Why the sudden plunge in the dollar?
John Stepek, MoneyWeek
Nov. 27, 2006

Has the tipping point finally arrived for the dollar?

On Friday, the euro rose to more than $1.30, while the pound hit more than $1.93, levels not seen for more than 18 months. And this is unlikely to be the end.

“We are just at the start of what we think will be a downtrend for the dollar - a tipping point has probably been reached,” said Tim Fox of Dresdner Kleinwort Wasserstein. He expects the pound to hit the $2 mark by March next year - a level not seen since 1992.

The biggest question isn’t so much ‘why is the dollar falling now?’ - it’s more ‘how has it managed to defy gravity for so long?’

The US economy is not really in a position to sustain a strong, or even particularly healthy currency. The country’s current account deficit stands at more than 6% of gross domestic product. To put that into perspective, most economists believe that 4% represents the danger point for an economy.

The US needs to continue to attract foreign investors’ savings to prop up that deficit - but the only way to attract foreign investors is to offer them a decent return on their funds. This is what has been holding the dollar up until recently - the prospect of rising interest rates.

But now, with the US housing market in ‘freefall‘, as some have put it, and the government downgrading its expectations of US economic growth, it looks like the next move in US interest rates could be a cut. This is at a time when interest rates in the UK, Japan and particularly in Europe, are all expected to head higher in the near future.

With rising interest rates no longer on its side, while other economies are strengthening, there is nothing to keep the dollar at its current levels. “Steadily the US dollar will decline through 2007, but probably at a faster pace in the second half of the year, as people realise the Fed is going to have to cut rates,” said HSBC’s Paul Mackel.

In fact, the only asset that is likely to benefit unequivocally from a weaker dollar, is gold.

If the world’s most important paper currency is losing its value, which would you rather buy as an alternative? The euro, which has been around for only slightly longer than the 21st century, and has at least one member country which is a complete economic basket case (Italy)? Or gold - which has been around for millennia, and with the exception of the past 35 years or so, has been used as a currency of some sort for that entire time?

So as demand for dollars falls, demand for gold will rise. And that means that the rise in the gold price triggered by sustained dollar weakness is likely to far outstrip the corresponding dollar fall, making it a good bet in any currency.

Metals: $650 gold nears - RMP
Why the dollar is falling so fast -BBC
Dollar Breakdown to Ignite Gold Market -SeekingAlpha
Crisis of the U.S. Dollar System -GR
PLAYING WITH FIRE: America and the Dollar Illusion -Spiegel

DISCLAIMER: All of the provided information is believed to be accurate, however errors are possible. The opinions in the Commentary section do not necessarily reflect the opinions of Swiss America. Past performance of any investment is no guarantee of future performance. All investments have risk.

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