What If the Dollar Just Keeps Rising?

January 12, 1998

Business couldn't be better, consumers are as confident as they've been inyears, the dollar is king and interest rates are bouncing near multi-year lows.

Not much for U.S. investors to worry about, right?

Think again. That strong dollar, of all things, is threatening to blight therosy picture by destabilizing financial markets and constricting global trade. Moreover, there is no apparent way to stop it.

I implied as much in an earlier column which held that the greenback's appreciation over time might come to resemble a perpetual motion machine.

And so it has, with two seemingly irresistible forces now driving the dollar ever higher.

The first factor, framed by the collapse of Southeast Asia's economies, is the stampede of foreign savings into the seemingly safe and still-promising haven of U.S. financial assets. As I recently wrote, this has seriously impaired the stock market's ability to correct bullish excesses.

The other spur to the dollar's move skyward is a tightening supply. As receivables from bankrupt Asian borrowers are wiped off the books, the asset base on which banks can make new loans contracts.

In our fractional reserve banking system a single new dollar of deposits can be used to create many new dollars in loans. The "money multiplier" is working in reverse now, and it is making dollars much harder to come by, particularly if you need them to prop up a shaky business in a country whose currency is falling.

The contractionary effect is a salient characteristic of the dollar short-squeeze I forecast here in September, but it has not yet kicked in with full force. When it does, perhaps late in 1998, commercial rates will soar. That would be an unmistakable though perhaps belated warning to investors to run for the safety of T-bills, or even precious metals.

Meanwhile, although Federal Reserve Chairman Alan Greenspan recently acknowledged what this column has been shouting for well more than a year -- that deflation has become a much greater threat to the world's economy than the phantom inflation he and his cronies have long feared -- the financial gnomes are poorly equipped to deal with it.

This is because a fundamental problem associated with the deflationary juggernaut , a squeeze on the dollar, lies beyond their experience and perhaps beyond their understanding.

But it is familiar to anyone who has spent a dozen years in the trading pits, as I have. I've watched stocks double or triple in a matter of days when driven by forces very similar to those I have described above.

No market remotely as the dollar's has ever been squeezed. But that is not to say it couldn't occur. All it would take is a slight ratcheting up of forces that are already in place: a potent combination of kamikaze desperation and insatiably bullish demand.

Bankers have remained oblivious to the threat as they've busied themselves with bailouts in Asia. But the sums involved -- about $60 billion in the case of South Korea, for instance -- are just cracker crumbs tossed into the deflationary maw.

The workout artists undoubtedly are acting in the quaint belief that global trade in goods and services determines relative currency values. Just shore up a few banks and float some emergency loans to key exporters, the thinking goes, and everything will turn out okay.

The strategy might have worked a decade ago, but it won't work now. With an estimated $60 trillion dollars of leveraged financial instruments in circulation, the trade in tangible goods has become almost superfluous to the fluctuation of currency values.

But not to the U.S. economy, whose continued robust growth will depend to a growing extent on the ability of the bankers to brake the dollar.

There are some compelling reasons they should want to try. The most obvious is that the greenback's steady upward drift is pricing our goods and services out of world markets.

Measured against a basket of currencies, the dollar has appreciated nearly 16% since last January, nearly half of it in just the last eight weeks.

That's a hefty surcharge on our exports and especially burdensome with hard-pressed manufacturers in Southeast Asia and elsewhere breathing down our necks. Have you seen the ads for those $7,995 Kia automobiles from South Korea?

But the potentially more serious concern, as I have suggested above, is the effect a soaring dollar will have on global lending. Mainly, banks will grow less inclined to lend to customers in countries whose currencies are sinking in value.

That is why there is such urgency about making loans to South Korea, whose economic problems could slip beyond immediate remedy if cash flow is choked off, even if for just a few weeks.

Japan, too, has its deflationary problems, and they are well-known. High level meetings between the U.S. and Japan were being held on Wednesday as this column was being written. Currency markets were rallying, obviously in expectation that a deal was being struck to bolster the yen.

If my technical indicators are correct, however, any artificially induced weakness in the dollar will be temporary. I project a further decline of 22% in the yen from current levels, to a rate of 159 yen/dollar.

Should this occur, it would be catastrophic for our exports, as well as to global purveyors who finance their dealings in dollars.

As such, as the dollar charges still higher it is almost inconceivable that U.S. stocks and bonds will continue rally. Something's got to give, and my guess is that it will be share prices.

The King James Bible mentions gold 417 times. Not once does it mention a paper currency.

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