Lord William Rees-Mogg (Fleet Street Invest UK):
In the last six months there has been a rebound of 50% in the great majority of world stock markets.

There has also been a comparable rebound in the price of oil, with West Texas oil rising very close to $80 a barrel. In the oil market there has been heavy two-way trading in options. There could be a sharp spike in the oil price if speculators have to cover their positions.

At the same time the US dollar has remained weak, and now stands at $1.4886 to the euro and $1.66628 to the pound. This is close to a 14-month low on a trade-weighted basis. The poor performance of the dollar reflects the low US interest rates and the twin US fiscal and trade deficits.

The demise of the dollar

The dollar nevertheless remains the world’s leading reserve currency, with the euro in second place. Investors are naturally anxious to protect themselves against markets, including currency markets, which have shown such a high degree of volatility.

The Chinese, who have the greatest number of dollars in their currency reserves, have already suffered substantial losses.

In what amounts to a crisis of the dollar, the euro is in second place as a reserve currency, but there are potential threats to the future of the euro, due to the weak productivity of the Mediterranean economies. There is a big stretch in productivity growth between the German and the Southern European regions.

The fall in the dollar against other currencies includes a devaluation of the dollar in terms of gold, which now seems to have stabilized at a dollar price of $1,050 an ounce.

The circumstances do indeed appear to be uniquely favourable to gold.

Interest rates and therefore carrying costs are exceptionally low. The dollar is exceptionally weak. The technical market position is strong, including good demand for gold in terms of jewellery. The oil price – which is often linked to gold – is rising. Those who believe that oil is due for a further rise to $100 a barrel are likely also to be confident about holding a proportion of their investment . . .
Click here to read the rest of Lord Rees-Mogg’s article at Fleet Street Invest UK.

The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback’s role as a reliable store of value around the world. Right now, with so much unused capacity in the American economy and so much unemployment – likely to persist for at least another year or two – the more pressing worry is deflation (a general decrease in prices), not inflation. But as the economy eventually recovers, the possibility of inflation will loom, and with forward-looking markets, worries about the future often play out in the present. Anxieties about future inflation can lead to a weaker dollar today.

Of course, a new global currency won’t happen right away. It will take global policy makers months – maybe even years – to wean the world off the greenback. But Stiglitz says its coming.

Like it or not, out of the ashes of this debacle a new and more stable global reserve system is likely to emerge, and for the world as a whole, as well as for the United States, this would be a good thing. It would lead to a more stable worldwide financial system and stronger global economic growth. The current system entails developing countries putting aside hundreds of billions of dollars a year – only weakening global demand and contributing to our economic difficulties. Also, there is something a little unseemly about poor countries lending the US trillions of dollars, now at an interest rate of close to zero.

Long time Notes readers shouldn’t be surprised that our addiction to credit has lead to the demise of the dollar. And if you’ve read James Dale Davidson’s “The Plague of the Black Debt,” you’re already yardsticks ahead of your fellow citizens. If you haven’t, we strongly urge you to see what this debt pile means to your investments over the next decade.

The death of the dollar is nothing new – the US currency has been terminally ill since the beginning of the last century. The value of the buck has collapsed 196% since its peak in 1900. That’s a pretty significant drop in a just century. This from Sean Malone at the Ludwig von Mises Institute (a great Austrian School of economics and libertarian resource):

Money supply from 1946-2009 has been increased 5938% to $8,235,900,000,000. In that time, the US has seen 10 recession, constant military action, massive expansion of government power, an explosion of the welfare state and the complete annihilation of the buying power of the US dollar.

Now try to imagine what your life might be like if every dollar you had bought you 20 times as much stuff… This is the cost of inflation.

And just who is Arjun Murti? He’s the Goldman Sachs analyst who called for an oil “super spike” more than three years ago.

When Murti first predicted oil could reach a $105 a barrel, way back in March of 2005, oil was trading below $60. The prediction was scorned and laughed at, even as it caused a bump in crude prices… some thought it was just a Goldman Sachs publicity stunt.

But it was no stunt. Murti’s call was dead right, and all the naysayers were wrong. For the past three years, many have been predicting that the bottom would fall out for oil prices. As crude passed through each new threshold — $70, $80, $90, $100 — there were loud drumbeats for how the price of crude would collapse “any day now.”

There are plenty of reasons why this hasn’t happened. The three biggest, in very simple terms, are (1) rising global demand, (2) a steady erosion of supply, and (3) the slow demise of the dollar.

Now that oil has broken above $120 for the first time, the naysayers — who have been wrong for more than three years now — are still calling for it to fall apart.

And as for Arjun Murti, the guy who predicted all this… he now says $200 oil is a possibility in the next 12 to 24 months.

Justice Litle

Editorial Director, Taipan Publishing Group

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