(This is Part 6 of a series. Go back to Part 5.)
Yes, the U.S. has been on a borrowing party from abroad, a little game that goes something like this:
We borrow money from Southeast Asia to finance U.S. federal deficits while U.S. consumers buy low-cost goods from Southeast Asia and finances them with withdrawals of equity from their houses which are rising because the Fed is goosing the money/credit supply which is helping to create the huge U.S. trade deficit which is being soothed by huge Southeast Asian purchases of U.S. debt...and so on round and round the merry-go-round.
"Everybody benefits." Developing nations get to sell us lots of goods and services while we get to borrow lots and lots of money to finance our lifestyle, our rising house prices and our government. Neat, huh?
Of course all parties come to an end soonor or later and so will this one, because it's an unsustainable party. As the economist Herb Stein said, "That which cannot continue forever—won't."
The Chinese currently hold nearly $1 trillion in U.S. government debt. The Japanese hold nearly that much as well. Central banks around the world are bulging with dollars. With the U.S. fiscal and trade deficits in disarray, with U.S. inflation building and with the Fed creating more dollars at a frantic pace, how long will it be before nervous central banks, particularly in SE Asia, begin to sell down their swollen dollar hoards? Answer: Probably not very long.
Various technical considerations lead me to believe that the renewed dollar selloff will begin in earnest sometime in the two or three months after the U.S. mid-term elections on Nov 7. The structural imbalances are so great that this swan dive in the U.S. dollar could arrive suddenly "out of the blue" and be much deeper and more dramatic than almost anyone now expects. I believe this is a matter of "when not if."
This drop in the dollar, in turn, will almost certainly have dire effects on the U.S. stock and bond markets. Yes I know, the DJIA is above 12,000 again as I write this one day before the elections, but I don't believe I've ever seen such a financial house of cards.
If panic selling in the dollar begins, the Fed would be forced to raise interest rates aggressively to defend the dollar. The stock markets would buckle under such pressure, and most likely resume in earnest the bear markets that they began in 2000. And the bond market would likely confirm that the downmove it began in 2005 was the start of a huge bear market that could easily take a decade or more to play out.
(This is the end of Part 6. Go to Part 7.)
—jim sloman, 11.13.06
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