Why 2006 is set to be a bad year for the dollar

The US Congress has just approved another rise in the US debt ceiling, to nearly $9 trillion. The US trade deficit, at 7% of GDP, is at 'Banana Republic' levels, say Andrew Selsby and John Robson of RH Asset Management. With the threat of rising Japanese interest rates already hurting Iceland and New Zealand, how much longer can the dollar remain the world's reserve currency - and which assets might benefit?

By MoneyWeek

Published 18 May 2006 In Features

The US Congress had no option but to agree for the fourth time since 2002 to raise the US debt ceiling, this time to $8.965 trillion. Minority leader, Harry Reid, said this was a result of reckless fiscal policy' and went on to suggest that there was little point in having a ceiling if all you do is keep raising it.

Of course, it had to be raised because the alternative would have been for the US to default on its foreign and domestic liabilities, unthinkable. We like the way Richard Russell reported this process: 'The government won't default, it will simply continue to do what it has been doingcreate more dollars to pay off its rising debts and deficits. It will continue to create dollars until the dollar becomes close to worthless and at that point either a new acceptable currency will come to the fore or a whole new system.'

The US trade deficit continues to rise. Now at about 7% of GDP, it is at Banana Republic' levels. The dollar is the world's most important reserve currency, but can only remain so if foreigners continue to take on board more dollars. Although of no more than symbolic importance, the United Arab Emirates has made a decision to switch 10% of its reserves out of the dollar as a response to the US rejection of Dubai Ports World as a potential owner of US ports.

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The dollar in technical terms continues to look very vulnerable, but what is more interesting is the decisive technical buy signal for the euro. We first reported this at the end of January 2006. That signal has now taken on a significant importance and makes sense as the eurozone plays catch up with its interest rates. We expect a very significant, positive move from the euro over the coming months.