The Crashing Dollar

Easy money is here to stay...

IT'S HARD to argue that the Dollar isn't crashing, writes Dan Denning in his Daily Reckoning Australia. 

June gold futures traded at $1,529.10 and silver futures rebounded almost five per cent to $48.35 in New York Wednesday. This was after US Federal Reserve Chairman Ben Bernanke fronted the media and told everyone...that nothing would be changing!

Specifically, Bernanke said that the Fed would end its $600 billion bond-buying program on schedule in June. But he also said, "We are going to continue to reinvest maturing securities, both Treasuries and MBS, so the amount of securities that we hold will remain approximately constant...The amount of monetary policy easing should remain constant going forward from June."

Translation: QEII is ending. But easy money is here to stay. Virtually any asset that's not US cash loved this announcement. The Dow and the S&P — also not US cash — both made their highest closes since 2008.

The next real test for the Dollar is when the US reaches its statutory debt limit sometime in May. You can expect some kind of cock-a-mamey deal between the Congress and the President. It will cut spending, raise taxes, and raise the debt ceiling. That may avert a full on rout in the Dollar.

The US Dollar is probably overdue for a rally. The fact that it hasn't rallied tells you global attitudes toward it as the world's reserve currency may be fundamentally changing. Even so, is it possible the greenback could rally and take some of the starch out of rising commodity prices (especially oil)?

Anything is possible. But Bernanke made it pretty clear he's not going to raise rates. A Dollar rally won't come from rising US rates. Where it will come from? US economic growth? A lower budget deficit? A lower debt?

Hmm. Well, we're just speculating now...but a full-on outbreak of inflation in emerging markets might scare people out of those assets for a bit and back into the Dollar. For example, truckers in Shanghai are striking in protest at the cost of fuel in China. That's just one small example of how inflation in food and fuel can threaten normal economic activity for normal people.

But let's assume China is not going to blow up into an inflationary mess just yet. There is always a European government that seems to be on the edge of a fiscal abyss. Interest rates on two-year Greek government debt are now 22%. Last week, Greece's government reported that its 2010 deficit would be 10.5% of GDP and not 9.4%

What's one per cent among friends? Well, to investors, this is confirmation that Europe's debt problems need to be restructured. The alternative is another bailout by the rich nations in Europe. But even then, a plan like that would involve money printed by the ECB, leading to Euro weakness. Mind you Euro weakness is not automatically Dollar strength. But it's a thought...

But if most paper currencies (the commodity currencies excluded) are getting weaker in terms of gold, what else could make the US Dollar rise? How about a geopolitical crisis? Or how about a genuine 20% correction in stock and commodity prices?

It will be interesting to see how the markets view the Fed action after a few days. If the Fed does keep the size of its balance sheet "constant" will it be enough to support stocks? Does it finally have enough strength to stand on its own earnings? Or is a version of the Dollar carry trade back on, where speculators borrow in greenbacks to load up on commodities?

The only thing we know for certain is that there are a lot of big borrowers in the world and not as many big lenders.