George Bush believes in a strong USD

President George Bush said in the wake of the Bear Stearns bail-out, that “the US believes in a 'strong dollar”. Does that give you confidence? Surely that news is likely to push the USD to its all-time low of Y81.12 set on 19^th April 1995. But we are a long way from that. I suspect the motive for the comment was to calm those governments holding large amounts of US treasuries, namely Japan, China and Saudi Arabia. Afterall why would a foreign government want to hold a basket of bonds in a depreciating currency on which real yields are also falling. So that’s the rhetoric to support buyers. Which raises the issue of whether the US government will have a problem financing its deficit. The US has had a succession of tax cuts under Bush, with the economy oftening it looks like there will be a series of tax increases in future. On the other side, who wants a weak currency at a time of weaker economic growth? Where is the value when most of your competitors are pegged to your currency? Only the Euro and commodity currencies like Australia, Canada and NZ offer competitive advantage, and they are not significant markets.

Currently the USD is trading at 98.05, well below its 2005 low 0f 101Yen. The doubts cast over the US economy, the high oil prices, the prospect of weaker global growth all seem to support a weaker USD, and more importantly the Fed is about to cut the Fed rate by another 1% to at least create the myth that there will not be a recession. The high oil price in USD terms is sure to undermine local spending too. It could not look much worse. The positive of course is that the USD can repay all its debts by merely flooding the world with USD. It is left holding a lot of very tangible assets, whilst Japan & China can monopoly money. But we are years away from that. Its all payback of course for the mercantilist policies in those countries. So sit back and watch the USD fall to 81.12 Yen. I actually though it would come later, but the Bear Stearns bail out will undermine confidence in financial institutions. I give the Fed credit – they are great at managing perceptions. If only they could manage money better.

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Andrew Sheldon www.sheldonthinks.com