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What Insiders Think of the Dollar

One thing I referred to in the October issue of WallStreetWindow Monthly is an article by Peter Peterson that was published in Foreign Affairs, the journal of the Council for Foreign Relations.

Foreign Affairs is probably the most influential journal in the United States. Some of the articles discuss subjects, which, years later, become the prime agenda. Their writers are among the most well-connected and influential people in the country. They have a better view of what is coming ahead than you or I do.

In the late 1950's, Henry Kissinger introduced the nuclear war concept of "Mutually Assured Destruction" in the journal and then wrote an article about a detente with China before he became Secretary of State.

In the early 1990's, Foreign Affairs devoted an entire issue to an article written by political science professor Samuel Huntington titled the "Clash of Civilizations," which predicted a terror war between Islam and the west. And now Peter Peterson just wrote an article about the deficit crisis facing the United States and the almost inevitability of a dollar crisis.

Peterson succeeded David Rockefeller as the Chairman of the Council for Foreign Relations. He took the position when David Rockefeller retired in 1985. He had been the CEO of Lehman Brothers and served as a director of RCA, Federated Department Stores, General Foods, and Minnesota Mining and Manufacturing. He also served as a trustee for the New York Museum of Modern Art along with David Rockefeller. When John McCloy (who had served as President of the World Bank, Chairman of the Rockefeller controlled Chase Bank, and Chairman of the Council for Foreign Relations) died in 1989, Peterson was an usher along with McGeorge Bundy and former Federal Reserve Chairman Paul Volker at his funeral. In short, he's connected.

Riding for a Fall

Peterson's article, titled Riding for a Fall, opens by discussing the huge increase in government expenditures over the past few years, noting that they are likely to rise due to the military budget and war on terror and the aging of America's population.

He notes that the government budget deficit and America's consumption of goods and services has forced the United States to borrow $540 billion a year from the rest of the world. "This unprecedented current account deficit is paid for through direct lending and net sales of US assets to foreign businesses or persons: everything from stocks and bonds to corporations and real estate. "The United States," he writes, "imports roughly $4 billion of foreign capital each day, half of that to cover the current-account deficit and the other half to finance investments abroad. At 5.4% percent of GDP in the first quarter of 2004, this deficit is substantially higher than its previous record (3.5 percent of GDP) in 1987, when the dollar fell by a third and the stock market took its "Black Monday" plunge."

Economists at the Federal Reserve believe this deficit is going to continue to grow, with dire implications. According to Peterson, "If nothing else were to change, borrowing would continue until foreigners accumulate all the US assets they cared to own, at which point a rise in interest rates(choking off investment) and a decline in the dollar (choking off imports and stimulating exports) would gradually close the current-account deficit....In the absence of an increase in the national savings rate, people would just have to get by with less investment in their own economy and debt-service payments would no longer rise. Instead, Americans would simply make do with less capital, slower growth in GDP, and, of course, a slower rate of increase in their living standards."

Peterson calls this a best case "soft landing" scenario. The alternative is a continual decline in the dollar that eventually snowballs into a fall blown panic, which leads to a sharp jump in inflation, soaring interest rates, and loss in confidence in the economy. It would be the type of thing that we've seen happen over the past few years in Argentina.

Peterson interviewed tons of powerful people to write this article. "Many see a real risk of a crisis. Former Federal Reserve Chairman Paul Volker says the odds of this happening are around 75 percent within the next five years," he writes, "former Treasury Secretary Robert Rubin talks of a day of serious reckoning."

Peterson notes that there are skeptics who say not worry "because governments around the world would never allow a crisis to happen. They would intervene massively to support the American currency by buying dollars....but foreign governments might lose their nerve sooner than place vast sums of their own taxpayers money into declining dollar-denominated assets. And once the mood of private investors worldwide changed decisively, there would be little that governments could do."

Peterson wants the adjustment to be a "soft landing." He thinks the only way this can happen is if the US works with foreign governments to help slow the dollar decline and also for the world to go on a path of more balanced growth. This would require the US to save and export more while the rest of the world imports and consumes more. The problem is, as he admits, this would require "profound cultural changes."

Peterson wants the next President, whoever that is (remember he published this in September), to stop leaving "the impression that vaunted superpower status comes with few long-term costs or responsibilities." He believes "the United States would greatly benefit from a serious and realistic discussion of the total cost of its long-term security agenda. It is a discussion that would lend welcome urgency to efforts to control the federal deficit, and, in particular, to reform ballooning entitlement programs."

You can expect these topics to be all over the press over the next 6 months and it wouldn't surprise me if Bush doesn't end up taking on some of them, especially the reform of social security. This is the type of "advice" Peterson is pushing. It's the type of thinking that is in the air now. But it has to be. As a country, this is the most serious issue we face.

What I want to underscore in this article is the point that the people in the know all recognize the reality of the deficits our country faces and the high possibility of a full-blown dollar crisis. They know the dollar will drop. The strong-dollar policy of the past is being abandoned, because there is now no other choice. Even Federal Reserve officials are saying as much.

The writing is on the wall. The dollar is going to drop and gold is going to rise. It is only a question of how fast and how far each will move.

To make money in the financial markets all you have to do is to understand what the dominant trend is. In the late 1990's, the trend was a boom in technology stocks and the Nasdaq. That boom was driven by super low interest rates thanks to Alan Greenspan's bailout programs for Long Term Capital, Asia, and Russia in 1997 and 1998. But all you had to know to make serious money was that technology stocks were going up.

All you need to know now is that the dollar is going to drop and gold is going to go up. The dollar decline will be the wheel that turns all of the financial markets over the next year and beyond. All of the implications for this aren't clear. No one knows exactly how it will play out. I'm still studying this myself and I know I'm going to grapple with it for the next few months; however, I am skeptical that George Bush and the Federal Reserve are going to be able to engineer a "soft landing" for the dollar. It is impossible to have full control over a financial market. Alan Greenspan said he was going to make a "soft landing" for the Nasdaq in 2000 and it didn't happen. But what I do know for sure is that the falling dollar means gold is going to up.

You have to keep your eye on this long-term trend. Right now the dollar is having a short-term bounce and gold is in a short-term correction and we have not yet seen any definitive technical signs that either are over. But when they are we will be presented with an incredible buying opportunity in gold stocks.

To find out what gold stocks Mike Swanson holds and plans on buying subscribe to his free Weekly Gold Report at http://wallstreetwindow.com/weeklygold.htm

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