Dollar/Yuan and Treasuries/Gold

   By Bob Shapiro

The relationship between currencies on the FOREX market has a lot to do with the trade balances between countries. If a country consistently runs a trade surplus against a second country, most likely its currency will rise. Certainly, there are other factors, mainly bearing on how they affect expectations of future trade.

For many years, China has run a trade surplus with the US. Of course, as China exports goods containing components from other of its trading partners, the China/US trade balance likely is overstated. But, China still has a surplus.

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China manages how that surplus affects its Yuan’s value against the Dollar in several ways. China has purchased well over $1 Trillion of US Treasuries with some of those surplus Dollars. And, China has purchased staggering amounts of commodities (most recently Gold) on world markets, also using some of those Dollars.

These Dollar purchases strengthen the Dollar. So, while China was allowing the Yuan to rise against the Dollar, it was more gradual than a PPP (Purchasing Power Parity) basis might have suggested.

Now, we have what looks like an erupting trade war between the two countries. I haven’t read The Art of the Deal, but I expect – from what else President Trump has done – that the tariffs are a negotiating tactic for President Trump.

Perceptions within the FOREX trading community likely are that one way or the other, over the next year or so, the US/China trade gap should narrow considerably. This, together with various ways that the Chinese can affect FOREX markets, have pushed the Yuan down almost 10% against the Dollar. A 10% tariff is negated by a 10% currency movement, so Chinese goods competitiveness is right back where it was before all this started.

Trade negotiations are proceeding all the while, and President Trump has put a rise to a 25% tariff rate on the table. A further decline in the Yuan vs the Dollar likely would be acceptable to the Chinese, except that movements in the Yuan/Dollar exchange rate are putting major strains on China’s other trading partners, especially those which have large US Dollar loans which need to be serviced and repaid in more costly Dollars.

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Eventually, China will settle the dispute with the US, and we’ll get back to a new normal. Importantly, China will have ‘inside information’ on when that dispute resolution will take place. Why important?

Along with the exchange rate changes, the value of things that China buys and sell has changed in Yuan terms. Treasuries, denominated in Dollars, have jumped in Yuan terms by 10%. So has Gold, likely causing a slowing in Chinese purchases. This thought likely has occurred to Gold traders helping to explain the roughly 10% fall in Gold (and Silver) Prices over the last two months. In Yuan terms, Gold and Silver haven’t changed.

The jump in the Yuan value of China’s US Treasuries provides China a major opportunity to gather in Gold and Silver while they are on sale. But, once a trade deal has been done, the sale likely will end. I expect that China will purchase physical metals – and lock in commitments for future delivery – before it agrees to a trade deal.

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Now, purchasing $1+ Trillion in Gold and Silver (plus Copper and other commodities?) is all but impossible, so I expect that as their purchases move the markets and eliminate the sale price opportunity, then they will act on a trade agreement.

I said that $1+ Trillion in purchases are nearly impossible, but I remember the saying, “The difficult we’ll do today, the Impossible will take a little longer.” Such massive purchases could provide the steam for a major up-leg in Gold and Silver prices.

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