In June 2002 I published an article entitled
“The Coming US Dollar Implosion”. At that time the
Euro was US$ 0.96 and the US Dollar Index 108. The figures today
(3rd Dec 2003) are Euro = US$1.20 and a US Dollar index of just
under 90. The Euro has gained 25%. The US Dollar index has declined
DOLLAR IMPLOSION - PART II
As Winston Churchill might have
put it, in regard to the US Dollar : “We have reached
the End of the Beginning and
are about to enter the Beginning of
the End”. What has taken place during the past
17 months has been no more than Part I of the US$ implosion.
We are set to start Part II.
During the past 17 months the US Dollar has
declined moderately against most European currencies, and
by even more against the currencies of commodity producers
such as South Africa, Australia, Canada, and New Zealand.
Elementary economics teaches that when a country’s currency
depreciates, that country’s trade deficit will gradually
diminish. Yet, despite a two year slide in the Dollar, there
has so far been no decline in the US trade deficit. Why the
The answer lies in the countervailing actions
adopted by some of America’s Asian trading partners.
Those with the largest surpluses, mainly Japan and China,
have been intervening in the markets to slow the appreciation
of their currencies against the Dollar in an effort to protect
their export industries. China, which today enjoys the largest
surplus of all America’s trading partners, linked its
currency directly to the US Dollar. Despite rising opposition
from the US Government, China’s currency strategy continues
Before condemning the Chinese, it is important
to understand what is happening in their country. The Industrial
Revolution in the UK and Europe in the 18th and 19th centuries
totally transformed their economies from agricultural dependency
to economies reliant on industry and commerce. People moved
off the land into the towns. Jobs in the new industries were
poorly paid, but they at least provided a living.
China appears to be going through a similar
experience. They are enjoying their own Industrial Revolution
that is rapidly transforming what was previously an agrarian
economy into one witnessing a massive build up in its industrial
and commercial infrastructure. China currently has the lowest
cost labour force in the world. They are therefore being inundated
with an influx of US manufacturers. Some transfer existing
operations, lock, stock and barrel. Others have closed down
out-of-date facilities back home only to establish brand new
plants in China. To this growing pool may be added factories
controlled by indigenous Chinese entrepreneurs.
With wages in Asia being a tiny fraction of
those paid to workers in western countries, the trend of moving
manufacturing and services to Asia – especially to China
and India – is bound to accelerate. Adding to America’s
nightmare is a Chinese cultural and business strategy that
places great emphasis on the distant future. This persuades
the nation to endure short-term pain in the interests of achieving
What seems to be happening is the following.
The Chinese view the US as their main export market, hence
the solid link between their own currency and the Dollar.
China has been earning massive Dollar surpluses from its trade
with the US. They re-invest those surpluses back into US Treasury
Bonds. By recycling their dollars back into the system, they
play a key role in keeping US interest rates artificially
low. This in turn holds America’s economic recovery
China must know that it is selling real
goods to the USA and being paid in pieces of paper that will
ultimately be worth a lot less.
The Chinese understand they will one day
have to take a loss on their dollar reserves, but this is
the price that they are willing to pay to maintain the existing
order. The longer they perpetuate the system, the faster their
industrial infrastructure will grow and the greater the number
of Chinese finding jobs. A fall in the value of their accumulated
foreign reserves is a price they are prepared to pay in the
interests of laying a foundation for their country’s
China is happy to see the status quo continue.
It will only change if the US takes unilateral action when
the US tires of losing jobs and services to Asia. The political
pressure is certainly building. American voters are becoming
increasingly aware jobs are disappearing as factories close.
The subcontracting of service work is going to India where
there is a culture of speaking English.
A sign that groundswell opposition is having
an impact was evidenced by President Bush’s recent tour
of Asia. He requested Asian countries to allow their currencies
to appreciate against the Dollar. Unsurprisingly his appeals
went unheard. Back in Washington, the Democrats have been
pushing to levy a 27.5% tariff on Chinese goods imported into
the US “to protect our jobs”.
These are all signs in the wind that this particular
trade arrangement is coming to an end. Sooner or later the
USA will be forced to take some form of unilateral action
to terminate the relationship. The side effects will be extremely
damaging. Their action will signal that the game is over.
It will also confirm the end of the US Dollar as a reserve
currency, triggering Part II of the US Dollar Implosion.
