The 24th Hour for the Dollar

By: Michael Swanson | Sun, Dec 3, 2006
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The past two weeks were busy ones for me. Thanksgiving was great and last week I went to a gold investment conference in San Francisco. I didn't speak at the show. But I went out to talk with different companies and get new investment ideas. I didn't have much time to listen to many of the speakers as I was busy meeting with so many different folks.

I only took time to listen to Congressman Ron Paul, a Republican representative from Texas. Paul sits on the Congressional banking committee and shared some stories with audience about the importance of gold. He said that years ago he was part of a delegation that was going to meet with then Federal Reserve Chairman, Paul Volker. He was early to the meeting, arriving before anyone else, and saw Volker ask an assistant what price gold was trading. They might not act like it, but Paul says that the Federal Reserve is obsessed with gold.

Paul is worried that the dollar is going to continue to decline due to the bloated trade and budget deficits that have been steadily trending up since the 1970's, but have been rising at an accelerated rate during the current Bush administration. Paul was against the war in Iraq and told the audience he is scared the Bush administration is going to launch an invasion against Iran in the next two years. He thinks such an event would cause the price of oil and gold to skyrocket. It seems hard to believe that Bush would go into Iran with the way his adventure in Iraq has gone, but Paul is correct in that there are a lot of figures in the Bush White House that are itching for another war.

Eerily, just like before the war in Iraq, people inside the CIA claim that the threat posed to the US has been exaggerated. Just a few weeks ago a CIA assessment of Iran said there is "no conclusive evidence, as yet, of a secret Iranian nuclear weapons program running parallel to the civilian operations that Iran has declared to the International Atomic Energy Agency." White House spokesmen dismissed the memo.

Paul did an interview at the show for the Korelin Economic Report. You can listen to it here. It's worth your time to get a perspective from someone on the inside.

Most Congressmen may be totally asleep when it comes to the dangers of a falling dollar, but there appears to be a buzz of activity inside the Federal Reserve and the Treasury Department. In two weeks the Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke are going to travel to China to discuss the US trade deficit with China and probably try to talk the Chinese government into lowering the value of the yuan.

The Treasury Secretary is taking steps to prepare for a dollar crisis. According to the Wall Street Journal, Paulson "has reinvigorated the President s Working Group on Financial Markets, which had languished. Mr. Paulson is chairman of the Working Group, which coordinates government policy on financial markets and includes the heads of the Federal Reserve, Securities and Exchange Commission, and Commodity Futures Trading Commission. Mr. Paulson has insisted that they meet about every six weeks. Before his arrival, the group met every few months and sometimes as infrequently as once a quarter."

The Wall Street Journal went on to say, "Mr. Paulson is having the Working Group look at the systemic risk posed by hedge funds and derivatives, and the government's ability to respond to a financial crisis, officials said. He has ordered his chief of staff, Jim Wilkinson, to oversee the creation of a Treasury command center to track markets world-wide and serve as an operations base in a crisis. The center would revive a market-monitoring room closed in a 2003 budget cut."

As you probably know the Working Group on Financial Markets is the official title of what some people call the "plunge-protection team."

After the Wall Street Journal article came out, Fred Barnes, of the neo-conservative Weekly Standard magazine, wrote this: "Paulson believes a financial crisis is overdue a serious crisis that would be a body blow to the economy. This fear is shared to some extent by Bush and Bolten, who wanted a major Wall Street player at Treasury in case an economic emergency occurs."

The Bulletin of the Atomic Scientists created the famous "Doomsday Clock," whose hands they move forward and backward as they see the dangers of nuclear war ebb and flow. A few years ago they moved the hands of the clock seven minutes to midnight, a setting higher than it was at the end of the cold war, because the US had rejected a series of arms control treaties while terrorists had been seeking to acquire nuclear weapons.

If you were to draw a similar clock to describe the threat of a currency crisis in the United States its hands would certainly be in the 24th hour.

The dollar has taken a plunge during the past two weeks. The US dollar index broke below its 85 support level and has been falling ever since. Its next support area is 80, which has been support for the dollar index for thirty years. It seems very likely that this level will be tested within the next few months. And if the dollar index stays below 80 for more than a few weeks a full blown dollar rout will be very likely.

The thing about currencies is when they get in a trend they tend to stay in that trend. The fundamentals behind currencies include economic growth rates, interest rates, and debt levels. The dollar topped out in 2000 and 2001 as the bubble in the Nasdaq burst and the US economy entered into a recession. It then fell until the Fed began to raise interest rates in 2005.

That cycle of interest rate hikes helped to put a bid underneath the dollar. That cycle came to an end this summer and it now appears that the Fed will actually start to lower interest rates next year. Fed funds futures contracts are now predicting a 60% chance of a rate cut in March as recent economic data points to signs of a slowing economy. A slowing economy and falling interest rates will bring with them a resumption of the dollar bear market.

I would expect an orderly drop in the dollar index down to the 80 level to occur in the first quarter of 2007. After that though, if the dollar stays below 80 for several weeks, a full blown dollar crisis will likely begin. Gold, of course, will move up ahead of that. I expect gold to go through the 700 level early next year as the US dollar index tests 80. A move below 80 in the dollar index however, will bring the price of gold above $1,000 an ounce.

This is the 24th hour. I'd say we are 15 minutes away from midnight on the dollar clock.

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Michael Swanson

Author: Michael Swanson

Michael Swanson,
www.wallstreetwindow.com

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