Friday, November 10, 2006

Dear Democratic Congress...Don't Even Think About It!

Dollar Declines After Reuters Says China May Diversify Reserves

By Daniel Kruger and Min Zeng

Nov. 9 (Bloomberg) -- The dollar fell to the lowest against the euro in more than two months after Reuters reported People's Bank of China Governor Zhou Xiaochuan said he has a ``clear'' plan to diversify the country's foreign-exchange reserves.

Is it coincidence that the Governor of the People's Bank of China chose yeseterday, the day after the Democratic takeover of Congress, to make this statement? I don't think so; it was just a couple of months ago that Sen. Charles Schumer (D-NY) and Sen. Lindsay Graham (R-SC) introduced a bill to impose a 27.5% tariff on Chinese goods if the Chinese weren't more accomodating in revaluing the Chinese currency upward agains the dollar. This was a shot across the bow of the new Democratic controlled Congress; pass the tariff bill and the Chinese will accelerate the "diversification" of their reserves, which are primarily US Dollar denominated Treasury Notes. The result was plain for everyone to see; gold shot up $18/oz and the dollar fell against most currencies.

The dollar traded at $1.2836 per euro at 2:06 p.m. in New York from $1.2757 yesterday. The U.S. currency touched $1.2848, the lowest since $1.2875 on Sept. 5. The U.S. currency traded at 117.91 yen from 117.84. The dollar earlier reached 118.59 yen....Gold rose after the announcement by the Chinese central bank's governor. Futures for December delivery increased $18.50, or 3 percent, to $636.80 an ounce on the Comex division of the New York Mercantile Exchange. A close at that price would mark the biggest gain for a most-active contract since June 30.

In a post yesterday, I said that anti-trade legislation is the greatest threat to the economy as a result of the Democratic takeover. This should be a reminder to everyone that our current prosperity rests almost solely on the continuation of the globalization process, which is characterized by trade liberalization. With reserves of $1 trillion, primarily invested in US Treasury Notes, the Chinese ability to punish the US for restricting trade is plain to see.

This also demonstrates why we believe that holding a position in commodities is not just a nice way to diversify your portfolio, but a necessary safeguard against the economic illiteracy of politicians. If populists in Congress succeed in imposing trade restrictions on China, the result will be much worse than the knee jerk reaction yesterday - and the best way to protect your assets is to own commodities, particularly gold.

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