Good Morning,

Overnight, it was the euro's turn to take a few uppercuts and head towards the ropes. Persistent deflationary aromas continue to waft around the globe, and now they are quite strong in Europe as well as Asia. The ECB's target rate of 2% inflation is in effect wishful thinking, and its stimulus-oriented wizards are toying with all sorts of unorthodox measures once the interest rate magazine empties. It almost has, already.

Not that conditions are better elsewhere. Check out Jim Rogers' hangout; Singapore. Its economy is shrinking faster than Rick Moranis' kids in 'that' movie. Faster than at any time since the patch of land became independent in 1965. China? How about an economic growth rate of barely above 6% for Q1 '09? In plain English, a pace about half of what had previously been boasted about. Not good. At all.

Earnings season is upon us, but the profit bombshell from Goldman may outshine whatever positive figures others may have to offer in coming hours and days. The firm is now going for a $5 billion stock offering to repay TARP funds. Look behind the veneer of earnings, and TARP repayments, and what you get is a pretty thinly disguised desire to return to the days when someone did not tell them to conduct 'stress tests' and/or how much to pay star producers. Nothing more complicated than that.

Gold prices retreated towards the $880 level after having once again run into a wall of resistance at the $900 mark, and after the dollar recouped some of yesterday's losses. Citi analyst David Thurtell feels that gold is not consolidating prior to another upleg, but that it will likely slowly bleed lower as equities pick up gradually from here. Thus far, he may be correct. Prices headed lower ahead of the NY opening this morning, and the rest of the complex did not fare much better either.

New York spot bullion opened with a $5.50 loss at $887.10 per ounce, as participants watched the greenback claw back towards 85 on the index, and as discord within OPEC threatened to seal oil's short-term fate at or very near the half-century mark. Silver lost 10 cents to start at $12.64 while platinum gave back about a third of Monday's explosive gains, to open with a $14 loss at $1223.00 per ounce. Palladium fell $2 to $236 per ounce.

Don't look now, but China's foreign exchange reserves rose 16% in the first quarter, and are but 600 billion shy of the $2 trillion - mark. And, exactly how much gold did the country buy while throwing some of its (many) US dollars into the dump? Try near zero. How much of the 403 IMF-owned gold tonnes will it take when the metal becomes available? IF any, just enough to maintain its current small gold-to-reserve ratio (with which, by the way, it is quite happy - for reasons we covered in many previous articles). None of this, however, has stopped the Confucian riddles and other pronouncements coming from its official quarters. Marketwatch's David Marsh delves into the mystery of the words emanating from Beijing and finds that:

Puzzlement reigns over Gov. Zhou Xiaochuan's musings on the future of the world reserve currency system.

The pronouncement by the head of the People's Bank of China three weeks ago combines elements of portentousness and mystery. Like papal encyclicals, edicts from Martin Luther or fiery messages in the heavens from Harry Potter tales, the declaration has the potential to move the world in undefined directions. With an assiduousness normally applied to the Dead Sea Scrolls or the Rosetta Stone, monetary experts -- some surprised by the governor's outspokenness, others by his inscrutability -- are poring over the document and hunting for its true meaning.

Clearly the governor's plea for a revived role for the International Monetary Fund's Special Drawing Rights as a super-sovereign reserve currency is intended as a shot across America's monetary bows. The G20 promptly gave more than a nod in Zhou's direction, agreeing at its London summit 10 days ago to expand SDR issuance by $250 billion -- the first such allocation since 1981 -- along with a general expansion of the IMF's resources.

But what exactly does Zhou want to achieve? Underlying his statement is an implicit admission of the short-sightedness of building up enormous paper claims in a currency China does not fully trust, on an economy it regards as spendthrift.

The logical conclusion is that China will seek to reduce the relative or absolute size of its international reserves -- whether held in dollars, SDRs or anything else -- in coming years, in what would be an important phase of international monetary disarmament.

