Dollar's Doomsday

Alf Field
8 Jul, 2008

Pressures are mounting around the world that will probably result in a sharp decline in the exchange value of the US Dollar. The source of the problem is the US current account deficit that has destabilised both the world economy and the international monetary system. The reason is that there is no automatic system in place to correct the US trade imbalance. Urgently required now is a decline in the US dollar exchange rate to a point where the US current account deficit is eliminated by lower imports and higher exports.

How much the US dollar needs to decline to achieve this transformation is uncertain, but it could be as much as 30%-35%. This would cause the US Dollar Index to drop from the current level of 72 to somewhere in the region of 47 to 50.

The article "Chaos Chronicled" sets out the reasons why the US current account deficit is to blame for the present economic malaise.

The US is the only country that has been able to run an ongoing current account deficit, with imports exceeding exports, paying for that deficit by the simple expedient of creating more US dollars. There are increasing signs that the world has lost patience with this state of affairs and that people are starting to demand action. The US dollar's reign as the world's reserve currency is about to come to an abrupt end.

Those countries that have been running trade surpluses and accumulating vast US Dollar reserves have a serious problem. In the article "Tribute Paid in Oil" by Hugo Salinas Price, the plight of Mexico is explained. Mexico is the third largest source of imported oil into the USA. Mexico's problem is that it is running out of oil reserves and within a few years (6 to 8), Mexico will actually have to import oil. Meanwhile it is selling this valuable asset in exchange for newly created US Dollars which are causing their reserves to swell. What do they do with their accumulated dollars? How do they ensure that the benefits of their valuable oil exports are not squandered?

The new Russian President, Demitri [Dmitry] Medvedev, in a Press Conference in Moscow on 3 July 2008 said the following:

"I'm speaking about attempting to solve the problems that we have already got now and to make this system more flexible, more suited to today's needs, learning to manage the processes that led to a significant change on the global financial market. This is not an easy task and, what is more, it does not necessarily mean that today's financial structures created over several decades should be broken. But it should be modified and should become more modern, more protected from risks and should not be nationally egotistic, it should instead be more fair in relations between states. The new system can not be oriented towards only one country of one currency. In future it should be based on the harmony of leading economies, on their substantial growth and on the principle of several reserve currencies."

It is unlikely that Medvedev's idea of several reserve currencies will work. That would result in there being several countries that could run current account deficits and pay for them by creating more of their own local currencies. That is the system that has caused all the current troubles. More of the same obviously is not a cure. What is important is that the problem is receiving attention at the highest levels. Unfortunately nothing will happen until there has first been a rapid, shocking, decline in the US Dollar exchange rate.

Richard Russell, who is very sensitive to changes in market sentiment, commented as follows in his 7 July 2008 web site review:

"To start with, my instinct tells me that we are moving into an era of momentous events. I believe that huge changes are being thrust upon us. I don't think these changes are being recognized as yet. I believe that underlying those changes will be the subject of fiat money and the importance of central banks throughout the world. The creation of "wealth" through the mechanism of fiat money is basically irrational and yes -- immoral. You can not mandate prosperity through the process of printing money. Yet nations and their politicians and central banks have been doing this since 1971. My guess is that we are fast moving toward the period in which "the piper will be paid." That's the big picture as I see it."

The next quote is from Larry Edelson at www.moneyandmarkets.com:

The Dollar's Eight Year Slide Looks
Like It's About To Get A Heck Of A Lot Worse!

"The supply of money in the U.S. is suddenly surging at an annualized growth rate of more than 16%. By some estimates, that's the highest rate of growth in the money supply since 1971!

"The scary part - things will only get worse ...

• There is no way the U.S. dollar can hold its current value when fiat money is being created with abandon out of thin air.
• There is no way the U.S. dollar can hold its current value when the Fed refuses to raise interest rates ... while other countries around the world are actively raising rates to bolster their currencies and put a damper on inflation.
• There is no way that the U.S. dollar can hold its current value when foreign economies are outgrowing the U.S. economy by miles.
• And there is absolutely no way that the U.S. dollar can hold its current value when so many overseas investors - who have lent Washington hundreds of billions of dollars to prop up the economy - are now waking up to the fact that holding dollar-denominated assets is a losing proposition.

"Foreign investors are losing loads of money on their investments in U.S. Treasury bonds. They're even further in the red on mortgage bonds, real estate and stocks."

The final quote is from an article titled "Scorched Earth Policy" by David Galland, MD of Casey Research:

"In a fiat monetary system the only tangible barriers to money creation are provided by a loss in stakeholder confidence. While the average American is, sad to say, almost completely ignorant of what a fiat monetary system is, let alone the consequences of same, the same cannot be said of the foreign holders of an unprecedented $6 to $7 trillion dollars.

"To be a touch more specific, by unprecedented I mean as in "never happened before". While, under other circumstances this fact might evoke a raised eyebrow or a concerned comment over cocktails... going into the jaws of a vicious economic/dollar crisis those foreign dollar holdings become akin to playing toss with a lit stick of dynamite. He who holds the dollars when the fuse meets the powder are in for a very, very bad day."

An earthquake analogy is appropriate. When countervailing forces are at work, as in tectonic plates moving against each other, pressures build up. Initially there are minor tremors felt along the fault line. Eventually the pressures become so great that a major movement takes place. An earthquake happens with sudden, unexpected, ferocity.

The same sort of thing happens in markets. It is the source of the saying that "markets spend 90% of the time making up their minds and 10% of the time doing what they have to do". Countervailing pressures build up causing minor tremors. Then pressures continue to build until there is a major change in the market place, the equivalent of an earthquake.

The US dollar index was 120 seven years ago. It is now 72, a decline of 40%. This magnitude of decline over a seven year period gives the impression of several minor declines (tremors) stitched together. The world situation is now fast developing to the point where the downward pressures on the US dollar will become overwhelming and there will be a sudden, earthquake-like, decline to a level where there is the prospect of the US trade deficit being eliminated.

Once the US Dollar index drops to a new low below 70, events will probably happen quickly. That will be the signal that the dollar's doomsday will not be far away.

Alf Field

321gold Ltd