The US dollar is poised to face its most serious challenges since the slamming of the gold window by Nixon in 1971. If the dollar fails and loses 20%, 40%, or even 90% of its international value, everything that we import, notably energy, will skyrocket in price.
And with that, so will all other basic living expenses, such as goods that are tied to energy. This means pretty much everything.
In short, a dollar decline will lead to rapidly rising inflation, and, ultimately, a shortage of goods. This means that assessing the risks to the dollar and tracking its value is of paramount importance.
Over across the Atlantic, talk of a major dollar decline is in the news:
[quote]
The US taxpayer bail-out of America’s banking sector is an event whose significance will reverberate for many years. What it means for free markets, for the way Western economies are run, for the prosperity of the world economy, must remain to be seen.
But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable – the US dollar will have to take another major fall.
[/quote]
While there is much that needs to be discussed about this massive turn towards corporate socialism that has suddenly been thrust upon as "the only solution," I remain more concerned about what will happen when – not if – the US dollar is shunned by a breakaway state, fund, or central bank seeking to finally protect itself by dumping dollars.
And why would they do that? Very simply, because there are about to be a few trillion more of them floating around even as the world economy stagnates or shrinks.
[quote]
Sept. 23 (Bloomberg) — Treasury Secretary Henry Paulson’s $700 billion proposal to stabilize the banking system may push the national debt to the highest level since 1954, threatening an erosion of foreign appetite for U.S. bonds.
The plan, which asks Congress for funds to buy devalued securities from financial institutions, would drive the debt above 70 percent of gross domestic product and the annual budget gap to an all-time high, possibly exceeding $1 trillion next year, economists estimated.
"This is sobering, absolutely sobering, even to someone who doesn’t drink,” said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington.
[/quote]
A $1 trillion dollar budget deficit is just the cash deficit that DC will probably rack up next year. Worse, I think the number could easily be as high as $1.5 trillion, given the other "troubled" assets they want to include and the fact that their tax projections assume positive GDP growth next year, an assumption that I am not willing to make.
This uncertainty over the funding level creates a level of uncertainty that will continue to push the dollar down. If it falls far enough, it raises the specter of someone "cutting and running" at some point. That’s when the dollar decline will begin in earnest.
[quote]
But analysts say foreign investors will be increasingly reluctant to finance the growing U.S. deficit at the current dollar exchange rate and that funding the gap would require higher interest rates and a weaker currency.
"Nobody knows what form the bailout package will take. We only know vaguely how much it will cost," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida. The U.S. fiscal position "does not look pretty for this year and next … Overall, the uncertainty is driving the current flight out of the dollar," he added.
[/quote]
As I’ve mentioned before, the final horseman of this entire mess will arrive on the day that the dollar begins to fall in earnest at the same time that interest rates begin to rise. When this happens, it will mean that someone "cut and ran," and I would expect the rest to follow quickly, leading to a very sharp decline in the dollar.
If and when that day comes, your options to reposition your portfolio will be severely limited. The doorway will be jammed.
I place the odds of a major dollar decline over the next six months at 50%. If I told you there was a 50% chance of your house burning down over the next six months, would you consider buying insurance? I hope so.
That’s what everyone needs right now – some insurance against a dollar decline.
by ike