U.S. dollar will consolidate recent gains and outperform the euro.
U.S. dollar bear’s case: Obama warns of trillion dollar deficits for years to
come just as the Congressional Budget Office estimates the 2009 U.S. deficit at
close to 1.2 trillion U.S. dollars, before the stimulus package. At 75% of GDP,
the gross national debt is 10.6 trillion U.S. dollars. As the global recession
widens and deepens; foreign government buyers of U..S. treasury debt may
refrain from further purchases at record low yields and instead opt to rescue
their own ailing economies. Funding huge U.S. deficits will become increasingly
difficult as the formerly eager buyers of China, Japan, the Middle East, etc
all turn inward to focus on domestic spending initiatives.
Without a “coalition of the willing” ready to lend to America, treasury prices
may soon begin to fall from their lofty highs and yields track higher, forcing
the Federal Reserve to monetize the debt and vastly increase the supply of
money in circulation. Debt monetization occurs when the Federal Reserve
purchases government debt from the Treasury and prints money. It appears that
Uncle Sam might be the lender of last resort to Uncle Sam when all else fails.
This could ultimately jeopardize America’s sovereign debt rating and send the
U.S. dollar over a cliff with inflation to skyrocket.
In the immediate aftermath of the credit bubble burst and the evaporation of
over 7 trillion U.S. dollars of stock market wealth in the U.S., the conditions
for inflation are not yet present in spite of humongous deficit spending and
monetary expansion. However, at some point the total debt and unfunded
liabilities of the U.S. government (exceeding 50 trillion U.S. dollars) will
become sufficiently alarming to its creditors, and a substantial rise in
interest rates will be necessary to forestall a precipitous fall in the U.S.
dollar.
Governments, businesses and consumers in America have collectively
over-extended themselves since Ronald Reagan was president. Although the debt
picture improved somewhat under Clinton, deficits have returned and grown since
2001. With foreigners holding more than half of its public debt, it is
inconceivable that this orgy of borrowing can continue without exacting a
penalty on America’s security and sovereignty.
As America stares into an economic and financial abyss today because of its
profligate spending, it is ironic that the solution for its dire predicament is
more borrowing and spending. Trillions of dollars of stimulus will eventually
end the recession. However, when recovery comes around, the lack of political
will to introduce tax and entitlement reforms and confront its debt overhang
will ultimately inflict permanent damage on the U.S. economy and the value of
the U.S. dollar.
Over the past 35 years, the cyclical pattern of the U.S. dollar has
historically provided a 7-9 year of peak to trough (and vice versa)
performance. Based on the above chart, it is possible that the U.S. dollar has
made its most recent cyclical low of 70 in 2008 and is now attempting to move
higher, although many skeptics question the fundamental soundness of the
currency in light of a much weakened U.S. economy and the ever greater
indebtedness of its public and private sectors.
