After the speculative devastation his policies have wrought on the US economy, perhaps the devalued Greenback should be renamed the Greenspan in honour of the worst central banker this side of Zimbabwe. However, everything has its price; to paraphrase Keynes, in the beauty parade that is investment, the alternatives look even uglier. The Euro, Yen and Sterling all risk major fundamental downside over coming months as evidence mounts that their respective economies are sliding into recession; decoupling is dead. Meanwhile the US trade deficit is in rapid decline (although the fiscal deficit is set to soar, perhaps to $1trn within a couple of years). I turned more positive on the dollar in April, when bearish sentiment was extreme, in ‘The Fed goes bust, the dollar goes up…’, noting that the dollar had reached an inflection point in previous cycles midway through a recessionary period. Since then, as the chart shows, the dollar index has traded sideways, which is technically a healthy sign after the prolonged slide since 2005 and particularly in the context of soaring crude prices, a big dollar negative, and relentless bad news on the US economy. After this basing pattern, the prospects of a sharp dollar rally in the next few months are high if as I suspect, the housing market stabilises and commodity prices slump. The risks of a US rate hike now outweigh those of a further cut. Moreover, the chances of intervention in support of recent official jawboning of the dollar are significant; the Fed and Treasury now see a stronger dollar as strategically important in battling inflation and the credit crunch fallout. I take the view that this is just a cyclical economic downturn rather than Armageddon, albeit an unusual one in originating on the supply side via the credit markets. The media and investors are seized by confirmatory bias when it comes to the US economy; every shred of bad news is trumpeted as proof supporting the recession thesis, while any positive evidence to the contrary is discounted (as we saw repeatedly last week). We have seen a similar pattern in oil until recently, where mounting evidence of demand destruction was ignored and even the most minor supply disruptions were used as an excuse to hype the price ever higher. The truly remarkable feature of the US economy is its impressive resilience in the face of the simultaneous impact of both the credit crunch and energy crisis. As with the markets, we are already probably closer to the end than the beginning of this slowdown and history suggests that the US will again show surprising regenerative powers both politically and economically, helped by a uniquely adaptable business culture and the best demographic profile of any developed nation. Right now, many blue chip US corporates are trading at fire sale prices to a foreign buyer, and I’d expect a spate of hostile deals like InBev/Anheuser in the next few months, particularly in banking, resources and technology. The real issue is going forward is inflation, rather than the lingering subprime mess. The purchasing power of currencies is under pressure just about everywhere; inflation is being systematically underestimated in official statistics, making bonds the worst long term investment (see US Inflation: A Three Card Trick…). The ECB has been printing money at 22% per annum, despite Trichet’s tough public stance on inflation, while in the US M3 money supply is growing at 20% annually, China is at 18%, India is at 20%, and Russia is at 45%; the world is awash in excess liquidity and this as much as the commodity spike is now feeding into inflation. All this of course gets the goldbugs hyperventilating, but I’m not one of them; the world really has moved on since Bretton Woods and gold is suffering fundamental demand destruction at these prices as much as oil. In a world of paper currencies managed by very fallible central banks, the least ugly contestant will take the prize, and right now that looks like the dollar.

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Commodities, Market Commentary