China revalues the renminbi
July 22, 2005

China finally agreed to revalue its currency against the US dollar this week. The token 2% revaluation was probably meant to appease Washington bureaucrats more than anything else. It seems to have worked: the White House and the Treasury applauded the move.

The magnitude of the renminbi’s revaluation against the dollar is totally insignificant, but it was interesting that China will in future peg the renminbi against a basket of currencies. They did not say which currencies make up the basket, although one can assume that it would include the dollar, the euro and the yen. It makes sense to use a basket of currencies for a currency peg since the US dollar is losing its hegemony as the world’s only reserve currency. The euro block economies rival the US economy and therefore the euro should be just as important to international trade and foreign reserve accounts as the dollar. The same goes for Japan; it is the third largest economy behind the US and Europe.

Perhaps the most striking result of China’s revaluation of its currency was the effect it had on the dollar with respect to other currencies in Asia. I expected Japan and many other Southeast Asian countries to follow suit when China revalued its currency and, indeed, just minutes after the Chinese announcement, Malaysia announced that it would loosen the ringgit’s peg to the dollar and adopt a strategy similar to China’s.

I also expected the dollar to fall across the board following the renminbi’s revaluation, and it dropped against the Japanese yen, the Singapore dollar, the Thai Baht, the Indian rupee and the Korean won, to name but a few. As the dollar declines anything bought on international markets with dollars will become more expensive, including gold.

The US dollar-gold price moved up as the dollar fell on Thursday although it was mitigated somewhat by the fact that the euro also fell against the yen and other South East Asian currencies. The big move, however, is unlikely to occur until China allows the renminbi to appreciate more significantly.

During the Mexican peso crisis in 1995 the price of gold in pesos doubled. When the yen fell in 1995 and 1996 the gold price in yen rose by 35%. In 1997 the gold price rose more than 40% in both Philippine pesos and Malaysian ringgits, 67% in Korean wons and more than 400% in Indonesian rupiahs. From 1999 to 2002 the gold price increased more than 40% in euros. We are currently in a US dollar bear market. The gold price has already increased by more than 60% in dollar terms and I expect it to increase another 75% or so before it’s all over.

During the past fifteen years gold protected investors across the globe as one currency crisis after another took its toll. It will do the same in the US, but you have to own it first.

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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