DarthMaul09 (30.34)

How low will the US dollar index go and when will the US bond market begin to fear inflation?

August 08, 2010 – Comments (2) | RELATED TICKERS: SA , TCK , SQM

The US dollar index has been on a relatively quiet two-month losing streak, which apparently has gotten the attention of the Chinese government.  Since they hold almost a trillion dollars of US treasuries it is not surprising that they become concerned when the US dollar index falls from 89 to 80 in just two months.  They understand the need of the US government to devalue the US dollar to minimize the real value of the US debt.  With the recent European debt crisis and the rising US dollar, their buying power had been temporarily improved, but now that the US dollar appears to be ready to break below 80, they may view this as a good time to trade this debt for hard assets around the world.

Seabridge Gold, Inc. (USA) (AMEX:SA), Teck Resources Limited (USA) (NYSE:TCK), Sociedad Quimica y Minera (ADR) (NYSE:SQM) have assets which China may prefer to have over their US debt holdings, especially if they believe that the US dollar will fall relative to gold and other commodities.  If this plays out, it will likely be noticed by other buyers of US debt and will cause some concern for future US bond auctions.  This ties into a previous blog I wrote: Will the floating Yuan finally do away with the illusion of low domestic inflation?  Since I wrote that last blog, crude oil has risen above $80 per barrel and wheat and other food commodities have also risen.  The pieces are all coming together to support the argument for price inflation of energy, food and other commodities that we use daily.  Since we have not seen an improvement in wage growth, employment or US real estate prices I believe that it is safe to say that for most US citizens their financial situation has not improved.  This begs the question, when will the US bond market begin to fear inflation and where will that money go if the bond market sells off rapidly?  Foreign bonds, high dividend paying stocks and large multinational companies will probably see most of the money but commodity stocks and metals will probably benefit as well.  If the demand for US debt drops, then it will become more difficult to finance all the new spending programs, which may trigger another decline in the US dollar index.  Later, when the US dollar index appears to be ready to break below 70 will the Yuan sever its ties to the US dollar?  Will the Yuan be ready to become the next world reserve currency or will a basket of precious metals deposited with the new Chinese metal exchange be the new trading currency?  As the US dollar becomes less relevant to world trade, the decreased flow of cheap goods entering this country will further add to domestic price inflation.  The US bond market may freeze up or see dramatic losses further fueling the wealth drain of the US consumer.  At that point, what interventions would be available to the Fed or the Congress, which could significantly alter this downward course?  Our currency is backed by the full faith of the US government, but what if the world loses faith in the ability of the US to service its debt with stable dollars?  This thought experiment is not new and how the world would respond to the mother of all debt crisis is really uncertain, but knowing that China’s actions will play a major part in this story it seems prudent to watch what they do and occasionally listen to what they say.  A very interesting audio-blog that binve found several months ago seems even more relevant today:  Gold - China's End Game?

So will we see the dollar bounce up this week?  Maybe, but if the trend is your friend, then the dollar’s decline appears more likely to continue unless the European debt crisis can be revived.