As the Chinese go about their daily chores, whilst coincidentally buying up the world’s commodity supplies using their hard-earned and rapidly devaluing US dollars, the Chinese Business News recently reported that a Chinese Central Bank official had said that China had cut its US Treasury securities holdings. The rest, as they say, is history … the dollar immediately tumbled beyond Euro 1.33. Then, when the same official denied having made this remark, the trades were reversed and the dollar recovered. Today the dollar is hovering around Euro 1.34. Enough said!
The Chinese and Japanese central banks together hold more than $800 billion worth of US treasury securities and their officials, together with those of Russian and Indian central banks, are beginning to muse publically about diversifying out of the dollar. Let’s face it – if they attempted to significantly reduce their dollar holdings en masse, all dollar holders around the world would suffer.
Diversification away from the dollar will surely mean a diversification “back” into gold. And it doesn’t take a deal of historical knowledge to be aware that this might very well appeal to the Oriental mentality.
Meanwhile, over in Moscow, a Russian central banker, Oleg Mozhaikov, was addressing
the London Bullion Market Association. Apparently not a man to mince his words,
Mr Mozhaikov has some information to communicate:
" The modern monetary system, although undoubtedly robust and long-standing, in fact has a number of flaws and weaknesses," Mozhaikov asserts, as he commences upon a scathing attack on American monetary and fiscal profligacy. He continues: "Although there are several reserve currencies, the blatant lack of discipline is demonstrated by the US dollar. I am leaving aside the main aspects of this problem, such as the social and economic injustice of a world order that allows the richest country in the world to live in debt, undermining the vital interests of other countries and peoples. What is important for us today is another aspect, which is connected with the responsibility of the state issuing the reserve currency and for the international community preserving that currency's buying power.”
Given the actual behavior of the dollar on the forex markets," says Mozhaikov, "the
problem could be more
accurately termed the irresponsibility of the US government in relation to the market valuation of its currency in international circulation. Today the net debt owed by the United States to the outside world (the so-called 'international investment position') is in the region of $3 trillion. To understand the scale of this figure, let me remind you that it exceeds the total official currency reserves in all the world's countries (including the United States itself). According to the International Monetary Fund statistics at last year-end, the world pool of foreign currency reserves totaled ... about $2,800 billion. The volume of cash only ('greenback' banknotes) available outside the United States totals about $400 billion.”
" The world has come to a paradoxical situation in which the creditor countries are more concerned with the fate of the dollar than the US authorities themselves are. Thus," says Mozhaikov, "the evolution of the U.S. dollar's reserve role in recent years has given ground to some quite pessimistic forecasts, based on rational economic theory. No wonder that the number of people who have held assets in dollars and now wish to diversify them partly into gold - the traditional shelter from inflation and political adversity - is steadily growing."
[Oleg Mozhaikov quoted in “The Rude Awakening” of 11/19/2004]
And there is a lot of room for diversification in this direction – gold represents 7% of Russia’s $113 billion foreign exchange reserves. In China gold represents just 2% of its huge $474 billion reserves. Clearly such quantities are very small in comparison to Europe, where many central banks still hold more than 30% in gold.
Meanwhile, holders of US dollar assets continue to lose money. The US stock market has been moving sideways for about the last five years, but the value of the American stocks in Euro terms has dropped - a European investor has seen his US stock holdings lose more than a third of their value.
We could still be several years away from the top in the gold price, or the bottom in the dollar. In fact, since the US presidential election, the dollar has dropped 3.5% against an index of the G10 nations' currencies and gold is up around 6%. Even Alan Greenspan is now saying that either the US dollar or the trade deficit has to decline - both cannot continue rising. Of course an “organic” devaluing of the dollar is the market's way of correcting the trade deficit. Following the natural laws of economics, the trade deficit is a virtual guarantee that the dollar will fall, just like the budget deficit will cause interest rates to rise. And the combination of a falling dollar and rising interest rates is going to hurt everyone holding US assets. It also means that the price of gold in dollar terms should head much higher.
At the moment, with gold making 16-year highs and the dollar continuing to fall, the new GLD ETF has come to market amid brisk demand with open interest in Comex gold futures at an all-time high. In contrarian terms this could well mark a near-term top in the bull market and time for some profit taking.
But with continuing little or no attempt to reduce the US budget deficit, market sentiment against the dollar should continue to be strong well into the coming year, and mid- to long-term bullish sentiment for gold should be equally strong. Long-term portfolio investors will undoubtedly see to this – both in terms of gold-related stocks (such as mining companies) and in holdings of the genuine article. A price of $500 might not be too far away, and prices well beyond that figure entirely realistic in the long term.
Article by: Tony Wood, The Midas Trader Club
Date: Dec 04, 2004