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 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 ( or contact his publisher at (800) 528-0559 or (602) 252-4477.


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