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
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
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
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
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”
Paul van Eeden works primarily to find investments for his
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