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Word from the World Bank
April 8, 2005

According to the World Bank, the global economic recovery has peaked. The bank sees the best-case scenario as a mild slowdown in global economic growth over the next few years, yet warned that a new global recession is a possibility.

The bank specifically suggested that the US shrink its budget deficit, as it saw the US's need to borrow from foreign entities to finance its trade deficit as a major risk factor for the global outlook.

Well, the good news is that we are not surprised.

Foreign reserve banks, particularly those of China and Japan, have been hoarding dollars (instead of selling them into the foreign exchange markets) to prevent the renminbi and the yen from appreciating against the dollar. These surplus dollars were invested in US Treasury debt, keeping trade dollars off the market and financing the US deficits.

But now there is growing pressure on China and Japan to let their currencies appreciate against the dollar. Once they allow their currencies to appreciate against the dollar we will not only see the dollar weaken on foreign currency markets, we will also see interest rates in the US rise because less trade dollars will be invested in US Treasuries. If this seems confusing, read the commentary I sent out on February 10, 2005 on my website (www.paulvaneeden.com). It is titled: "Dollar weakness and higher interest rates: how it works."

I often hear people comment that China, Japan, and other countries will not reduce their dollar holdings or their purchases of US Treasuries because there are no other currencies that can compete with the dollar. That is not the case.

A reduction in these countries' holdings of US dollars, or even just a moratorium on the accumulation of any more dollars, only means that they would sell more dollars into foreign exchange markets and buy back their own currencies. Japan would sell dollars for yen and China would sell dollars for renminbi. There is no need for them to buy euros, or any other currency for that matter. They can each take their own currency and use it to stimulate their internal economies.

So the suggestion that these countries will not stop buying US dollars for lack of an alternative is just plain nonsense. They don't need to hoard as much foreign reserves as they are currently doing. The only reason dollars are piling up is that the US's trade partners are trying to prevent the dollar from falling. But the US, Europe, the World Bank, and others are all pressuring China and Japan to let the dollar fall. It's coming.

The result will be higher prices for imported raw materials and finished products in the US. As I already mentioned, it would also cause US interest rates to rise because less hoarding of dollars would mean less foreign demand for US debt. As interest rates rise the US economy will stall and with it the global economy. While a global slowdown would be bad for base metal demand, a weakening dollar could mask some of that effect. A weaker US dollar would, however, mean a higher US dollar gold price and most of the world is still using the US dollar gold price to make gold related investment decisions.

So if you're feeling down because your gold stock portfolio has lost ground recently, realize that we are in a counter-cyclical rally in a US dollar bear market. The gold price will turn up soon enough. Use this time to average down on some of your best investments and look for new opportunities.

I will be in Calgary this weekend at the Calgary Resource Investment Conference where there will be ample good investment opportunities. Visit www.goldshow.ca for details. Hope to see you there.

Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477.

Disclaimer

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