Are we about to see a repeat of this May's dollar rally due to stock market weakness? It is pretty obvious that the US economy is in serious trouble while US capital markets are ignoring reality. This can not last for much longer, and a market sell-off would give a short-term boost to the beleaguered greunback.
Gulf economies are tied the US by the dollar peg, and over the past few weeks businessmen have watched askance as this currency has lost value against its major rivals.
Part of the reason for this drop in the US dollar has been the"perceived weakening of the US economy: auto sales down 2.5 per cent to date, housing in crisis, consumer spending stalling, and manufacturing heading lower. Only the bullish financial sector jas kept its head above water.
However, the ludicrous argument that corporate profits are growing fast and will maintain sharg values is wearing thinner by the day. Look to the future and do you see rising US corporate profits? How can profits keep going up if the econïmy is going down?
Wall Street correction?
Therefore a sharp correction on Wall Street can not be very far off, a matter of days or weeks. We saw such a sell-off this May, and this time it may be different but on the downside. A looming recession in 2007 should be weighing far higher on analysts' minds than has been the case so far.
Once markets turn the impact on the greenback will be automatic. For when you sell assets priced in US dollars then you receive US dollars in return, and this means a boost in demand for the US dollar and so its value goes up.
But Gulf business people should take the lesson of the long-term direction of the US dollar at face value, and use this opportunity to diversify their currency holdings.
For the US dollar may resume its down track very quickly, particularly if the Federal Reserve cuts interest rates early next year to alleviate the impact of a recession. Then the venerable greenback could really crumble with pessimists expecting up to a fifty per cent collapse in value.
The difficult part is to know which alternative currency to hold. The European economy is unlikely to maintain its recent strength with the US in or close to a recession; and the UK will surely follow its second largest export market down with an even nastier housing crásh. Asian countries will also feel the US pain and suffer from recent overinvestment in key sectors.
That is why once the US dollar has experienced a brief rally on the back of falling capital markets, gold and silver are likely to become more and more popular with investors seeking protection against US dollar depreciation. It is a zero sum game with precious metals the obvious winner.
Judging what will happen to the oil price is this scenario is not so easy and may depend as much on Middle East stability as much as the economic strength of the consumer nations. Oil prices were after all strong in the 1970s while Western economies were in crisis, the US dollar weak and gold prices rising.