Today's comment is by Jack Crooks, our Currency Director and Editor of both The Money Trader and Crooks on Currencies.
Dear A-Letter Reader:
If I was at home right now, I'd be bombarded with the election news. I would be scanning my favorite financial news sites to read their opinion on this latest political upheaval. As a currency trader, I'd be analyzing exactly how a Democratic congress will affect the U.S. dollar over the next two years.
Luckily for me, I'm still enjoying the serenity of idyllic Puerto Vallarta, Mexico. And I'm soaking in all the knowledge at The Sovereign Society's first ever Offshore Advantage Seminar.
This is my first seminar as Currency Director for The Sovereign Society. Let me just say, I'm very impressed with The Sovereign Society members and other conference attendees I've met over the last couple days. They are a down-to-earth, extremely nice group of people. They're all open to new ideas and serious about learning the ins and outs of offshore investing and asset protection.
And I'm also extremely impressed with the quality and depth of the speakers, who have assembled from all over the globe. This lineup speaks volumes about the respect The Sovereign Society has for their members.
While our attendees are busy taking notes, you don't need to lift a pencil. Catch every word from our esteemed experts by pre-ordering the Offshore Advantage audio recordings. Click here to reserve your copy now.
Ok, this is the part where I should report on all the asset protection, tax haven, and investment presentations here at The Offshore Advantage Seminar.
But I just can't help myself. Even surrounded by the intriguing investment ideas (Thomas Fischer and Rob Vrijhof have revealed several investment recommendations so far that made me raise my eyebrows and take some mental notes), I'm still wondering how the U.S. election is going to play out for the U.S. dollar.
A Democratic House and Senate combined with China's soaring trade surplus could equal some stormy weather for the U.S. dollar. And that's news I just can't ignore.
An Eerie Parallel Is Shaping Up...
As you may know, China's currency, the yuan, is controlled by the Chinese government. The tension over China's trade surplus has already led to politicians demanding that China revalue its currency. Some analysts believe the yuan is undervalued against the U.S. dollar by as much as 30-50%.
Now I'm not sure how much the Chinese yuan is "undervalued." But if the Chinese currency were traded freely, chances are it would appreciate considerably against the U.S. dollar.
Chinese economic growth is still driven by the export model. The country's leaders believe by keeping the value of the yuan suppressed, they can keep exports flowing more freely. Howls of disapproval have been heard from most of the industrialized nations coping with the flood of Chinese made products. This is especially true in the United States. Yet China continues to dig in its heels in on the question of revaluing their currency.
I think the major reason for Chinese stubbornness stems from its leadership's fear of what happened to the Japanese economy when their currency dramatically increased in value against the dollar back in the late 1980's.
Insert "China" for "Japan" and History Repeats
Japan was the China of the 80's-flooding markets everywhere with "cheap" but good quality products. Japan's trade surplus soared. Then U.S. manufacturers, and manufacturers from other industrialized countries, howled that this was unfair trade on Japan's part. They all cried out that the Japanese currency, the yen, was too low and being manipulated by the Bank of Japan to keep it low. Sound familiar?
So how was it resolved? The group of industrialized nations known as the G5 nations (France, West Germany, Japan, the United States and the United Kingdom) agreed to intervene in the currency markets to sell the dollar and push it lower, as the dollar was "too high." But this agreement, known as the Plaza Accord, included the understanding that the Japanese yen would increase in value, and hopefully reduce the country's massive trade surplus. This agreement would also help reduce the U.S. massive trade deficit and effectively right the "global monetary imbalances."
(NOTE: The Japanese yen was trading at around 218 yen to one dollar before the Plaza Accord was inked in September of 1985. It bottomed at around 80 in April of 1995-that represents a 63% appreciation. Yikes!)
All you need to do is insert the word China in place of Japan and it's exactly what's happening in the global economy today. This eerie parallel hasn't gone unnoticed by China. As I said, the leadership in Beijing attributes Japan's 15+ years of deflation and stagnation as a direct result of the yen's rising value. And the Congress (with outspoken trade critic Senator Chuck Schumer leading the charge) declares the Chinese currency the prime culprit as the USA's trade deficit continues to expand and manufacturing jobs are lost.
Interesting Timing for the Elections
It's a case of auspicious timing that just this week China announced another record trade surplus. "China's trade surplus for October ballooned to a monthly record of $23.83 billion, far surpassing the previous record and posing a challenge for policy makers trying to manage both the domestic economy and its external imbalances," The Wall Street Journal reported.
"The trade surplus this year has reached $133.62 billion, or 66% bigger than the $80.37 billion surplus accumulated in the first 10 months of 2005. More money -- about $40 billion so far this year -- is coming into the country in the form of long-term foreign investment. Those inflows helped push China's foreign-exchange reserves, already the world's largest, past the $1 trillion mark this week," the Journal said.
Wow! "66% bigger" so far this year! You can bet Senator Schumer has committed those numbers to memory.
So here's the rub. The Democrats want to "prove" to the nation there will be a "new direction" for the U.S. on a whole host of issues. And Democrats also know that China is painted, rightly or wrongly, for the loss of jobs and decline in U.S. wages with the burden falling most acutely on the middle-class. So the Chinese trade issue will likely take center stage for the party now in complete control of congress. The threats to retaliate on trade can now materialize into legislation. The pressure on China to do something on the currency front could increase tremendously.
Asian Currencies Could Rise, While the Dollar Plummets
If the Chinese currency is allowed to move sharply higher against the U.S. dollar, it will likely support the entire Asian block of currencies. In fact, I think it would lead to a decline in the U.S. dollar across the board.
China holds a massive amount of foreign exchange reserves, mostly in U.S. dollars. These reserves are used to hold down the value of the yuan. If the Chinese currency was revalued, those reserves would be significantly reduced. And if China dumped reserves, other central banks in the region would likely follow her lead and do the same. This would lead to the much feared reallocation away from the U.S. dollar.
If China is pressured to revalue the yuan, thanks to the shift in congressional leadership, it could be very bad news for the buck.
The last time the U.S. dollar tumbled was in 1985, but the circumstances were very different. At that time, the dollar fell from a very high perch. Now the dollar is already in the cellar against the major currencies. The U.S. dollar index was around 139 before the Plaza Accord in 1985. The dollar index bottomed at an all-time low of around 78 on the index. We aren't very far from that "all-time low" right now, with the U.S. dollar index around 85 (thanks to a four-year bear market that began in 2002).
Bottom line: No one knows if China will revalue the yuan or if we'll see a new low in the U.S. dollar anytime soon. But the threat is real. And a new low in the U.S. dollar would hammer the wealth of all U.S. citizens holding dollars and dollar assets.
That's exactly why our attendees at the Offshore Advantage Seminar are studying so hard and learning about currency diversification rather than frolicking on the beach in beautiful Puerto Vallarta.
JACK CROOKS
From Puerto Vallarta, Mexico
www.crooksoncurrencies.com
EDITOR'S NOTE: You can hear Jack's top currency plays and the rest of our speakers' presentations, by pre-ordering the audio recordings from the seminar. Plus, you'll receive our offshore experts' safest and easiest ways to diversify out of the U.S. dollar, which could tumble even further in 2007. Click here to reserve your Offshore Advantage audio today.
