Will Uncle Sam let the dollar collapse ?
The American economy is breaking down. But the US dollar is one of the
strongest currencies in the world right now.
U.S. investment vehicles are crashing. Retirement funds have lost trillions..
America has significant unemployment and the Federal Reserve continues to
inflate the US dollar. Yet the greenback has outperformed almost every major
world currency since the middle of summer.
How can this be?
The reeling finance and banking sectors currently has investors running and
screaming from the speculative equity markets
It seems a bit strange that investors would be buying the US dollar right now,
considering the myriad of problems currently facing the American economy. But
the fact is the United States isn’t the only country with financial problems.
Every country in the world is facing its own economic challenges right now. As
a result, foreign speculators have been rapidly selling their own domestic
currencies and buying the U.S. dollar.
This influx of buying has effectively increased value of the U.S. dollar. I
believe that this increase, however, will only be temporary and followed by a
steep and abrupt drop leading to an official recession in the United States and
the resumption of gold bull market. I’ll talk about all that in just a minute.
First we need to answer…
Why Are Foreign Investors Buying the U.S. Dollar as a Hedge?
Despite a legion of fundamental problems, the U.S. dollar remains the most
important reserve currency in the world today.
Throughout the last decade, an average of almost two thirds of the total
allocated foreign exchange reserves of countries have been in U.S. dollars.
This massive US dollar-denominated forex reserve base makes the greenback
appealing to foreign investors who are looking to diversify out of their own
currency in times of domestic difficulties.
The U.S. dollar’s reserve currency status does many positive things for
America. It allows the country to purchase the commodities at a marginally
cheaper rate than other nations, which must exchange their currency with each
purchase and pay a transaction cost. It also permits the government to borrow
money at a better rate, as there will always be a larger market for that
currency than others.
But there’s a catch.
In the event that foreign holders suddenly decided to shift U.S. dollar-based
holdings to assets denominated in other currencies, there would be horrific
consequences for the U.S. dollar and economy. Fortunately changes of this kind
are rare, and typically change takes place gradually over time. However,
significant drops in foreign exchange reserves of the U.S. dollar do occur from
time to time.
Between 2001 and 2002, foreign exchange reserves denominated in U.S. dollars
dropped almost 6%. As world governments and large institutions flooded the
market with U.S. dollars, the value of the greenback collapsed leading America
into the 2002-2003 recession.
I expect a similar chain of events to occur in the next several months.
The Next Big Leg Down for the U.S. Dollar
I believe that the current accumulation of U.S. dollars will soon reverse.
Investors will begin to buy back their foreign currencies pushing the value of
the U.S. dollar lower than ever.
The U.S. Dollar Index, a measure of the value of the greenback against of six
major world currencies, has increased 13.4% since mid-July on the back of this
buying pressure. But the long-term trend is down.
Take a quick look at the 25-year chart of the U.S. Dollar Index below. You’ll
see the that the index was on a general trend down until it was turned around
in the mid-1990s, a period characterized by significant growth in the United
States. But after only a few years, the U.S. dollar was back on it’s downward
track.
In the short-term foreign investors may continue to buy the U.S. dollar,
pushing the value of the greenback ever higher. But there’s no doubt in my mind
that the long-term downward trend in the U.S. dollar will continue.
Once the governments, institutions, and private investor who are buying the
greenback right now begin to convert back to other currencies, I believe that
the market will once again be flooded with U.S. dollars. This will lead to a
collapse in value for the U.S. dollar and most likely another official
recession.
When this all takes place, gold will inevitably resume its march higher.
I would not be surprised to see the U.S. Dollar Index below 70 as early as the
first quarter of 2009. I believe that there is still a bit of short-term
downside to gold as the value of the U.S. dollar continues to grow. However, I
completely expect gold prices to break back above $1,000 in 2009. Get ready now.
