in Five Reasons Gold Is Great in the Long Run, but before I proceed with providing you with my thoughts on the current situation, I'd like to put this analysis into proper perspective.

I'm in London this week and the city is vibrant. Rubbing elbows in Piccadilly Circus with the crowds rushing to catch the latest West End show, you hardly feel that there's a global economic crisis.

Londoners seem to have shrugged off the Dubai crises, as did the rest of the world. They seem to be happily unaware, or else they're ignoring the fact, that Britain's government debt is on the rise and is expected to be more than 80% of the nation's economic output next year.

It does make you wonder.

Dubai went from boomtown to doomtown in very short order. This one-time desert wonderland with palm-shaped islands, extravagant architecture, and indoor ski slope, is now strapped to pay its bills.

Is this an isolated event or is it an omen of more debt bombs waiting to explode? Will governments, gorged on debts, be able to shoulder their obligations?

The New York Times reported this week that bills for an "unprecedented borrowing binge" by nations around the globe are starting to fall due. "The numbers are startling," said the New York Times. Germany's debt outstanding is expected to increase to the equivalent of 77% of the nation's economic output next year. Ireland and Baltic countries are in even worse shape, with Ireland's public debt expected to soar to 83% of gross domestic product next year.

Governments have taken on increasingly short-term debt, which will be coming due soon. They plan to "roll over" the loans extending the debt as long as there are creditors willing to buy short-term paper.

In the US, for example, treasury bills maturing within one year have risen from around 33% of total debt two years ago to around 44% this year, according to the New York Times.

Within the next year, the US Treasury will have to refinance $2 trillion in short-term debt. If you add deficit spending to that, estimated at $1.5 trillion, pretty soon you're talking about a whole bunch of money.

Most economists don't believe that in the near future we'll see nations defaulting on their government debts. They say that it's likely that rich nations and the International Monetary Fund would intervene with a bailout.

What does a country need to do in order to insure that it doesn't go bankrupt?

There is what economists call The Allan Greenspan and Pablo Guidotti rule, named for the former chairman of the Federal Reserve and former Argentinean deputy minister of finance. The rule, presented in 1999 in a G-33 seminar and in a speech at the World Bank, states that a country should maintain enough hard currency reserves equal to 100% of its short-term (one year) foreign debt. In other words, countries should have enough reserves to resist a massive withdrawal of short-term foreign capital from their shores.

So how does America stack up? Does it have enough hard currency to back up a year's worth of foreign debt?

The US is the world's largest holder of gold with 8,133.5 metric tones. At today's prices, that's a little over $300 billion. That's not enough.

If you throw in America's petroleum reserves and its foreign currency holdings, that still won't cover $2 trillions worth of debt that will mature in the next 12 months. Who will want to buy US Treasury paper? India has already voted in favor of gold when it bought 200 tons of IMF gold last month.

In any case, we'll be glad that we got into gold when we did, and even more glad that we got into silver.
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No positions in stocks mentioned.
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