Investors should expect continued weakness in the dollar over the coming months and year, by 8-12% against most major currencies. Dollar weakness this year already has exerted a bearish influence on U.S. stocks and will continue to do so with a lag. If, as we expect, the greenback weakens further, the bearish influence will persist — and U.S. equities will likely underperform equities in many other (stronger-currency) markets.
Two main factors are likely to further press down on the dollar’s value: 1) a poorly executed U.S. “war” effort and 2) a U.S. Treasury which welcomes a weaker dollar.
The so-called “war on terrorism” is really no war at all. That has nothing but bearish impacts. In recent weeks U.S. appeasement of terror-regimes has heightened the risk of conflict — now with North Korea. Having failed to eradicate Iraq’s regime, U.S. officials now have emboldened the communist, nuke-wielding regime in North Korea. The dollar’s decline has accelerated in recent weeks, as North Korea admitted it is building nuclear weapons (in violation of a 1994 agreement with the United States), kicked out UN nuclear “inspectors” and said it will ramp up its nuclear efforts. On Christmas Eve North Korea’s dictators warned of an “uncontrollable catastrophe” unless the United States provides it with economic aid. That’s blackmail. The dollar is weaker because Secretary of State Colin Powell “promised” recently that no U.S. military action would be taken against North Korea — and that negotiations would begin. Thus appeasement persists.
There is (in the President’s phrase of last January) an “axis of evil” — and these two regimes (Iraq and North Korea) are its lead members. But U.S. foreign policy persists in catering to them. As long as that’s the official U.S. policy, the dollar will be under pressure. President Bush’s high “approval ratings” aside, markets are issuing a vote of no confidence in the Bush administration. If — and to the extent — the United States takes military action and begins to curb or eradicate these demonstrable threats to American security, the dollar could strengthen.
The second factor that’s likely to continue lowering the dollar is U.S. Treasury policy. We warned last March that the strong dollar policy was being abandoned. In early May the Congressional testimony of then-treasury secretary Paul O’Neill gave further evidence of our view. The dollar began its descent last spring and has deteriorated more rapidly in recent months. Despite the recent firing of O’Neill, there’s been no sign of a reversal of the weak-dollar policy. In fact, President Bush picked a near-clone of O’Neill as the new Treasury chief when he named industrialist John Snow on Dec. 9. Snow has a history of lobbying for a weaker dollar. Thus it’s no coincidence that since Dec. 9 the dollar has plunged by nearly 4% against the yen and by 5.2% against gold (at annualized rates of 68% and 90%, respectively). Since Snow’s appointment the dollar also has declined against the euro (by 3.5%) and the Swiss franc (by 4.9%). This is a dollar crisis.
Significantly, Snow has been silent during the dollar’s plunge. That suggests he welcomes it. In response to a reporter’s question the White House tried recently to slow the dollar’s plunge and said people should wait for Snow’s confirmation hearings in Congress. But there’s no rule against Snow speaking now. When he does speak, we suspect it won’t help the dollar — especially if he regurgitates the White House line. In the words of White House spokeswoman Claire Buchanan, “Our policy is unchanged. We support a strong dollar and believe that growth policies lead to a strong dollar.” Similarly, Bush press secretary Ari Fleischer said “The position of the administration on the dollar is unchanged. The administration supports a strong dollar. And growth is one of the best policies to help create a strong dollar.” But this reverses cause and effect. It’s not a strong economy that ensures a strong dollar but a strong dollar that ensures a strong economy. In fact, historically, the dollar has weakened amid strong growth and has strengthened amid weak growth or recession. The White House is repeating the old myth that Treasury has nothing to do with the dollar.
The administration’s “support” for a strong dollar is no support at all. Indeed, since the dollar has weakened for the past 10 months, any administration official who now says “our policy is unchanged” could easily be interpreted as saying, “We continue to favour the dollar’s decline and support Treasury’s malign neglect of the decline.”
Commodities that are sensitive to inflation and geopolitical threats — such as gold and silver — should see appreciation over the coming year, though not perhaps at the rate seen in the past year. The price would drop, however, if the United States waged war quickly and effectively — and if the Treasury Secretary came out with words and actions to support the dollar. We think an effective war and an effective Treasury stance on the dollar are unlikely in 2003. And as we’ve shown, dollar weakness that’s already in the pipeline — together with the Nov. 6 rate cut by the Fed — both signal a further rise in the gold price.
Needless to say perhaps, but investors should realize there is less risk associated with actual war (given the supreme capabilities of the U.S. military) and, in today’s context, far more risk associated with no war (given that the United States has been attacked and has not yet responded by ending any terror regimes or groups), because the United States remains vulnerable to attack and to ever-more brazen posturing (and arms-building) by its declared enemies.