USAToday study of gold quotes GATA supporters Centennial and Blanchard

Beaten-up Dollar Unsettles Investors in USA and Abroad

By John Waggoner
USA Today, McLean, Virginia
Thursday, June 22, 2006

http://www.usatoday.com/money/economy/2006-06-22-dollar-cover-usat_x.htm

Rob Goreham is more sensitive to the price of gold than most of us.
Goreham, who lives in Columbia, Calif., sells gold-mining supplies
and leads chartered gold-hunting outings in the old California gold
fields. He prospects for himself, too. Powered by a three-year bull
market in gold, the supply business is roaring -- and so are
Goreham's returns.

"It's just wonderful," he says.

Not everyone is so giddy. As gold has soared, the value of the
dollar has sunk on international markets, making imports and trips
abroad more expensive. And in recent months, the rise in gold and
fall of the dollar have begun to unsettle investors here and abroad,
with potentially severe consequences.

In the short term, a weak greenback means higher prices for imports
and weekends in Paris. In the long run, though, the sliding dollar
could dry up the world's appetite for the USA's oceans of debt. Were
that to happen, some warn, we could see surging interest rates, a
sinking economy and, perhaps, an end to the dollar's reign as the
world's premier currency.

And something else, too: a possible return to 1970s-style "stagflation" -- a miserable blend of a stagnant economy and
inflation. With stagflation, prices continue to creep up even as joblessness keeps many of us out of work. "Ask any investment
professional what his real absolute fear is, and he'll say a crash in the dollar," says Terry Connelly, dean of the Ageno School of
Business at Golden Gate University in San Francisco.

You now need about $1.25 to buy a euro, the pan-European currency.
Five years ago, a euro would have cost not even 90 cents. It costs
more to buy Japanese yen, too: A dollar buys about 115 yen, 7% less
than five years ago.

So it costs more to travel abroad. The Economist, for example, makes
regular surveys of the cost of a McDonald's Big Mac hamburger around
the world. As of May 22, the date of the survey, it was $3.10 in the
USA. A Big Mac attack in Britain will set you back $3.65. Buy a Big
Mac in euros, and you'll pay about $3.77.

The Economist uses the Big Mac Index to show which currencies are
overvalued or undervalued, relative to the dollar. (By this gauge,
the yen is cheap, euros expensive.) Multiply the currency
differences in the Big Mac Index by the price of a hotel room, and
you'll have a powerful reason to stay put in the USA.

... Long-term worries

A weaker dollar also makes imports more expensive, which fuels
inflation at home and strains relations with our trade partners,
notably China. It's normal for currency markets to rise and fall.
But the dollar's recent erosion is spooking people -- and not just
for the summer travel season. "Most people are long-term bearish on
the dollar," says Richard Asplund, chief economist for the Commodity
Research Bureau.

Soaring gold prices are one sign of how bearish investors have
turned on the dollar. Gold tends to rise when the dollar falls, and
vice versa. After all, if you fear that the mightiest currency on
the planet will lose buying power, you buy gold, which has served as
currency for as long as currency has existed.

An ounce of gold costs $587.50. Gold is way down from its recent
high of more than $700. Still, it sold for as low as $255 an ounce
in 2001, and it's up 130% from those lows and 49% over the past two
years.

Investors in the USA buy gold when they fear inflation, which erodes
the dollar's purchasing power. The consumer price index, the U.S.
inflation gauge, has risen 4.2% for the 12 months that ended in May.
Minus the volatile food and energy components, it's up 2.4%.

That might not seem like a big jump, but after 10 years of 4.2%
inflation, $100 in today's dollars will have the buying power of
just $65 -- a 35% reduction. Federal Reserve officials have said a
2.4% core inflation rate is higher than they deem acceptable.

It's higher than many consumers would like, too. Which is why
they've been buying gold. Michael Kosares of USA Gold [Centennial
Precious Metals] in Denver says his upper-middle-class clients are
buying gold in lots of $100,000 or more. "Our clientele is looking
at the price of commodities going up around the world and seeing
inflation coming down the pike," he says.

... A symbol of safety

Foreign investors are buying gold, too. And that signals dwindling
confidence in the dollar. As the USA rose in political and military
power, the dollar symbolized safety. When the currencies of Russia,
Thailand and other countries plunged in 1998, devastating their
economies and sending world stock markets reeling, the trade-
weighted dollar rose more than 5%. That was because investors sought
shelter in ultrasafe U.S. Treasury bills. Gold rose to just $300.

