- The dollar is no longer responding to traditional stimulants.
This week, despite the apparently "hawkish" tone in
the recently released Fed minutes, and trade deficit figures
that were slightly less horrific than expected, the dollar nevertheless
declined against just about every currency on the planet. As a result,
it now teeters dangerously close to the edge of a very large precipice.
Looming large is the 80 level of the U.S. Dollar Index which has
stood as long term support for almost thirty years. This week, the
Index broke below 82, and is sinking fast. When this critical level is
breached, look out below. Without any support beneath it, the dollar could
literally fall off a cliff.
- The trajectory of the dollar is linked to America's
economic status in the world. Last week we learned, thanks in part to
the strengthening euro, that the market capitalization of European shares
now exceeds the market capitalization of American shares for the first
time since before the First World War. At the current rate of appreciation,
European shares will have a market cap 50% greater than American shares
by the end of the decade. However, should the dollar decline turn into
a free fall, this could happen much sooner.
- For individual currencies, the British pound warrants
particular attention as it approaches the significant two-to-one level
against the dollar. The pound currently trades for about $1.99,
and has not meaningfully breached $2.00 since the early 1980's. The
euro, currently trading above $1.35, is bumping against its all time high
of just under $1.37 against the dollar. The Australian dollar has
already hit a new 17-year high and is perhaps a harbinger of things to
come. The sole laggard among major currencies has been the Japanese
yen (and to a lesser extent the Swiss franc), which has been held down
by the infamous carry trade. When it unwinds (which would clearly be evidenced
by a break below the 110 level), buckle your seat belt as all that will
stand between the dollar and oblivion will be the Bank of China.
- On that note, yesterday the Bank of China quietly dropped
the bombshell that its foreign currency reserves, which had just passed
the $1 trillion benchmark a few months ago, had swelled in the first
quarter of 2007 to more than $1.2 trillion. At this rate, China will amass more
than $2 trillion dollars in reserve sometime next year. I can only
imagine how low the dollar would already be were it not for the massive
foreign aid provided by the Chinese.
- So far the Dollar Index has tested the 80 level five
times in the past: 1978, 1990, 1992, 1995, and 2004. On several of those
occasions it took massive, coordinated interventions by all the world's
central banks to rescue the dollar. However, given the enormity of today's
imbalances and the sheer number of dollars in foreign hands, such a bailout
- Perhaps the most significant warning sign is the break
out in the price of gold. This is the first time the Dollar Index has
hit this level with gold trading above $400 per ounce (although it might
have been slightly above that level in 2004). Of course gold was considerably
above $400 per ounce in 1980, but it was only about $200 per ounce in 1978.
Though the dollar was under pressure in 1980, the index itself only fell
to about 85. Currently, spot gold is trading at about $680 per ounce.
- The strength in gold is also a good indication that this
time around the U.S. dollar can count on little help from its friends.
Rising gold prices reveal the suspicion with which many now view
fiat currencies and central bankers' resolve to keep them sound. Therefore,
foreign central banks will be reluctant to take actions to further weaken
their own currencies, ushering in greater domestic inflation and calling
into question the soundness of their own respective monetary policies.
Low gold prices gave cover to such inflationary interventions in
the past, but today's rising prices urge caution. As a result, the
chances that the dollar can dodge another bullet are increasingly
- Despite the impending gravity of this situation, few show
any worry. Perhaps the dollar will bounce from these levels and will buy
us a little more time, but how much? When the support ultimately gives
way all hell will break loose. A sharp decline in the Dollar Index below
the 80 level will likely take down the bond, stock, and real estate markets
as well. Since a lower dollar will exert additional upward pressure on
already rising consumer prices, the ensuing combination of rising inflation,
higher interest rates and lower asset prices will be a toxic mix.
- - Peter Schiff CEO and Chief Global Strategist
- Euro Pacific Capital, Inc.
- 10 Corbin Drive, Suite B
- Darien, Ct. 06840