The ultimate test of Najib's leadership

An Appeal To Malaysia’s Prime Minister cum Finance Minister - Re-examine The Country’s Strategy For Foreign Reserves - By Matthias Chang (27/8/09)

By Matthias Chang

Wednesday, 26 August 2009 20:30

Many visitors to my website have queried why I have not written any articles concerning the global economy in general and the Malaysian economy in particular in the last few weeks. I have not bothered to reply to those queries because what needed to be said and or written have been said and written by me repeatedly for the last one year.

I have warned that the present global stock market rally will not last, it is a suckers’ rally. But few have taken heed of the warning. There are no green shoots, and recovery if any, will be a few years down the road, not 2009 or 2010.

Just a few days ago, Nobel Laureate Joseph Stiglitz warned that the dollar’s role as a store of value is questionable and the currency has a high degree of risk. Professor Nouriel Roubini is of the view that there will be a U shape recovery, with a rising risk of a double-dip W shaped recession. But what was significant is that Professor Roubini takes the view that the present crisis is one of solvency, and not just liquidity and that true deleveraging has not begun yet because the losses of financial institutions have been socialized and put on government balance sheets.

Only time will be the final judge as to who is correct in the assessment of the present and future economic scenarios.

The purpose of my writing this article is to highlight the deafening silence of experts on the issue of gold reserves held by key central banks of the developed nations.

This is also my primary concern for the Malaysian economy.

I am known for using common sense in analyzing complex economic / financial problems and thus far, I have been proven right time after time in the general direction in which the global economy and the Malaysian economy are heading.

I believe that in the coming months, many countries in Asia will experience a rude awakening, to put it mildly.

In medical terms, it would be a massive financial heart attack in which our financial doctors will be totally disorientated and unable to assist the patient!

Since the financial crisis of 1997, many Asian central banks were led to believe that the best way to prevent future attacks on their currencies was to accumulate as much foreign currency reserves, preferably US dollars. And the quickest and safest route was to export and export to the mighty US in exchange for the dollars created out of thin air by the Federal Reserve.

The hardworking Asians worked their butts out and sold goods for mere paper currency, in actual fact toilet papers!

China led the way, and today she has the largest US dollar foreign reserve, followed closely by Japan.

But, our central bankers in Asia took no notice of the status and ratio of the gold reserves held by key European central banks. Additionally, Europe had the advantage of the euro as a “secondary reserve” currency.

As a result of the ongoing financial crisis, the Fed and the US Treasury have caused $trillions to be created out of thin air to stimulate the US economy. Never before, has so much US toilet paper been injected into the international banking system. The system is now choking in toilet papers!

While China, Japan, Russia and other Asian central banks are fretting about the decreasing purchasing power of the US dollar, the global banking elites seem impervious to the risk and danger of such an amount of toilet paper in the system.

Why?

The answer lies in the opening statement of the 3 Central Bank Gold Agreements (CBGA). In the latest CBGA, 19 national central banks and the European Central Bank were parties to the arrangement for the orderly sale and purchase of gold. The first agreement was made in 1999. Read the opening statement carefully:

“Gold will remain an important element of global monetary reserves.”

In the latest agreement, dated 14th August 2009, the above statement was repeated and followed by:

• The gold sales already decided and to be decided by the undersigned institutions will be achieved through a concerted program of sales over a period of five years, starting on 27th September 2009, immediately after the end of the previous agreement. Annual sales will not exceed 400 tonnes and total sales over this period will not exceed 2000 tonnes.

• The signatories recognize the intention of the IMF to sell 403 tonnes of gold and noted that such sales can be accommodated within the above ceilings.

• This agreement will be reviewed after five years.

It is significant to note that the IMF intends to sell 403 tonnes of gold and it is a no-brainer to venture a guess as to who will be the main buyer. China is desperate to unload its US toilet papers for gold and it has to be done carefully, as such sales “will be accommodated within the above ceilings.”

In the 90s, European central banks’ reserve portfolios were dominated by gold, ranging from 70% to 90% of total reserves. The abovementioned CBGAs were agreements made by the central bank cartel to control the price of gold when they are being sold by signatories of the CBGA.

During the period of the 1st CBGA, when 2000 tonnes of gold were sold, the price of gold rose by 52%. Since then, gold has risen continuously in what has been a secular bull market and in spite of gold sales by central banks. And the future trend is one of rising prices. Anyone who refuses to pay attention to this startling fact is an idiot!

Applying common sense, why should there be anymore debate as to the strategic value of gold?

For the doubting thomases out there, maybe the quotation below will be a wake-up call:

“With gold holdings amounting to 1,040 tonnes, it holds a substantial part of its currency reserves in the form of gold.”

- The Swiss National Bank

And with the dollar weakening further in the months and years ahead, the need for gold as a strategic reserve is one of paramount importance. The fact that the signatories to the 3rd CBGA have agreed to cut back the ceiling from 500 tonnes to 400 tonnes and inclusive of the IMF sales is indicative that there is a shift in the thinking of the 19 central bankers to this agreement.

The implications are obvious. When the shit hits the ceiling fan, following the run on the dollar, countries with significant amounts of gold as reserves will have a strategic advantage.

The current situation of key European Central Banks’ gold reserves as a percentage of their total reserves are as follows:

France: 73%
Germany: 69.5%
Italy: 66.1%
Netherlands: 61.4
Switzerland: 37.1%

In contrast, the key Asian Central Banks’ and Russia’s gold reserves are as follows:

Russia: 4%
India: 4%
Taiwan: 3.8%
Japan: 2.1%
China: 1.8%

Given this state of affairs, any sales by European central banks under the 3rd CBGA will not depress gold prices, as it will be inevitable for the underweighted Asian central banks to pick them up so as to bolster their miniscule reserves in gold. For more data, please reference World Gold Council.

The central bankers that control the gold supply will be better able to steer their countries through the second wave of the financial turmoil when confidence in the toilet paper US$ sinks to the very bottom and the dash to the safety of gold is in full flight. It will not be inconceivable for the price of gold to shoot up to US$ 3,000 or more per oz! And I AM BEING VERY CONSERVATIVE in this estimate.

So where will Malaysia be in the coming second wave of financial turmoil?

I am not optimistic that we are prepared for such an eventuality.

Bank Negara is in a state of denial.

The Ministry of Finance is also in a state of denial.

I am told that some key advisers are pre-occupied playing golf and other extra-curricular activities rather than hunkering down and doing basic ground work.

Yes, Mr. Prime Minister, Tun Dr. Mahathir Mohamad had his chance in governing the country for 22 years and Badawi had a go at it for five years and now it is your turn. There is much to learn from the two administrations, the good and the bad.

The string of By-election defeats is most unsettling as well as distracting.

I hope you are still focused on economic issues as the perception on the ground is that you are being deluded by the rebound of the stock market as being indicative of a general recovery.

Mr. Prime Minister,

Please take heed of the warnings by Professor Stiglitz and Professor Roubini, even if you take the view that my analysis does not deserve your scrutiny.

This is the ultimate test of your leadership – to keep the Malaysian ship on even keel in stormy waters. Should you fail, disaster will visit the Barisan Nasional in 2012/2013.

As the Prime Minister of Malaysia, I wish you every success, but please do hurry up, as we had wasted five years of warming up during the previous administration.