Dollar on the Edge

Over the past two months a strange and disturbing thinghappened to the dollar: China and Japan began to shift awayfrom buying US Treasury debt (dollars) and into the Euromarket and other curriencies. Across April and May, the Eurobegan to rise, moving from about $1.20 to the area of $1.30.

This has happened despite the fact that the US Treasury hasbeen signaling more and more aggressively that US interestrates will continue to rise, making the dollar theoreticallymore appealing to foreign purchasers. There is anextraordinary economic danger associated with this: if thedollar collapses, the US economy is going to suffer acatastrophic blow that could double gas prices and sendinflation soaring beyond anything Americans have ever known.

The weaker the dollar becomes, the higher US interest ratesmust go, and the more pressure Americans will be under, atevery level. The Organization for Economic Cooperation andsome elements of the International Monetary Fund arepredicting that the dollar will fall from 35% to 50% toaccount for the gigantic debt that the Bush Administrationhas created by the combination of tax cuts and spending onthe war in Iraq.

This will result in an increase in gasoline prices from theregion of $3.00 to the region of $6.00, and will cause allimports to roughly double in price. This will mean thateverything from clothing to cars to many grocery items willshoot up in price. At this point, the housing market willcollapse, and there will be a wave of bankruptcies. But thenew bankruptcy act, forced through congress by Tom DeLaylast year after he received a half million dollarcontribution from the credit card industry, will insure thatdebtors can never liquidate their indebtedness, meaning thatthey can never re-enter the economy, and therefore thatrecovery, if it occurs, will take at least a generation.This legislation had languished for years, because it is soeconomically dangerous.

A ‘run’ on the dollar, caused by panicking foreign holdersattempting to sell into non-existent buying, could causethe dollar to collapse very suddenly, even over a matter ofdays.

There is evidence that the US is attempting to manage thedeclineby purchasing its own debt. As Asian purchasing of USpaper declined last month, the slack was taken up byCaribbean and UK banks that would not normally have theliquidity to make such purchases. Therefore, they are actingfor a third party, and the only party that would buy dollarswhen a loss in value is inevitable is the US Treasury.

By doing this, the US is hoping to prevent a sudden collapseof the dollar and the subsequent unwinding of the US andworld economies in a fiscal disaster so profound that itwill eclipse the Great Depression. It can work for a while,but inevitably if the US becomes the only major customer forits own currency, the dollar will go into freefall. Where itwill stop, and what will happen to the world economy then,are the looming unknowns that have made world equity markets so uneasy over the past thirty days, and promise to bring more trouble in the future.

Art credit: freeimages.co.uk

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