When China understands that the game is over,
the time will have arrived for them to dispose of their US
Treasury Bonds, effectively switching out of Dollars into
something safer like the Euro (the only viable paper reserve
asset) – and into gold, which will soon become the reserve
asset of choice. In recent years China has steadily been building
up the gold component of their country’s foreign reserves.
This trend will soon accelerate.
It is possible that China may eventually revalue
their currency, the Remnimbi. In the meantime, the result
of confrontation will be to tip the US, and therefore the
world economy, into recession. US interest rates will rise
rapidly as the Chinese dump their Treasury Bonds, causing
havoc in the US real estate market. The Chinese economy will
not be unaffected and may well dip into recession simultaneously.
Recently constructed factories in China may fall on hard times.
Those that have been financed through debt could go to the
wall. Chinese entrepreneurs will pick up these factories for
cents in the dollar.
Part II of the Dollar implosion will differ
substantially from Part I. If the US-China economic relationship
changes or ceases, the effect on commodity prices could be
immediate and dramatic. “Commodity” currencies
may then no longer look quite as attractive as they do at
present. In the face of spreading recession, the prices of
most commodities would decline, severely denting the attractiveness
of the currencies of commodity producers. This could cause
a severe reaction to events of the past two years in which
the Australian dollar has risen 50%, from 48c to 72c; the
South African Rand that is up almost 100%, from 8c to 15.5c;
and the New Zealand dollar that has risen 60%, from 40c to
The feature of Part II of the US Dollar Implosion
will be a recognition that even presently popular commodity
currencies are mere paper, ultimately no different to the
Dollar itself. There will be an awareness that, unlike the
1930’s when competitive currency devaluations were made
“by decree”; we are now
in an era of competitive currency creation or printing.
The country with the fastest growth of currency creation will
have a short term trade advantage as their currency depreciates
against competitive nations. As investors withdraw from the
erstwhile favoured currencies, they will have a problem deciding
where to invest their funds. This is when gold will be seen
as a viable alternative.
There will therefore
be a growing awareness and recognition of the vastly more
attractive reserve asset role that gold must and will play
in the future. This recognition is the fuel that will
fire a rocket under the price of gold, driving it to substantial
new highs in terms of ALL currencies.
In past crises, the wealthy have protected
themselves buy purchasing gold and gold related assets. Ordinary
people, by far the greater number, could rarely afford to
buy gold. Being far cheaper, they have previously had to buy
silver. This metal became the poor man’s choice as an
asset to protect their savings. Silver has so far lagged gold
in the early stages of this bull market, but that situation
seems about to change.
Throughout recorded history the average relationship
between silver and gold has been 15oz silver to 1oz gold.
The ratio at present is a far higher 75:1 ($400/$5.30). This
is massively out of line. If gold were to double to $800 per
oz, it would not be unreasonable to expect the silver/gold
ratio to decline sharply, possibly as low as 40:1. With gold
at $800, this would position silver at $20.
Thus a 100% increase in the price
of gold could possibly be accompanied by a simultaneous 400%
increase (perhaps more) in the price of silver. This offers
significant opportunities both in silver bullion and silver
mining shares .
The above graph of the price of silver has been borrowed from
an excellent recent article by Dan Norcini entitled “A
Technical Look at Silver – Update”.
What is quite clear from the graph is that silver’s
22-year bear market down trend has come to an end. As Dan
Norcini says, a new bull market in silver has been born. It
is difficult to argue against this contention and I have no
intention of doing so. A silver price above $6.80 would complete
a fabulous head-and-shoulders base formation. With this as
a foundation, it would be possible to project a very large
rise in the price of silver for the future.
3 December 2003
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Statement: The author has personal
investments in JCI Ltd (JCD), in the JCI Redeemable Convertible
Debentures (JCDD) and in Randgold Exploration Ltd (RNG). The
author has not been paid to write this article nor has he
received any other inducement to do so. The author will benefit
from any appreciation in the market prices of these securities.
authorís objective in writing this article is to invoke an
interest on the part of potential investors in these securities
to the point where they are encouraged to conduct their own
further diligent research. Neither the information nor the
opinions expressed should be construed as a solicitation to
buy or sell these securities. Investors are recommended to
obtain the advice of a qualified investment advisor before
entering into transactions in any of these securities.