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03-Jun-09
In Defense of the Dollar
Last week in both my weekly newsletter EPIC Insights and my weekly market commentary I described how the U.S. dollar was destined to fall 5 to 10% over the coming weeks. While weakness would negatively affect Americans' living standards, a slow, deliberate drop would allow the U.S. economy to evolve and become more competitive in a dynamic world. Since I made this prediction, the U.S. dollar index has fallen 4.5% in ten days. Because of this drop, Fibonacci retracements have been violated, the downtrend remains in place, and further declines appear imminent.
Even though steady weakness should be permitted, investors must carefully watch the rate of decline. Over the past three trading days, this rate has accelerated. Such action points to investors' unwillingness to hold the global reserve currency and calls into question the role the dollar will play in the global economy. While some may yearn for a move away from the dollar-based system, they should also watch for unintended consequences.
Many people view money as the root of all evil. Although wealth clearly corrupts, there is one thing more corrosive-power. History shows that people who obtain power are often reluctant to relinquish it. Some commit acts that seem unfathomable to maintain what they have.
The worldwide fiat money system is centered on power. When governments and their central bankers can magically create money from thin air that has no true intrinsic value, these groups yield tremendous power. When that power is not abused, the system thrives. Unfortunately, though, we have now crossed that line. Governments have ramped up the printing presses to such an extreme pace that the future of the fiat system has been jeopardized.
History has not treated fiat money kindly. Dating back to the 11th century, fiat-based systems have appeared in China, France, and England. While the ability to constantly expand the monetary base to fund consumption and investment had immediate benefits, these systems collapsed when the states that sponsored them could no longer support the currency. As the U.S. dollar dives lower, is this what the markets are attempting to forecast?
The U.S. dollar represents the centerpiece of our current fiat money system. With the largest military, economy, and capital markets, the United States has been afforded the luxury of maintaining the world's reserve currency. Recently that advantage has been abused. As our capital markets have become more regulated, our debt has grown, and our military power has diminished, the dollar has declined. The key question is, what does the decline represent?
If the decline is orderly, it points to an evolving globalized world. However, a sharp drop is more ominous. Were we to see the dollar crash, it would question the entire fiat money system. After all, if the dominant power can see its currency devastated in a few short weeks, why should any faith be placed in the fiat currencies of other countries? The United States has a fluid economy. However, the European Union is marked by infighting; and the United Kingdom has a banking sector that exceeds its gross domestic product (GDP). Why should either of these currencies, backed by nothing of value, be seen as safe havens if the U.S. dollar is not?
As we watch currency markets we should consider these factors. I do not believe that central bankers will allow their power to disappear by witnessing the fall of the fiat currency system. Instead, the dollar will eventually stabilize and rebound. For investors profiting from the collapse, we must consider this point. If not, hard-fought gains will eventually morph into quick losses.
Posted at 15:38 in Market Report | Permalink | Top
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