-- Posted 5 May, 2011 | | Discuss This Article - Comments:

According to a new statement from the International Monetary Fund, the United States will be the world’s leading economy for four more years, at which point China will overtake the US in total annual production of goods and services.  While economists can and have expressed their doubts about how this plays into the world economy going forward, most everyone can agree that this news is not a positive release for the United States, nor the US dollar.

At present, the US accounts for roughly twenty-percent of total global output, whereas China represents only fifteen percent.  However, by 2015, the two countries will come to settle at 17% of world output each, making China as economically important to the world as is the United States.

But where the trouble rests is in the greenback.  While the US is responsible for twenty percent of global output, the US dollar is held by world governments at a disproportionate level.  In 2010, 61% of all assets held as foreign exchange reserves were dollars.  To compare, China only recently allowed investors in overseas markets easy access to its currency, and in 2010, the Chinese Reniminbi was found safely in the “other” column, which tallied only 4% of global reserves.

Investors should ask themselves how this could play out.  If the United States economy represents only one-sixth of world output by 2015, what incentive will the world have to store more than 60% of its assets in dollars?  Likewise, if China continues to grow to produce one-sixth of all goods and services produced across the world, why would foreign nations hold only a very small percentage (virtually zero) of their currency reserves in China?   Wouldn’t it make sense that foreign governments and businesses would want to hold currency in proportion to their current importers and exporters?

Currency Crisis

There couldn’t be more bearish news for the US dollar, as stockpiles of the greenback grow against a decline in the relative value of the United States’ exports in world trade.  Should governments around the world find that their dollar stockpiles are too large—China has already suggested it may cut its dollar holdings in half—wouldn’t it be the case that they would naturally flee to Chinese currency, which is already horribly underrepresented in world trade?

Flocking to the Renminbi looks to be a safe bet for most investors.   China is tightening its interest rate policy and the economy has yet to respond poorly to the measures.  Instead, China benefits in the long-run with lower prices for fuel, which are still mostly set in US Dollars.

The true play for this currency trade, however, isn’t in currency, but in metals.  The Wall Street Journal found that Chinese and Indian demand for silver would grow 30% in 2011.  But what happens when the dollar falls against the Renminbi?  What happens when the Renminbi appreciates further, and Chinese factories, which consume 70% of imports for industrial use, can suddenly afford more silver?

The play here is three-fold; it is anti-dollar, pro-silver, and pro-emerging markets, but unlike equities or bond funds, silver has real, tangible and intrinsic value.  Expect this trade to further explode through the rest of the year until the tailwinds of summer silver consumption in India take the trend even further. 

The fundamentals haven’t changed; they’re just developing faster than ever.

Dr. Jeffrey Lewis

www.silver-coin-investor.com