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Mainstream economists and mainstream media remain convinced that the economy and markets are in full recovery mode. Along the same lines, gold is unanimously expected to decline in the year(s) head.

One of the most recent appearances of that kind was the 2014 outlook of IMF economic counselor, Olivier Blanchard, who explained last week that global growth would average 3.7% in 2014.

Ironically, the recovery story, based on the central bank premise that they can create wealth by simply exploding their balance sheets, seems as solid as a “house of cards.” Past week Thursday and Friday, several emerging markets suffered from an economic earthquake, especially in their currency markets, which resulted in losses in most developed world markets not seen since 6 months. The Yen and the Swiss Franc were considered a safe haven, just like gold and US Treasury bonds.

Bloomberg says this is the worst selloff in emerging-market currencies in five years, revealing the impact from the Federal Reserve’s tapering of monetary stimulus. “Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus. While Brazil, Russia, India, China and South Africa were the engines of global growth following the financial crisis in 2008, emerging markets now pose a threat to world financial stability.”

Argentina, Venezuela and Turkey have been hit hard. Argentine’s Peso and Turkish Lira lost significant value against other major currencies in the past week. They recovered slightly today.

In Argentina, the central bank pared dollar sales aimed at propping up the peso to preserve international reserves that have fallen to a seven-year low. “The central bank said it would lift two-year-old currency controls and allow the purchase of dollars for savings starting next week. […] The government told today it isn’t intervening in the peso’s decline, allowing the market, which is mostly closed to buyers of dollars, to adjust prices. It wasn’t a devaluation induced by the state. For the lovers of free markets, supply and demand was expressed in the capital markets yesterday.”

The Turkish central bank tried an unscheduled intervention in the market to stop the lira from falling to record lows, something they haven’t done since two years. “Investors are speculating the central bank’s efforts to prop up the lira by burning through foreign-exchange reserves will prove futile without raising interest rates.”

The loss in purchasing power for people holding Argentine’s Peso is astonishing:

• The Peso closed on Friday January 24th at USD 8.0.
• Week on week, the Peso lost 17.6% of its value against the USD.
• Three months ago, the Peso stood at USD 5.9, a decline of 35.5%.
• Since September 2012, the Peso lost 69% against the USD.

The loss in value of the Turkish Lira is not as dramatic as the Peso, but it is still very bad:

• The Lira closed on Friday January 24th at USD 2.24.
• Week on week, the Lira lost 4.4% of its value against the USD.
• Three months ago, the Lira stood at USD 1.97, a decline of 19.2%.
• Since September 2012, the Lira lost 27% against the USD.

The interesting part for us, gold enthusiasts, is the price of gold in the slaughtered currencies (prices on the close of January 24^th):

• Gold in Argentine’s Peso is up 30% in the last 30 days; it is trading at all time highs.
• Gold in Turkish Lira’s is up 17% in the last 30 days; it is trading just 10% below its all time highs of September 2011.

This chart shows the price of gold in USD (yellow line) and in Peso (blue line). The black line is the currency exchange rate Peso against the USD. Chart courtesy: Sharelynx.

Interestingly, the explosion of the gold price in Peso and Lira has pushed the gold price higher in the Western currencies. That is an important evolution, as it indicates what gold really stands for: a monetary asset. One should note that gold has gone higher even without inflation fears. This could be one of those catalysts that could break the downtrend in gold in major currencies.

The underlying reason for the emerging market turmoil is said to be attributed to capital flight out of  those markets. Directly linked to that is the tapering fear from the US Federal Reserve.

What is the importance of this for Western investors? There could be a counter intuitive answer to that question.

Basically, up until today, there was a narrative surrounding the Federal Reserve who got credit for the positive economic results after having stopped the implosion of the financial system in 2009. However, there is still no empirical evidence that the plan has worked, because the world is still on the monetary infusion. We should note that the present type of situation, characterized by tapering in a global fiat based monetary system with huge amounts of debt, is unique in human history.

As John Mauldin pointed out this week, if the narrative about central planning changes, indicating that the present monetary experiment was the wrong answer to the problem, there could be very nasty effects, especially out of the emerging markets. This is why (courtesy of Ben Hunt):

For 20+ years there has been a coherent growth story around Emerging Markets, where the label “Emerging Market” had real meaning within a common knowledge perspective. Today … not so much. Today the story is that it was easy money from the Fed that drove global growth, Emerging Market or otherwise. Today the story is that Emerging Markets are just the levered beneficiaries or victims of Fed monetary policy, no different than anyone else….

I’m not asking whether the growth rate in this Emerging Market country or that Emerging Market country will meet expectations, or whether the currency in this Emerging Market country will come under more or less pressure. I’m asking if the WHY of Emerging Market growth and currency valuation has changed. The WHY is the dominant Narrative of a market, the set of tectonic plates on which investment terra firma rests. When any WHY is questioned and challenged you get a tremor. But if the WHY changes you get an earthquake.

What are the investments that such an earthquake would challenge? You don’t want to be short the yen if this earthquake hits. You don’t want to be long growth or anything that’s geared to global growth, like energy or commodities. You don’t want to be overweight equities and underweight bonds. You don’t want to be overweight Europe. You can run from Emerging Markets with US equities, but with S&P 500 earnings driven by non-US revenues, you cannot hide. If you think that your dividend-paying large-cap US equities are immune to what happens in China and Brazil and Turkey … well, good luck with that. My point is not to sell everything and run for the hills. My point is that your risk antennae should be quivering, too.

Nodoby knows how exactly a change in the narrative will play out, but given this week’s evolution, it seems likely that a flight out of risk assets into gold as a safe haven is very likely. Once the narrative changes, the product of the most powerful central bank, i.e. the US dollar, could be hit by a serious trust crisis. That is the point where the Western world could rediscover the monetary value of gold. That is the point where the correlation between the commodity index and precious metals prices (as evidenced since 2011) will break. Gold is more than a commodity. It is the ultimate protection against the central banking illusion.

There really is a reason why we advocate holding physical gold outside the banking system.