But the dollar's reputation as a haven is eroding, thanks to the
gargantuan U.S. trade and fiscal deficits. Economists and
politicians have long wrung their hands over those deficits. And for
years, the markets have averted their eyes.

Gold's rise and the dollar's fall could mean that, suddenly,
deficits matter. The difference now? "The magnitude," says Mark
Zandi, chief economist at Moody's Economy.com. The trade deficit is
nearly twice as large as it was a decade ago. So is the budget
deficit.

The federal debt weighs in at more than $8 trillion. It's estimated
to be 67.5% of gross domestic product by 2007, up from 58% in 2000
and 35.8% in 1977. The trade deficit -- the gap between the value of
goods we import and those we export -- was $63.4 billion in April.
At those levels, foreign investors start to worry, despite the USA's
economic might.

Once foreign investors lose confidence in the dollar, the
consequences can be dire. They are, after all, financing a big chunk
of the U.S. debt. Foreigners are big buyers of U.S. Treasuries at
auction. They own nearly half of all publicly traded U.S. Treasury
securities and 25% of U.S. corporate debt and mortgage-backed debt.

If foreign buyers lose interest in U.S. debt, the Treasury will have
to offer higher interest rates to attract buyers. The dollar could
fall further. Import prices would rise. Inflation would surge.
Higher rates, in turn, would slow the economy.

"If there's a slowdown, we could see stagflation," says Neal Ryan,
director of research at Blanchard & Co., a major gold dealer. Those
fears are amplified by the holders of U.S. Treasuries. Japan holds
$639 billion in Treasuries. China holds $323 billion, the Treasury
says. Oil exporters own $99.1 billion. "It's one thing to have your
financing from Japan," Connelly says. "It's another to get it from
China." Japan has a democratic government. China is a Communist
nuclear power, and its relations with the U.S. have often been
strained.

... Buying other currencies

But even with cordial international ties, foreign holdings of U.S.
debt are problematic. Many foreign central banks are diversifying
their holdings, which have traditionally been in dollars. Instead,
they're buying euros and other currencies.

Russia's central bank has cut dollar holdings to about 50% of its
portfolio. In February, South Korea's central bank said it planned
to diversify out of dollars. That caused the dollar to plummet. At
the moment, that seems to be fine with U.S. policymakers. Throughout
the 1990s, the government promoted a strong dollar. But that may be
changing. U.S. officials have been encouraging China to let the
value of its currency, the yuan, float on international markets.

China and Japan have been keeping their currency low vs. the dollar
by stockpiling dollars. If they eased that policy, they'd also have
to stop buying so many dollars -- which would cut the dollar's
market value.

The nightmare scenario: a collapse in the dollar, which would send
interest rates soaring and the economy plunging. Some, though, see
that as unlikely.

"I'm not convinced that the trade deficit is a disaster in the
making," says Art Steinmetz, portfolio manager at Oppenheimer Funds.

To some extent, a drop in the dollar can help ease the trade
deficit. Steinmetz notes that when the dollar drops, import prices
rise. And that means fewer imports. Meantime, U.S. exports will
eventually rise because U.S. goods and services will become cheaper
abroad. "It will adjust as consumption adjusts," he says.

The USA still has a gold-plated credit rating, in part because all
its debt is in dollars. Emerging-markets countries often run into
trouble because they issue debt denominated in other currencies. As
their currency drops, the payments get more onerous.

"There is a big risk of an adjustment in the dollar, but that
doesn't affect U.S. creditworthiness," says Steven Hess, senior
credit officer at Moody's Investor Services.

For U.S. investors, a long-term dollar slide means major portfolio
adjustments:

-- More international. As the dollar falls in value, U.S. investors
benefit from converting overseas profits into dollars.

-- More metal. Gold is one of the most volatile investments you can
make. But a small investment in gold could protect some of your
assets from inflation or a falling dollar.

-- More cash. If rates rise because of a falling dollar, yields on
money market funds and CDs will, too.

So long as investors think U.S. rates will keep rising, they should
continue buying dollar-denominated U.S. debt. But what happens when
investors figure the Fed is finished? That's where things get sticky.

Sooner or later, the Fed will have to stop raising its target for
short-term rates or risk recession. Then, foreigners will have one
less reason to buy dollars. The dollar's fall could resume. And so
could the rise in gold.

One beneficiary would be Rob Goreham's prospecting business. But
gains in the gold industry would hardly offset damage done if the
dollar falls and the economy sputters. Financing the trade and
fiscal deficits are hard enough with a robust economy.

"Try financing them with a slow-growth economy," says Golden Gate
University's Connelly.