JOHANNESBURG - Last Tuesday when discussing inflation, Federal Reserve Chairman Ben Bernanke stated that the current increase in commodity prices was due to the increasing demand from emerging countries. Now if you believe that explosions in the price of corn (118%), wheat (71%), cotton (83%), sugar (61%) and coffee (96%), in the last year have been due to increasing demand from emerging markets, then you are totally clueless about what is going on in the global monetary system. While the value of the US dollar looks exceedingly precarious, it still remains the reserve currency of the world. Practically, every international trade transaction is facilitated in US dollars. Crude oil for example which is the largest traded commodity in the world is traded in dollars. As the dollar weakens against the national currencies of the major oil producers, these countries receive less for their oil in their local money and so in order to preserve the value of their exports they may choose to buy other currencies or commodities such as gold with their dollars. Alternatively, the price goes up in dollars. Now, if the supply of commodities is hampered for whatever reason, prices will obviously go up on account of the tight supplies. And, if demand suddenly increases, then it is logical to expect price increases. But, when you see price increases of nearly 100% to simply suggest that it is due to fundamental imbalances created by increasing demand, is pure stupidity. This ridiculous hypothesis suggests that either billions of people around the world were not eating anything until a year ago, or the billions of people in emerging markets who were eating suddenly increased their appetites and began to eat more than two or three times what they were eating previously. Furthermore, when people at the Fed and the Treasury suggest there are no signs of inflation, I truly wonder how such statements can be made. As far as I and many other analysts can see, there are nothing but signs of inflation. And, these massive increases in prices are due to a large extent to the expansionary monetary policies of the US Fed, dubbed as quantitative easing, QE1, and QE2. On several occasions, Bernanke has stated that the mandate of the US Federal Reserve has been to maintain price stability and strong economic growth. Yet, this policy in which the central bank has bought government bonds to stimulate economic growth has not resulted in any economic growth whatsoever. And, instead of price stability all we have seen is huge price volatility. Also, there has been practically no improvement in the high level of unemployment in the US. The size of the Fed's balance sheet has now ballooned while the dollar amount of capital held at the Fed has remained fairly constant. Today, the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet. Prior to the bursting of the credit bubble, some of the largest US investment banks were leveraged 30 to 1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51 to 1! If the value of their portfolio was to fall by just 2% the Fed would be wiped out. In a recent report by Raoul Ruporel and Mats Person, A HOUSE BUILT ON SAND? The ECB and the hidden cost of saving the euro published by Open Europe they state; In parallel with the IMF's and EU's multi-billion euro interventions, the ECB has engaged in its own bail-out operation, providing cheap credit to insolvent banks and propping up struggling Eurozone governments, despite this being against its own rules. The ECB is ultimately underwritten by taxpayers, which means that there is a hidden - and potentially huge - cost of the Eurozone crisis to taxpayers buried in the ECB's books." The report estimates that the ECB's current exposure to these struggling euro zone economies is around €444bn. "Critically, struggling banks in insolvent countries have been allowed to shift risky assets away from their own balance sheets and onto the ECB's (all the while receiving ECB loans in return). Many of these assets are extremely difficult to value." Overall, the ECB is now leveraged around 23 to 24 times, with only €82bn in capital and reserves. In contrast, the Swedish central bank is leveraged just under five times, while the average hedge fund is leveraged four to five times. This means that should the ECB see its assets fall by just 4.25% in value, from booking losses on its loans or purchases of government debt, its entire capital base would be wiped out." If you consider the current state of the world's reserve currency as well as that of the next most important currency in the world, the euro, surely you can see that the value of these two currencies are looking increasingly precarious. And, if these currencies should collapse the value of gold and silver will go through the roof. TECHNICAL ANALYSIS While the upward trend in gold prices remains very much intact, prices are currently consolidating between $1525/oz and $1550/oz. About the author David Levenstein began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients. www.lakeshoretrading.co.za

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