That may be a generally welcome state of affairs, but will it take place on terms that are significantly more positive for China than the status quo? Zhou should bear in mind that the historical precedents for undermining the dollar are not especially favorable. In the 1960s, under President Charles de Gaulle, France accused the U.S. of enjoying an exorbitant privilege -- its ability to issue apparently endless streams of self-debasing dollars to foreign central banks and other asset holders.

The phrase was popularized by de Gaulle and his young and imperious finance minister, Valéry Giscard d'Estaing -- but its origins go back to pre-war deliberations of the General's arch monetary guru Jacques Rueff. At the heart of the exorbitant privilege jibe lies the established fact that the U.S. earns higher returns on its stocks of foreign assets -- financed by dollar issuance -- than those yielded by foreigners' claims on the U.S.

The corollary of the exorbitant privilege -- hugely more important now than it was in de Gaulle's day, when international reserves were puny compared with today's levels -- is that central banks which build up excessive dollar claims suffer a negative carry on their international asset operations.

De Gaulle's campaign on exorbitant privilege was one of the reasons for the establishment of the SDR in 1969. But the IMF's synthetic composite currency has had negligible effect on the world monetary order over the past 40 years. And in the exhausting process of attempting to do down the dollar, France suffered monetary overstretch that ushered in humiliation for the General and a period of significant French franc weakness against the dollar and the Deutsche mark.

Indubitably, Gov. Zhou, in charge of a portfolio of foreign monetary reserves totaling close to $2 trillion, of which two-thirds are thought to be in dollars, is signaling that the U.S. has to pay close and full attention to the needs of its foreign creditors.

But is this anything more than saber-rattling? Certainly, if the U.S. were to embark in coming years on a reckless devaluation of the dollar against other leading currencies -- predominantly against the euro and the yen -- China might feel duty-bound to take retaliatory action, for instance by discriminating against U.S. exports, blocking American foreign investments or favoring other currencies in its trading and investment preferences.

Swapping dollars into SDRs would be one potential step. In all these cases, it is difficult to see how China can act in a way that does not harm further the valuation of the dollars in its reserves. In preparing the ground for a debate on the international reserve system, Zhou needs to pay attention to the uncomfortable truth that no one has forced the People's Bank of China to accumulate dollar reserves.

As commentators have frequently pointed out, the astonishing rise in China's dollar assets would not have come about had China not been attempting to cap the rise of its own Renminbi currency to generate export-fuelled growth. Zhou would be on safer ground if he had concerted his position with that of the other large dollar-holding Asian central banks -- which may or may not gave been the case -- and if he had informed the U.S. government about his intended statement -- which, judging by Treasury Secretary Tim Geithner's flat-footed initial response, doesn't seem to have happened.

In the wake of the G20 summit, the thrust of international monetary cooperation now lies in a greatly expanded role for the IMF.

The reassuring message from the IMF is: You don't need your reserve -- trust us. If you believe that, the central banks from Asia and other emerging economies which, like China, have hoarded greatly-expanded reserves since the Asian monetary crises in 1998, should now be running down their foreign exchange stocks on the grounds that self-insurance is no longer necessary. If they get into trouble, they can rely on the IMF to bail them out.

That may be a long-term possibility, but it is hardly likely that such an idea will catch on in the near term. Another outcome -- which would actually fit in rather well with China's dollar preference hitherto -- is that the dollar stabilizes in coming years as a result of a revival of the U.S. economy, growing problems for the euro area and renewed belief in the effectiveness of American monetary leadership.

This was the result the last time the world debated an effort to replace the dollar with the SDR under President Jimmy Carter's ill-fated and barely remembered SDR substitution account plan 30 years ago. It would be an ironic consequence of Gov. Zhou's declaration if it helped spur the U.S. into rebuilding its credentials for leading the international economy, and thus defusing the problem of the dollar overhang to which China is now drawing the world's attention.

Thus, to all of the fired-up hard money newsletter vendors out there who proclaim that 'this is it' as regards China, the $2 trillion, and gold, we say: Not so fast, buckaroos. There is more to all of this than meets the eye. Or, the pocketbook. Or, both.

The Cautious Seldom Err...

And the beat goes on...