RISKY
BUSINESS Another nail in the US dollar's
coffin By Jephraim P Gundzik
Growing political instability in the US
will weigh heavily on the dollar during 2007. This
weight, combined with growing political pressure
for dollar devaluation and a slew of negative
economic factors, is likely to prompt significant
dollar depreciation against most other currencies.
The dollar's decline will help send asset values
in the US sharply lower and precious metals prices
soaring.
Smells like
impeachment The aftermath of President
George W Bush's State of the Union
address last month provided a
clear picture of the now-gaping divide between the
policies of the US president and the opinions of
Congress, the American people and most of the
world. The president pleaded for the support of
Americans for his plan for "stabilizing" Iraq and
the Middle East by escalating the US military
presence in the region. Rather than stabilization,
this policy could fuel civil wars in Iraq, Lebanon
and the Palestinian territories. It could also
lead to military conflict between the United
States and Iran.
Bush, whose only solid
support comes from within his own exceedingly
cliquish administration, is challenging Congress
and the American people to defy his will. A strong
challenge is already brewing in Congress, where
Democrats are teaming with moderate Republicans to
rebuke the president and to withhold funds for US
military operations in the Middle East. Americans
have challenged the president, too, by recently
staging large anti-war protests.
Opinion
polls indicate that Bush's approval rating has
slipped toward 30%, a nadir for a US president not
seen since the days when the impeachment of
Richard Nixon was unfolding in the 1970s.
Ironically, Bush may face the same fate as that
Republican, who also tried to defy the will of
Congress and the American people.
Congress
reacted almost immediately to Bush's pleas for
support by delivering a resolution in the Senate
Foreign Relations Committee declaring that the
Bush administration's plan to send some 21,500
more troops to Iraq is "not in the national
interest of the United States". Similar
legislation is expected to be passed with
bipartisan support in both houses of Congress
within the next few weeks. Such a formal rebuke of
executive-branch policy by the legislature has
very few modern precedents.
The Bush
administration has responded to the prospect of a
rebuke by asserting that the legislature has no
power over the executive branch. Vice President
Dick Cheney told the CNN television network that
any resolution opposing more US troops in Iraq
"won't stop us". Cheney also said a congressional
rebuke "would simply validate the terrorists'
strategy that says Americans will not stay to
complete the task, that we don't have the stomach
to fight".
Over the next few weeks, a
spirited debate will increasingly grip Congress
over how the legislature can exercise its
constitutional powers to impose its will on the
Bush administration. This debate will form the
backbone of legislation that will significantly
reduce funding for the war in Iraq and US military
adventures in the Middle East.
If, as
expected, the administration ignores such
legislation, impeachment proceedings against Bush
or Cheney, or both, may ensue. This battle royal
between Congress and the Bush administration will
create enormous political instability in the US.
This instability will weigh heavily on the value
of the dollar.
No legs left to stand
on In addition to rapidly increasing
political instability, growing pressure in the US
Congress for the devaluation of the dollar will
also undermine support for the greenback.
Democrats, who now control Congress, have long
lobbied for the revaluation of the yuan and yen
against the dollar. Revaluation of the Chinese and
Japanese currencies means devaluation of the
dollar.
The political pressure for dollar
devaluation ratcheted higher late last month after
the announcement by US auto maker Ford that it
lost US$13 billion in 2006. This record loss
surpassed the record loss posted by General Motors
in 2005 of $11 billion. While some of these
enormous losses can be pinned on very high
health-care and retirement costs burdening US auto
makers, much of the blame for these losses is
landing squarely in Tokyo for its weak-yen policy.
Backed by US manufacturers and their
unionized employees, Democrats in Congress are
also vilifying Beijing for its weak-yuan policy,
which has helped push US imports from China to
dizzying levels over the past several years. In
the coming months, Democrats are likely to push
strongly in Congress for legislation calling on
China and Japan to take action to strengthen their
currencies - at the dollar's expense.
More
immediately, the upcoming Group of Seven meeting,
which will be held this Friday and Saturday in
Essen, Germany, is very likely to produce a
statement calling for revaluation of the yuan and
yen. As in the US, European manufacturers are
applying pressure on their politicians for yuan
and yen appreciation. Japan is expected to respond
positively to such demands.
Economic
factors in the US are also cutting the legs out
from under dollar support. In addition to huge
current-account and budget deficits, inflation in
the US is much higher than in many other
countries. Continued high international energy
prices and very rapidly rising grain and oilseed
prices - the product of soaring demand for
biofuels - will push inflation in the US higher in
2007. The idea that inflation will increase in the
months ahead is just beginning to register with
financial markets in the US, where nominal bond
yields have begun to climb.
Though
inflation expectations in the United States are
now heading higher, the Federal Reserve continues
to resist pushing official interest rates higher
for fear of provoking an economic recession and
widespread losses among US banks, which are very
vulnerable to mortgage defaults. Though economic
growth in the US is widely expected to slow in
2007, US stock markets continue to move higher,
making equities increasingly overvalued.
Finally, as the prices for many
dollar-denominated agricultural goods double in
2007, many of the world's central banks will
encourage the appreciation of their own currencies
in order to contain imported inflation. This
process has already begun with several large
central banks beginning to shift reserves out of
dollars and US Treasury securities.
The
only factor supporting the dollar is the
misunderstood contention that interest-rate
differentials favor the greenback. In nominal
terms this is true. However, real yield
differentials favor most other currencies, even
the yen, against the dollar. Rising inflation in
the US will further widen real yield differentials
in favor of other currencies against the dollar
during 2007.
The dollar's swoon appears
inevitable in the coming months. As the value of
the dollar drops, US asset markets will also
swoon. Against this background, precious-metal
prices will head sharply higher as investors
increasingly diversify out of dollar assets backed
by weakening profit outlooks and falling real
yields.
Jephraim P Gundzik is
president of Condor Advisers. Condor Advisers
provides investment risk analysis to individuals
and institutions worldwide. For more information,
please visit www.condoradvisers.com.
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