Taking A Hard Look At The Dollar

The range of the dollar index is roughly 75 to 85 and presently sits just under 80; 80 is where we have been many times before over the last 30 years. Yet, we read and hear almost daily that the dollar has been devalued due to QE over the last many years, that the dollar is falling, that it will lose its reserve currency status, etc, etc.

The fact is the dollar has been stable for years. It was where it is now at the end of 2010. I have personally hardly mentioned it in my articles more than a few times over the years. It simply hasn't been an issue. But as of last week I noticed its trend looks to be breaking down. It has marginally broken through 80 and if it falls through 79 it may well be signaling a return to past lows.

One reason is dwindling confidence in the U.S. government's ability or willingness to pay its bills. Another is the appointment of Janet Yellen, who is admittedly more concerned about unemployment than inflation. And over the weekend China criticized the U.S. for threatening default and recently a Chinese rating agency downgraded the dollar. Meanwhile China has been expanding the role of its own currency in world trade.

All of these factors are real reasons for the dollar to drift lower. Some are predicting this will lead to higher gold and commodity prices - and that may happen. However, I am not one who believes that a falling dollar necessarily means rising gold, or a rising gold price means the dollar will fall. That's because I've lived through periods where both the dollar and gold rose together. 2001 to about 2006 was such a period. And in fact, within the last few months the CRB, gold, and the dollar have all fallen simultaneously. But, the dollar is an important factor to keep an eye on, and could be signaling a shift in sentiment and investor confidence.

For example, if the dollar were to fall sharply from here and become an issue in the press for a period, it could lead to a sustained rise in gold and other commodities. A lot depends on why it's ! falling. Perhaps even more to the point is to keep an eye on the factors pushing the dollar down.

For years there has been talk of the dollar losing its reserve currency status. I've never taken the talk seriously. The depth of the dollar market is too big to lose it's trading use any time in my life time. Even assuming its use will diminish, it will still be used as reserves by governments and as money by people all over the world. Even if the dollar was not the reserve currency, individuals and governments would still use it as they do today because it's the most acceptable and accessible currency in the world.

China will eventually have a currency that competes with the dollar - it's almost inevitable. But it will have no more affect on American's than the creation of the euro which now is used as a currency and accumulated as a competing reserve asset throughout the world. The dollar has been diminished by the euro, but not replaced by it. The same may be true of the Chinese currency as the years go by. It will no doubt grow in use, but will be far from able to replace the dollar.

The fact is that no other country offers the transparency, the court system, or the reputation developed over centuries as does the U.S. This will not change anytime soon unless the U.S. actually commits financial suicide by defaulting on its creditors, which it has never done. The fact is that the U.S. has over 10 times the amount of money coming into the Treasury as it owes in interest to service its debt. It would take an act of intentional default not to pay our creditors. And since we are not at war with any of them there's no reason to choose to default.

Meanwhile, China for all it's attempts to establish a world wide currency, has no court system to protect creditors as does the US. It has no reputation to trust. And it's currency is not convertible and has no market value of its own -- it's tied to the dollar. For China to rival the dollar would take years of independent sound monetary polic! y, a conv! ertible currency, and a reputation of trust. Not until people are clamoring for Chinese money, euros, (or gold for that matter) rather than dollars, will the reserve status of the dollar end involuntarily.

This is not to say the dollar is immune to plunging or soaring in value at any given time. But since the mid 1980s the dollar has never been a major factor in determining the gold price, inflation rate, or interest rates. It's range has been contained with 80 being about par. That's where we are right now, and why we will watch it closely for any sign of it breaking down.

The recent budget fight has dented the reputation of the United States throughout the world. We may see a subtle but continuous shift away from dollars and toward gold and other currencies and assets in an attempt to diversify investments and reserve assets held by governments. The physical demand for gold has risen sharply during this debt ceiling battle, and as I type this, the price of gold is up over 30 dollars and the dollar index is breaking lower. The question now is whether this is the beginning of a trend.

Source: Taking A Hard Look At The Dollar

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)