Total Disaster for the US Dollar?

5 April 2007

I will be the first to admit that I am over my head on this topic. So I will defer to Jim Sinclair, who has been around to call the entry and exit points on the gold bull and bear markets since 1967. Mr. Sinclair has just issued a warning that "total disaster" is near for the US Dollar. Mr. Sinclair's chart is here. I honestly don't know when or if the US dollar will fall below the critical .80 figure on the international US Dollar Index (its all-time low), but I do know that if that happens, it will be Mr. Bernanke's first real test.

At its recent .8240 level, it is clear that the US dollar is in critical condition. At the same time, a historic fall below the .80 level will be a signal event, and no global decision-maker is going to allow this level to be compromised in the absence of a contingency plan.

The fall of the US dollar makes it less attractive to global policy-makers (particularly the central bankers of the countries most heavily committed to holding US dollars – specifically, China, Japan and some of the Arab states). However, the primary central bank holders of the US currency have no interest in seeing its value diminish, as this will compromise the worth of their international reserves.

Thus, the international face-off may continue to play out in complex and difficult to predict ways.

Specifically, the US dollar's primary holders will at some point desire to be rewarded for holding this declining currency, and stable or lowering interest rates will not address their needs.

On the other hand, if Mr. Bernanke continues raising interest rates (to reward the international investors in US dollar bonds who daily prevent a US dollar débâcle by adding to their holdings), then he risks bringing the US economy to a stalling point, which will undercut the attractiveness of US general equities (stocks) to foreign investors.

(N.B. The US must sell $2-3 billion dollars per day in bonds so as to cover the massive US current account deficit, which runs at 5-7% of US GDP. This level of imbalance is typically seen only in countries whose currency values are breaking down.)

Given the present stalemate situation, Mr. Bernanke would prefer neither to lower nor to raise US interest rates, and he may be able to extend this no-win game for a lengthy period – so long as the US dollar does not fall below the critical .80 level and the US economy does not crash and burn.

Most all of those in the gold camp expect Mr. Bernanke at some point to lower rather than raise US interest rates under pressure, but this will weaken the US dollar further.

Hang on for the ride – as Mr. Bernanke cannot preserve the present stalemate situation indefinitely.

My advice – hang on to gold for its ability to provide security in times of turmoil!

P.S. By the way, if the US dollar falls below the .80 level, my guess is that we will gradually start pricing gold in terms of currencies other than the US dollar. For example, even Canadians almost never consider the Canadian dollar price of gold.

At some point, whether sooner or later, Mr. Sinclair will be proven right on his call. We will then start to look at the price of gold more in terms of our own national currencies, and less in terms of the US dollar – as it will no longer function as a single global reserve currency. For example, Canadians are buying gold in pooled accounts on Kitco today at $782.38 Canadian. These numbers will gradually become more familiar to us as the US dollar wanes in global significance.

19 April 2008: For more recent opinion on the fundamental problems with the US dollar, click here or here.

($9000 gold as the US dollar collapses? Click here)_