It was a good day to be back in the office, after a week in Europe... because events seem to be unfolding according to our expectations. China has decided to allow its currency to appreciate. As long-time readers know, we hold a simple view of the world. We expect as the Fed creates more dollars, the exchange value of paper money will decline. You might say we believe the printing press is more powerful than the mortgage defaults, if only because its work can be accomplished faster and without limit. The government's decision to bail out the banks, Fannie, Freddie, AIG, etc. will cause commodity prices to rise. Most foreign currencies will rise too, but perhaps not the euro, which seems poised to print even more money than the Fed.
Unsustainable trends – like America's trade deficit with China – can't go on forever, but they can last a very long time. China's currency peg, which has been in place since 1994, allowed America's trade deficit to grow without limit. It also allowed the Federal Reserve to export our domestic inflation to the Chinese market and its nearly endless supply of labor. Now, finally, these trends seem to be reversing. From now on, increasing demand for Chinese goods will result in higher prices as the yuan appreciates.
What does all of this mean to you? We offer a warning: The move on China's currency presages a big increase in interest rates. China's central bank controlled its exchange rate by selling yuan and buying Treasury bonds. As the country allows the yuan to rise, it will undoubtedly buy fewer Treasuries. The U.S. Treasury, meanwhile, will be selling record amounts of bonds as it attempts to raise nearly $4 trillion in the next 12 months to extend maturing debts and finance OBAMA!'s record deficits.
One other point to consider about a stronger yuan... It should allow China to purchase more commodities, which, along with a corresponding weaker dollar, should cause commodity prices to rise substantially. That's why crude oil jumped nearly 2% on the news. Freeport-McMoRan, the world's largest copper miner, gained 6%.
And finally... we know the world's central bankers are now facing an even bigger quandary. U.S. dollars might not have been the best currency in the world, but at least they were good for buying things in China. Now... they might not be so good at that anymore. If you were a central banker, what would you do? The central banks of Russia, the Philippines, Kazakhstan, and Venezuela are all buying gold, the World Gold Council said on Friday. Also, Saudi Arabia's gold reserves more than doubled to 323 tons from 143 tons in March. The WGC said the revision was due to an accounting adjustment. We know accountants can get creative, but hiding nearly 200 tons of gold takes talent. With gold trading at all-time highs, we're seeing nearly every central bank add to its reserves...
It doesn't seem like that long ago (2006) when people looked at us as if we had three eyes when we warned the U.S. dollar standard was on the verge of collapse. Now, it seems more and more inevitable each day. We sure hope you started buying gold and silver back then.
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