Another nail in the US dollar's coffin

US President George W Bush's intransigence on Iraq is fracturing the American body politic. This destructive trend, combined with growing political pressure for dollar devaluation and a slew of negative economic factors, is likely to prompt significant dollar depreciation, sending asset values in the US sharply lower and precious-metal prices soaring.
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Feb 7, 2007

RISKY BUSINESS

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.

Copyright 2007 Asia Times Online Ltd.