/www.fxserver.com/ IF there’s one thing that the market hates, it’s uncertainty. In troubled times, investors hold their cash; they place it on deposit, or buy gold and other precious commodities that become more valuable as anxiety grows.
And this is exactly what's happened over the past thee months. As America's resolve to disarm Iraq has grown, the US dollar has fallen, and the price of gold has risen to seven-year highs.
So it might seem reasonable to assume that this pattern will be reversed as soon as the uncertainty that's driving the market is resolved. On this basis, many analysts now expect that the dollar will reverse its recent 10% fall against the euro as soon as war is concluded or averted.
In fact, some forecasters even predict the dollar will recover the 25% it's lost against the single currency since this time last year, once the Iraqi question has been answered. But the facts behind the dollar's decline tell a different story, one that warns us to expect further dollar weakness in the year ahead, even if war is over by summer.
Let's examine the facts: admittedly, the rapidity of the dollar's recent depreciation can mainly be attributed to the threat of imminent war. The market is 99% certain of a swift and successful US victory in any campaign, but as long as there's a nagging doubt in the minds of investors, all assets linked to the US will fall.
As long as there's a chance that war might drag on longer than anticipated, while there's a risk that the conflict will escalate into a regional war, or if there's an opportunity for Iraq to destroy any part of its oil reserve, then the market will remain nervous and will distance itself from the dollar and US stocks. The market takes this view because it rightly assumes the US will lead any potential attack on Iraq. But to assume that the dollar will rally as soon as Saddam has been ousted is na?ve.
Yes, there will be a sense of relief that might see a short-term correction, but as soon as the desert sands settle, the market's attention will turn to other problems. North Korea represents a far more serious geopolitical threat, given that we know it's a nuclear power and given its close proximity to China.
And last week, the CIA noted with "very grave concern" that Iran had resumed the mining of uranium for its domestic energy programme. Add to these concerns the ongoing threat posed by international terrorism, and investors will have many reasons to stay away from the US markets, which they've abandoned recently.
The US also faces two serious fundamental economic problems: the so-called Twin Deficits. America runs a massive trade deficit, because every day it imports $2 billion more worth of goods and services than it exports, and this has arisen because of the strength of the dollar.
America will need the dollar to stay weak after war to reduce this deficit. And the Federal Budget in the US (the budget which pays for schools, hospitals and the military) is conservatively projected by the White House to record a deficit in excess of $300 billion this year and that estimate doesn't make provision for the cost of war.
The US Treasury will have to fund this deficit by issuing bonds, on which they will have to offer high rates of return to entice investors, and this ultimately will retard consumer activity in the US because mortgage rates jump when the rates offered on long-dated treasuries rise.