The perception that the dollar is getting stronger is mostly an illusion. Deflation is "dollar positive" because investors who flee from toxic assets naturally move into cash. But that doesn't mean they have faith in the dollar; far from it. The fundamentals for the greenback get worse by the day. Fiscal and trade deficits are out of control, the national debt is tipping $10 trillion, foreign investment is drying up, and confidence in US leadership has never been lower. The dollar is on a time-line of roughly 6 to 18 months before it's rolled into spools and sold as toilet paper. Paper currency is a country's IOU; and foreign central banks are wary of taking checks from a country that no longer wins wars or has the capacity to pay off its debts. That's why, for the first time, there's serious talk about the US losing its triple A rating on government debt. And it could happen sooner than anyone thinks. Every time the Fed uses the dollar to prop up the faltering banking system or provide limitless capital for defunct GSEs like Fannie Mae and Freddie Mac; the dollar comes under greater and greater pressure. At a certain point the dollar will crumble and the country will have to sell off its assets and industries to pay the bills. That's when the private equity vultures and Sovereign Wealth Funds will swoop down and scavenge anything of value for pennies on the dollar.
Two weeks ago, Merrill Lynch sold $30 billion of Mortgage-backed junk for 20 cents on the dollar. But they also financed the deal, which means that they really only got 5 cents on the dollar! This reflects the true "market value" of these assets. They are virtually worthless. Naturally, Merrill's sale sent tremors through Wall Street where banks and other financial institutions are sitting on trillions of dollars of this garbage marking it down at a few percentage points every reporting period rather than doing what Merrill did and putting it all behind them. As a result, the banks have less capital to lend, which means economic activity will continue to slow and the country will go into a deep recession. The point is, that the Federal Reserve now holds about $400 billion of this junk-paper on their balance sheets and the US Treasury is planning to take on hundreds of billions more (perhaps as mush as $800 billion more under the new legislation!) to prop up Fannie Mae and Freddie Mac. The Bush administration is using the credibility of the dollar as collateral in its plan to bail out the most reckless, high-stakes Wall Street gamblers and their multi-trillion dollar Ponzi scheme that has blown up in their faces.
So, how does this affect the dollar?
The nation's debts are entirely balanced atop its currency. The greenback is like a circus strongman holding a barbell precariously over his head; as the weight is increased, the sweat begins to appear on his brow while the veins in his neck and forehead begin to bulge. Finally, the knees buckle and the over-matched weightlifter crashes to the canvas in a heap. That's the future of the dollar in a nutshell. Its just a matter of time.
No one knows where the bottom is for gold, but one thing is certain: it's future looks a lot brighter than the dollar's. The Bush administration has yet to demonstrate that it can enforce Dollar Hegemony via military intervention. That is a very big deal indeed. If the dollar isn't backed by Middle East oil, then the $6 trillion stockpile of dollars and dollar-denominated assets that are languishing in foreign central banks and sovereign wealth funds, will continue to dwindle until the dollar's position as "reserve currency" comes to an end.
