Dollars and Dragons
That it is in nobody's best interests to see a US dollar decline and financial system spiral out of control is stating the obvious. Not so obvious to many (read: mainstream economists) are the reasons why such a scenario might actually occur. Those reasons are most surely the topic of conversation in the halls of China's central bank and others around the world, notwithstanding all the talk about how our foreign friends will continue to play the US Federal Reserve's game given "all that is at stake".
Against any backdrop of public solidarity we continue to hear foreign countries expressing unease with ongoing levels of US spending and debt, rumblings about oil bourses denominated in other currencies as well as economic advisers to foreign governments professing the virtues of foreign exchange reserve "diversification".
This diversification, or what might more accurately be described as US dollar aversion, has clearly been taking place; the run-up in gold this past year as well as the impressive comeback from the May-June declines point to rather large, strong hands at the core of the precious metals market. It may also explain why the currency has barely gotten out of the starting blocks the last couple years despite favourable conditions, such as seventeen quarter point rate increases and corporate repatriation rules that yielded permanent tax savings last year.
So far in 2006 we have a slowing US real estate market and declining refinance activity. With the Fed funds rate now at 5.25%, and a large portion of ARMS coming due this year and next, consumers would arguably be more than hard-pressed to come up with that extra cash that 2-3% mortgage rate loans were generating the last few years. With the nation dependent on consumer spending for 70% of its economic prowess, it should be clear as day that trouble looms for the economy.
With its inverted yield curve the bond market is predicting as much, as well as an eventual Fed reversal on interest rates. It also appears - for the time being - to be unconcerned about any future dollar weakness and is pricing itself accordingly. But if a lower fed funds rate is expected in the near future, it is difficult to see how the dollar keeps from falling out of the blocks altogether.
In all likelihood it may very well be the degree of US economic weakness, and the realization that things are much worse than initially assumed, that will catch many - foreign central bankers included - by surprise. That may be the point where even the worst of habits, admittedly so totally and completely ingrained in money printers, finally get broken as a certain "faith" threshold is breached.
A separate dollar decline consideration is what happens to outsourced jobs as well as the hundreds of thousands of foreigners working in the US. As many come here to earn dollars that they regularly send back to their extended families in their home countries, converting back less and less every month might make the whole exercise rather pointless. The turn of events, particularly if things get really nasty, will be the cruellest of fates for these individuals, who in many cases experienced similar hardships in their own countries and who opted for the financial "security" of the US.
US corporations, who profited pretty smartly on the front end slashing their payroll costs by hiring lower paid foreign workers, would surely pay on the back end when they are forced to scramble and hire whomever they can find to replace them - namely, unemployed Americans. Training these new workers and getting them "up to speed", after years of voluntary retirement thanks to home value paper gains that will be quickly evaporating, will further magnify the payroll cost shocks awaiting many of these corporations and their shareholders.
The timing of any decisive dollar move to the downside is not knowable, although in the short term anything is possible. We are more concerned with the longer term trend and preservation of purchasing power. Bankers maintaining a coordinated public face - win or lose - is quite unrealistic when one side consistently loses while history has also shown that even the most carefully "engineered" of plans can take unintended turns for the worst. Thus, any role-playing agreement made in central banking heaven can easily come crashing back down to earth in very quick and destructive fashion.
To learn how to preserve your wealth and protect your purchasing power, I suggest that you download a free copy of Euro Pacific Capital's research report entitled "The Collapsing Dollar; The Powerful Case for Investing in Foreign Equities" available at www.researchreport1.com.