Please, click here to read this article in pdf format: september-12-2011

Today’s comments will be brief. In fact, we will not seek to provide answers but to leave the reader with questions.

By now, everyone is surely aware of the decision by the Swiss National Bank to peg the Swiss Franc to the Euro, at 1.20. Effectively, the SNB would buy as many Euros as sold to them, at 1.20EUR/CHF.

On this news, Dennis Gartman, last week wrote that from now on, the policy of the SNB will be driven by that of the European Central Bank. We think that is not correct. Because the European Central Bank has no policy of its own. The ECB has its hands tied. As we wrote back in May 10th, 2010 , when we foresaw this:

“…We think that (…), the ECB would tend to behave like a convertibility board, where sovereign debt is converted to Euros. Therefore, (…), the supply of money would be determined by the growth rate of the EU’s consolidated fiscal deficit! The ECB is not under control but is always “chasing the rabbit”…Governments puke debt and ECB comes after and cleans up buying in the secondary! Thus, what would be the exit strategy (…)? In the long run, the only way out for the ECB (…) is a consolidated fiscal surplus, which is totally out of ECB’s hands. De facto, the ECB is denied an exit strategy …”

Indeed, we think that with the peg, the supply of Swiss Francs will also be determined by “…the growth rate of the EU’s consolidated fiscal deficit…”.

Back then, on our next letter dated May 13th, 2010, we further discussed this point and added this graph, that now looks ominous:

The letter, titled “ECB Plan = The End of Paper Money?” already mentioned the importance of currency swaps extended by the Fed (seen in the chart above). We finished that letter noting that gold looked like a bargain at $1,240/oz. And just like we wrote about these swaps 16 months ago, last Monday we went on record stating that: “… AS LONG AS THESE FX SWAPS (USD BACKSTOP) REMAIN IN PLACE, WE WILL BE LONG GOLD. THE TOP FOR THE GOLD MARKET WILL BE REACHED THE DAY THIS BACKSTOP IS ELIMINATED EITHER VOLUNTARILY OR FORCED UPON THE FED BY THE MARKET AND NOT ONE MINUTE EARLIER…”

With this in mind, we invite readers to think about this: If, in the face of upcoming US dollar funding problems for Eurozone banks, the Fed will commit to lend unlimited US dollars to the European Central Bank, to further sell them to Eurozone banks….WILL THE FED NOT BE EFFECTIVELY PEGGING THE US DOLLAR TO THE EURO? WILL THERE NOT BE AN UNOFFICIAL EQUILIBRIUM EXCHANGE RATE AT WHICH THE FUNDING MARKET IS CLEARED?

And if that is the case…What will differentiate the Fed from the Swiss National Bank? We think nothing!

After the German’s High Court ruling, where any institutional fix to the Eurozone problem, including Eurobonds will be legal but operationally unfeasible, the European Central Bank is the only savior and will have to monetize the consolidated fiscal deficit of the Eurozone. If the Fed, just like the Swiss National Bank, pegs its currency to the Euro, then the supply of US dollars will also be driven by “…the growth rate of the EU’s consolidated fiscal deficit…”.

We saw it coming . This scenario will eventually make the case for gold clearer and clearer. In the process, the banking system of the world will go bankrupt, nationalized and more concentrated, and financial repression will grow exponentially.

Martin Sibileau