Wednesday, July 05, 2006

N.Korea fires up Gold but not the USD

EUR/USD 1.2752 / 55 Hi 1.2839 Low 1.2742
USD/JPY 115.12 / 16 Hi 115.26 Low 114.58

If you needed any proof that the USD's days as a global reserve currency are over you only had to watch market activity today. Gold shot up on the news that the North Koreans were taking pot shots with their missiles but the USD hardly budged. Gold as the global reserve of choice is back in vogue.

And while the U.S. continues to run a huge external deficit, an out-of-control Federal Government Deficit and an incredibly unpopular Foreign Policy (unpopular that is practically everywhere on the planet except Washington), the chances that foreign confidence in the USD will spontaneously recover are virtually nil. Unfortunately the ease with which the U.S. attracted foreign capital inflows in the past means that policy makers don't understand just what the shift away from the USD as a global reserve currency will mean for the U.S. economy. The lesson is likely to be a painful one.

Action is needed.

If the U.S. wants to stop relying on the kindness of strangers it has two choices: it can either increase domestic savings or it can reduce domestic spending. Otherwise it will continue to be at the mercy of the people with the spare cash. And who are those people ? Well, for instance Foreign Central Banks located in not so U.S. friendly places - like Russia and China - and Foreign Investors with lots of spare OIL MONEY, and the U.S. hasn't exactly endeared itself to the people of the Middle East lately. Only the Policy Wonks in Washington don't seem to be in the loop on that issue. Maybe if they stopped spying on U.S. citizens and started reading some foreign news media they might get the general idea.

Let's assume that the U.S. is going to continue losing friends in the wider world, this puts the USD at risk and it needs to do something about its external funding requirement. That is, it needs to reduce it. Fast.

So what are the prospects for generating increased savings and/or reduced spending in the Government sector?

First, there is a (losing) war in Iraq and Afghanistan to finance. Second, there is a Presidential election around the corner and the electorate is not happy. Right. So there is no chance that any progress in reducing the Federal Government's dependency on foreign capital will be made in the short to medium term.

That leaves the Private Sector.

Right. So what does that mean? Well the Government is not keen to curb Private Sector Demand with targeted Tax Hikes or Government Spending Cuts. But there is another policy option.

Interest Rates.

If the FED keeps hiking they just might save the USD. There is no chance they can save the Stock Market. If the FED doesn't keep hiking then it risks a USD collapse. And the Stock Market goes anyway.

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