Why does the weak housing market lead to a falling dollar and strong gold?
"Dollar by dollar, billion dollars by billion dollars, the rest of the world, the world that saves -- is buying up the US. We create the fiat dollars with which we buy the world's products -- and the world collects the dollars -- then uses them to buy up the US. The figures are mind-blowing. As of this October, foreign investors owned almost 43% of all US marketable treasuries, 32.7% of all outstanding US corporate bonds, and just over 16% of all US equities. And the numbers keep continuing to climb.
With foreigners owning so much in US Treasury and corporate paper, you know that our creditors are keeping a watchful eye on the US dollar. And why wouldn't they? After all, foreigners own upwards of $4 trillion in assorted US assets.
The Fed is in what I call a tight spot. Many foreign central banks are now diversifying out of dollars. Even Alan Greenspan noted this phenomenon in a speech he gave in Canada last week. In order to increase the dollar's "attractiveness," Mr. Bernanke would normally be tempted to raise rates. But with a trillion dollars worth of variable rate mortgages coming up for re-setting next year, this would not be the time to raise rates. In fact, Goldman Sachs is betting that the Fed will lower rates to 4 percent next year. And analysts at JP Morgan agree, as does Bill Gross of PIMCO.
Yet analysts at the Fed appear to be worried about inflation, and they are even predicting a better economy in 2006. The bond market disagrees. Bonds have been rallying and rates have been declining. The yield curve has been turning increasingly negative (inverting). The bond market is betting that business will slow down next year.
Lower interest rates make the US dollar less attractive. And over the last few weeks the dollar has been heading down. How far down is the big question. A lower dollar means that imports to the US become more expensive. More expensive imports in turn mean rising inflation. It becomes a vicious circle, and if it continues Ben Bernanke is going to be facing a nasty and rather puzzling situation.
A weakening dollar represents a "wake-up call" for gold. Most people don't realize it, but rising gold is a form of dollar-devaluation. It's not an official devaluation, I call it a "free market devaluation". "