The Fate of the Dollar

In the lead article for the International Speculator that I wrote on December 24, 2004, entitled “The Dollar Bounce”, I commented that the U.S. dollar was overdue for a period of strengthening.

While that bounce has now occurred — and continues as I write this — nothing has changed about my mid- to long-term views on the U.S. dollar (it’s going down the drain) and, by extension, gold (it’s going to the moon).

In support of that outlook, I need only take a quick look at the global perception of the U.S. dollar.

Take the OPEC countries. They certainly have no incentive to either own the dollar or keep assets in the U.S. If I were them, I’d be very afraid that the USG might hold my U.S. assets hostage in the so-called War on Terror, wherein all Muslims (correctly) see themselves as the enemy of choice.

That’s one reason why OPEC reports show that its member nations have cut their holdings of dollars from 75% to 61% of deposits in the last three years. It’s true that Arab FX reserves are small, totaling only about $65 billion for Saudi Arabia, Kuwait, Qatar, and the UAE – a mere tenth of the Chinese reserves, for example. And I doubt they’ll ever grow much beyond that, simply because practically every economy in the OPEC is chronically corrupt and socialistic. But as OPEC countries move away from the dollar, the world will see it as one more straw in the wind. That’s on top of the gold-backed dinar, created by Malaysia, which I expect will gain favor.

Even if I should be right in believing the Euro will ultimately share the same fate as the dollar, I am of the opinion that OPEC member nations are going to begin pricing their oil and hold larger percentages of their currency assets in Euros, not dollars… if only because Europe is a much bigger trading partner for them than the U.S. OPEC imports from Europe rose 29% between 2001 and 2003, while those from the U.S. fell by 14%. The way I see it, that trend is likely to accelerate (unless the collapse of the dollar prices U.S. goods at giveaway levels), mainly because the Europeans haven’t positioned themselves as enemies.

The Asian Element

Moving to the East, we are beginning to see the Chinese, (soon to be followed by other big potential bag-holders of U.S. dollars) divest themselves of their U.S. dollar positions by trading for real assets. IBM has just sold its laptop division to a Chinese company for $1.3 billion, and the Chinese are bargaining to acquire Noranda in Canada. No doubt they’ll be spending scores of billions in the U.S. on capital assets in the near future, while Americans are spending hundreds of billions on worthless trinkets from the Chinese. It’s almost as if the Chinese will be doing to Americans what Americans did to the Indians when they bought Manhattan. It never makes economic sense to trade capital goods for consumer goods. And, unlike the Japanese, who managed to shoot themselves in the foot by top-ticking every market they entered in the late ‘80s, I suspect the Chinese will be shrewd buyers. The only thing stopping them is that they’re probably afraid, like the Muslims, that the USG could go psychotic and freeze their assets on some pretense.

While the Japanese Central Bank has recently been making noise about redoubling its efforts to support the U.S. dollar, it is increasingly helpless to do much about it. They simply don’t have enough money to keep the floating abstraction of the dollar afloat.

How’s all this going to end up? As nationalistic and paranoid as the U.S. has become, it’s entirely possible that the government might do something irrational in the military or economic arenas, where it is most powerful. Militarily, I expect it to continue the present trend of pointless adventurism. That’s an easy call.

Economically, however, I suspect we’ll see a reversal of what has been a longstanding trend towards freer trade and freer markets. As the USG sees capital leaving the U.S. and the world dumping dollars, it’s not going to solve the problem by controlling itself – which is the only, and ultimate, solution to the problem. What they’re going to do (and I recognize this is a radical prediction) is put capital and FX controls in place. We have already seen attempts by Bush to erect trade barriers; capital and FX controls are just points further up the continuum. Of course they will be completely counter-productive. Disastrous. But desperate men with power do desperate things.

The bottom line?

While the dollar was overdue for an upward bounce, which is currently ongoing, the long-term downtrend is still very much intact.

Of course, dollar strength is bearish for gold, because so far the strength in gold has been as much a mirror image of the dollar’s weakness as anything else.

Within that statement, however, are two big positives:

First, the strong correlation between the U.S. dollar and gold over the last few years confirms that there is a significant subset of the world’s financial community that now, correctly, views gold as a global currency. Foreigners know that their own currencies are little better fundamentally than the dollar – they’re just pieces of paper that are temporarily strong against the dollar. The Euro zone countries have all the problems of the U.S. dollar (like bankrupt national pension plans) and more, stemming from an even more socialistic approach to problems. At least, perversely, the USG can ultimately support the value of its currency by taxing Americans: with the implementation of the European Union, and considering already high tax burdens across the Euro zone, Brussels can’t steal the assets of Europeans nearly as easily.

The cycle that is unfolding is, at this point, fairly predictable. Namely that the sheer volume of negative attention paid to the intrinsic flaws of the U.S. dollar will lead, in a natural progression, to a comparison with competing currencies, the Euro and gold in particular. At that point people will increasingly begin turning to gold (and electronic forms of same) to preserve purchasing power.

This is not going to happen overnight, but it is going to happen. In the meantime, I expect the U.S. dollar to continue its rally for a bit longer.

The second positive is that the gold stocks move down as the dollar rallies, providing us with what I would consider a last-train-out chance to load up our portfolios with the best of the best. Provided you own stock in quality companies – well-run, financially sound operations with big projects – a dip in the stock shouldn’t be concerning at all.