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Very dangerous situation for the dollar: escape from the US dollar currency up; fall to $US1.50 against the euro by the first quarter of 2008 possible

Posted by gasweek on 26 September, 2007

The escape from the US dollar had begin. Kuwait became the first of the oil sheikdoms to break its dollar peg in May, a move that has begun to rein in rampant money supply growth. A fall in the dollar to $US1.50 against the euro is not out of the question at all by the first quarter of 2008. According to Ambrose Evans-Pritchard, writing in The Sydney Morning Herald, (22/9/2007, p.44), said Saudi Arabia had refused – for the first time – to cut interest rates in lockstep with the US Federal Reserve, signalling that the Gulf kingdom was preparing to break the dol­lar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East”.

In­vestors will shun the US bond markets: “This is a very dangerous situation for the dollar,” said Hans Redeker, currency chief at BNP Paribas. “Saudi Arabia has $US800 billion ($929.5 billion) in their future gener­ation fund, and the entire region has $US3500 billion under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States.” The Fed’s half-point cut to 4.75 per cent this week has already caused a plunge in the world dollar index to a 15-year low, touch­ing the weakest level ever against the mighty euro at just under $US1.40. There is a growing danger that global in­vestors will shun the US bond markets.

Collapse in purchases of US bonds: US data on foreign holdings released this week show a collapse in purchases of US bonds from $US97 billion to just $US19 billion in July, with outright net sales of US Treasuries. The risk is that this could accelerate as the yield gap between the US and the rest of the world narrows rapidly, leaving America starved of foreign capital flows needed to cover its current account deficit, which is expected to reach $US850 billion this year, or 6.5 per cent of gross domestic product.

Fall in the dollar to $US1.50 against the euro: Redeker said foreign investors have been pulling out of the long-term US debt markets, leaving the dollar dependent on short-term funding. Foreigners have funded 25 to 30 per cent of the US’s credit and short-term paper markets over the past two years. “They were willing to provide the money when rates were paying nicely, but why bear the risk in these dramatically changed cir­cumstances? We think that a fall in the dollar to $US1.50 against the euro is not out of the question at all by the first quarter of 2008,” he said.

The US itself is the problem: “This is nothing like the situation in 1998 when the crisis was in Asia, but the US was booming. This time the US itself is the problem.” For Saudi Arabia, the dollar peg has become a liability. Inflation had risen to 4 per cent and the broad money supply (M3) is surging at 22 per cent. The pressures are even worse in other parts of the Gulf. The United Arab Emirates faces inflation of 9.3 per cent, a 20-year high. In Qatar it has reached 13 per cent.

The Sydney Morning Herald, 22/9/2007, p. 44

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