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China And The Dollar
By Gold Economist: Jay Taylor
Goldinvestor.com
Wednesday, March 3, 2010
Although we don't account for cash in our Model Portfolio, I continue to keep a fair amount of cash in my own IRA because I do indeed believe the gold shares will get taken down with the market as a whole when the next major decline hits us in this secular bear market that began either in 2000 or 2007 depending on how you look at it.
Brian Rich, the foreign currency hedge fund manger and currency expert from the Weiss Group, just put out an excellent article, titled, "Why You Should Be Worried About China."
Brian mentions that at the present, the global financial markets are taking cues from three key themes:
- Sovereign debt problems – "Fiscal problems in Greece re mushrooming into a global, sovereign debt crisis."
- China Tightening Credit – China is curtailing easy credit for fear of a bubble bursting of its own. This may slow down growth in China, which is becoming ever more important with respect to the global economy.
The Fed is actually starting to move toward an exit from its easy money policies too. Brian points out that the Fed's surprise announcement of a discount rate hike came only eight days after the text of a Bernanke speech was released that said the discount rate would start to move higher "before long."
Mr. Rich, who expressed his strong dollar views on my radio show on February '16th, (Listen at http://www.voiceamerica.com/voiceamerica/vepisode.aspx?aid=44543) suggested that the above three current events are helping to underpin the current strength of the dollar. However, Brian noted that the dollar, which seems to move in cycles of about seven years dating all the way back to 1971, is likely to get an even bigger boost as the G-20 countries begin to apply pressure on China to stop manipulating its currency to a level that is between 40% and 50% undervalued vis-ŕ-vis the U.S. dollar. (Note below long bullish and bearish cycles for the dollar)
Brian's rational for a "stronger dollar" related to the growing currency dispute with China is based on his belief that we are likely to see rising protectionist policies on the part of G-20 nations when it becomes clear that China will not "play ball" with the other countries.
Just as it did in the 1930s protectionism would curtail world growth and thus shrink income on a global basis. A reversal of the global trade would then be expected to cause wealth to flow back into the senior currency as it happens when the "risk trade" disappears.
With declining global income, mountains of debt that already can hardly be serviced would start to become an even bigger problem, leading to massive international defaults. And as that happens, as Bob Hoye has pointed out, the "senior currency" always gets stronger.
Please don't think I believe a "strong dollar" means a weak gold price. I do not believe that at all. In fact, I'm suggesting that the imbalances we see in the undervalued Chinese currency are all related to lack of a gold standard. China doesn't want the dollar so it is pawning it off for whatever more valuable asset it can exchange our currency for and one of those is gold. In fact, this past week according to Pravda, the Chinese arranged with the IMF to purchase the remaining 50% they have agreed to sell, India having already purchased the first half. Gold is so much in demand everywhere that it is likely to remain in a horrendous bull market for years to come, until the existing global financial system breaks down and, out of necessity, a hard money system is re-established.
What is the point to all of this discussion about the dollar? It has everything to do with the inflation/deflation argument. If the risk trade and expansion of the global economy is in play, then we can look for higher prices and a weaker dollar. If on the other hand the risk trade is over—and Mr. Rich points out some reason to believe the "B" wave up is just about over if it is not already over as Dr. McHugh believes, then we can look for a "stronger" dollar and U.S. Treasury rates to remain surprisingly strong for a long time to come. By the way, with regard to strong U.S. Treasuries, Mish Shedlock provided a strong argument for that when he noted the aging demographics in America and how that necessitates the need for safety and income. Meager though treasury rates are, they do provide some income but more importantly, they also provide safety of principal.
Jay Taylor
Mr. Taylor is editor of J Taylor's Gold, Energy & Techn Stocks newsletter. A native of Ohio, he has resided in New York since 1973 when he began working there for Barlcay's Bank International. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares.
In 1981 he began publishing North American Gold Mining Stocks, which preceded his current newsletter. His continuing interest in gold mining prompted him to study geology at Hunter College in New York City, supplementing his MBA in Finance & Investments. Throughout his career Mr. Taylor worked as a commercial, then as an investment banker. Most recently, he worked in the mining and metals group of ING Barings in New York. Prior to that he was involved in the first gold loan made in modern times in the U.S. to Amax Minerals, a 250,000 oz. loan facility led by Citicorp.
In 1997 he resigned from ING Barings to devote himself full time to researching mining & technology stocks, writing his newsletter and assisting companies in raising venture capital.
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