It’s Over
November 19, 2004
While the US dollar has already declined 35% against the
euro in the past four years, the main event has not yet occurred. The
euro was just the opening act.
Correcting the US trade deficit requires the dollar to weaken
against the currencies of those countries with which the US has the largest
trade deficits, meaning the Chinese renminbi and the Japanese yen.
The Bank of Japan sold 14.83 trillion yen in the first two
months of this year, and bought roughly 140 billion dollars to keep the
dollar from falling below 105 yen. But in March they called it quits.
Since March Japan has been noticeably less determined to support the dollar
and, guess what, the dollar has declined by 7% against the yen since then.
In September Japan actually reduced its Treasury position
by 1.5 billion dollars. It was the fist time in two years that Japan sold
more US Treasuries than it bought.
I’ve often been asked how long I thought Japan and
China would continue to support the dollar. Well, it seems that we now
know the answer: until March 2004. With Japanese support for the dollar
waning, it won’t be long before China lets the renminbi float and
other South East Asian countries start concerning themselves with issues
other than competitive devaluations against the dollar.
For a while now the US has been pressuring China to let
its currency float, a move that is widely anticipated to lead to a stronger
renminbi against the dollar. This must rank as one of the dumbest things
I have seen the US do in recent times.
Calling for a stronger renminbi is, by definition, calling
for a weaker US dollar. However, US Treasury Secretary John Snow said
in London, just this week, that “Nobody has ever devalued their
way to prosperity.” I guess the US Administration feels that the
US is already so prosperous that it could afford to pursue a weaker dollar,
even though its official policy is one of a strong dollar. If that sentence
confuses you, don’t worry, it seems to confuse John Snow as well.
While the fixed exchange rate between the dollar and the
renminbi has allowed Chinese exports to remain very competitive in US
markets, it cost the Chinese dearly. China has had to buy in the order
of 500 billion dollars’ worth of US Treasuries to keep the renminbi
pegged to the dollar. This year alone China bought in excess of 100 billion
dollars. At the same time, the falling dollar has caused the price of
Chinese raw material imports to soar. Just in the last year the cost of
oil is up 33%, copper is up 55% and nickel is up 18% -- you get the picture.
If China allows the renminbi to float, and it appreciates against the
dollar as is widely expected, then the cost of raw materials imports to
China will drop significantly and that is most certainly positive for
the Chinese economy.
China alone will not be able to support the US dollar. With
Japan clearly indicating that it is getting indigestion from an overdose
of US Treasuries it would imply that China has to take up the slack if
the dollar is to remain at its current exchange rate.
Given that China is under pressure from the US to let its
currency float, and appreciate against the dollar, this would be an opportune
time for the Dragon to politely grant the US its wish. But if the Chinese
let the renminbi float it also implies that they would not have to buy
as many US Treasuries going forward.
Japan has reduced its Treasury purchases since March and
I wonder if our intrepid leaders in Washington have thought about who
will finance the growing US budget deficit. Life has been far too easy
for US politicians in the past fifteen years. Just like US consumers,
they have become proficient at spending in excess of their means, in the
belief that there will always be someone out there to lend them more money.
But the game is over. With the US economy sinking into quicksand
the buyers of last resort have been the Asians, and now it seems that
they have had enough.
According to The Conference Board Inc., a private economic
research group, the outlook for the US economy further weakened in September.
This is the fifth straight decline in economic leading indicators. With
such a bleak outlook for the US economy it’s going to be tough to
replace decreased Chinese and Japanese appetite for US bonds with private
purchases.
For most of this year I have been saying that we need to
see the US dollar decline in conjunction with rising interest rates before
the dollar-gold price will sustain a meaningful rally.
Since the day after George Bush was re-elected as president
of the United States interest rates have risen and the dollar has declined.
It’s too soon to call it a trend, but my own feeling is that the
dollar is heading much lower and the gold price is heading much higher.
The US trade deficit is a virtual guarantee that the dollar
will fall and the budget deficit is a guarantee that interest rates will
rise. It’s busy happening, and there is no end in sight.
Prepare yourself, buckle up, and hold on.
Paul van Eeden
PS I’ll be in San Francisco next weekend, November
28th and 29th, for the last investment conference of the year. Given the
recent gold price activity it’s shaping up to be a great conference.
For more information please visit http://www.iiconf.com/sf04/default.aspx
and don’t forget to register for my workshop if you’re going
to attend. Registration for the workshop can be done at http://www.iiconf.com/sf04/Registration_sf2004.aspx.
Just check the box right above the “Submit Registration” button.
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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