France and the euro
May 26, 2005
On Sunday France will hold a referendum to decide
whether the country should ratify the proposed constitution of the
European Union. Current polls indicate that a majority of the voters
may vote against ratifying the Constitution.
It is quite possible, then, that the recent strength
in the US dollar is a result of capital flowing out of euros and
into dollars. The euro has declined more than 4.5% against the dollar
during the past three months and the gold price, in US dollars,
has been weak.
If France votes “No” on Sunday we could
see further erosion of the euro, increased strength in the dollar
and weakness in the gold price. Another possibility is that given
the lack of sound currencies investors will turn to gold itself,
and the gold price might benefit in spite of dollar weakness. I
find the latter to be an attractive possibility and it would certainly
be my first choice, but we have not seen gold benefit much from
uncertainty in the past fifteen years, so I suspect that instead
of gold, the dollar will benefit the most from euro uncertainty.
If France votes “Yes” and ratifies the
European Constitution we could see the euro rally, the dollar fall
and the gold price rise. That would be good news for gold stocks
and might catch a few people off guard, as many anticipate weakness
in gold stocks at least until autumn.
Regardless of what happens on Sunday, we should keep
our eyes the dollar itself and the issues facing it. I am no fan
of the dollar. Recent weakness in the euro may have given it a boost,
but we must remember that the US trade deficit is putting immense
pressure on the dollar. The dollar has not declined significantly
as a result of the trade deficit only because Japan, China, and
several other trading partners of the US have been buying US treasuries,
instead of selling their dollars into foreign exchange markets to
prevent their currencies from appreciating.
The party ends when these countries stop buying US
Treasuries with their trade dollars and convert them back into local
currency instead. That is why the key to the gold price, in my opinion,
is whether China will allow the renminbi to float and, if so, when.
Washington is putting tremendous pressure on China
to let its currency appreciate. If China complies it will eliminate
China’s need for US Treasuries. You can bet that Japan, together
with many other countries in Southeast Asia, will follow suit and
let their currencies appreciate as well. But then who is going to
buy all the US debt that Washington has to sell in order to finance
its spending?
Net Foreign Official purchases of US Treasuries were
negative $14.98 billion in March this year. This was the largest
net redemption of US Treasuries by the Foreign Official sector since
August 1998 and the first net redemption since August 2003. A warning?
If the impact of this does not immediately strike
you I suggest you read my commentary from February 10th (available
on my website at www.paulvaneeden.com in the Commentary section).
You may also find it interesting that Ben Bernanke, a governor of
the Federal Reserve Board who is being nominated by President Bush
to become Chair of his Council of Economic Advisors, stated that
there would be a measurable impact on US interest rates if China
stopped buying US Treasuries. Keep that in mind when you read the
February commentary, and next time you hear Treasury Secretary John
Snow call on China to revalue its currency.
The thought I would like to leave you with today is
that even though uncertainty about the European Constitution may
be boosting the dollar in the short term, the outlook for the dollar
is grim. I will be the first to admit that I have no idea how long
this dollar strength will last, or what is going to happen in Europe,
but I will tell you that I have a lot of patience and the surest
bet I know of is a bet against the dollar. For me, that means a
bet on gold.
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.
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