The u.s. dollar seems to be floating in mid-air, subject to some anti-gravity laws unknown to physicists and economists alike.

But many still think the greenback is headed for the dumps. Even the venerable International Monetary Fund recently said in a report that the US$ is considerably overvalued.

What should you tell your clients? Long-term investors among your client base could
go short. Speculators? Well, good luck.

Ross Healy, president of Strategic Analysis Corp. in Toronto, is one of those who play the short side. In his view, the U.S. economy is already bankrupt and it’s only a question of time before that fact becomes obvious. In the first quarter of this year, the U.S. government’s deficit was US$339 billion and it grew to US$396 billion in the second quarter. To correct that on a quarterly basis, it will mean taking US$1.2 trillion-US$1.6 trillion in purchasing power out of the economy. It’s not going to be pretty, and it will have to happen over an extended period of time.

“That recession will be exacerbated by the fact that so much employment in the higher-paying manufacturing sector has been pushed overseas, leaving the lower-paying service jobs at home,” Healy says. “When you have lower revenue and higher debt levels, digging yourself out of debt is a tad more difficult.”

And that is only one problem. Another is the commercial deficit. When former president Richard Nixon uncoupled the US$ from the gold standard in 1973, columnist John Plender wrote recently in a Financial Times article, it was in large part because of a balance deficit that everyone then considered colossal but which represented only half a percentage point of gross domestic product. Today, the deficit stands at 6% of GDP. “We are in the middle of an unprecedented credit bubble,” Plender wrote. “As in 1971, everyone knows the U.S. balance of payments is unsustainable and Alan Greenspan, chairman of the U.S. Federal Reserve Board, made an alarming admission to the French finance minister … that the U.S. had lost control of fiscal policy.”

The US$ has lost a lot of ground in the past few years. “In 2000-01, it traded at
US$0.82 per euro,” says money exchange expert Normand Faubert, vice president of risk management at Groupe Financier Monexia Inc. in Montreal. “Last December, it had lost value by 50%, at US$1.36 per euro. That’s a major beating.”

And the beating isn’t over yet. “It’s not unusual to have a plateau for a while after a major move,” says Martin Barnes, managing editor of International Bank Credit Analyst at BCA Research in Montreal. “I’m still bearish and I think the US$ will fall even more in the coming years.”

But why is the greenback still standing tall, defying the economic gravity specialists say should bring it crashing down?

For André Marsan, president of Sigma Alpha Capital Inc. in Montreal, there is no mysterious anti-gravity phenomenon at work here. The US$ is propped up by temporary conditions that maintain its good standing with the ultra-speculators that control the dance of money all over the planet.

“In the past few years,” he says, “capital movements have been in large part determined by short-term speculation coming from traders in New York, London, Chicago and elsewhere. These people are paid for the profit they generate on a day-to-day basis, and their decisions are based on the last bit of news: a party election, the price of copper that has just hiccuped, a bomb that just went off.”

But there’s more than the speculators. Add to their numbers the large central banks, mostly in Asia, that work very hard to support the US$. As Barnes recalls, even when private investors were dumping the US$ after the technology bubble burst and interest rates fell, Asian banks were still buying it. “They were leaning into [the US$], so there was no increase of interest rates to create a crisis. Had Asian banks not bought to sustain the US$, things would have been ugly. But the slide was smooth, without a rate crisis. And Asians have an incentive to do that again. These countries don’t want to see the US$ fall because it would hurt their production capacity and their sales to the U.S. consumer,” he says.

@page_break@Of course, people are not buying the US$ — they’re buying the U.S. economy and for a very simple reason: “If others are relatively weak, then the U.S. shines somewhat,” says Barnes.

Faubert points out that interest rates have been rising in North America for the past two years but, in Europe, countries are only starting to move their rates upward. Economic growth in the U.S. has been good and should stand around 3.2% next year, with an unemployment rate that remains low compared with levels of 9%-10% in Germany and France, for example.

And news from Europe is not encouraging. The French referendum has sidetracked the European constitution project, the new German chancellor isn’t promising the reforms financial markets hoped for and the Italian economy is in a slump. “Many question the survival of the euro over the next 10 years,” says Barnes.

Japan is a bright spot, but its economic growth and stock market rise are only starting. “We need the Japanese economy to show us that it can be strong quarter after quarter,” Faubert says.

So although the U.S. advantage is relatively thin, for now it’s the least worst place to be.
The US$ is holding on because colossal money flows allow the economy to defy traditional laws that would command it to fall to correct the balance of payment deficit.
“It’s almost an international conspiracy to keep the US$ high,” Marsan says.

When the party will end is anyone’s guess. Most think the deflation of the housing bubble will be the moment of reckoning. But perhaps not. Marsan thinks the situation could hold for another five years or more, enough time for Asian banks to stockpile gigantic reserves. “When they have piled up US$2 trillion-US$3 trillion, they will have more power than the Fed. The Fed will virtually be in Beijing,” he says. “At that moment, the Chinese will hold financial weapons of mass destruction. When the moment suits them, they will use [this] as a lever to obtain anything they want. They’ll be in a position to blackmail the U.S. simply by threatening to force interest rates up or down.”

Meanwhile, Marsan says, “We’re creating the biggest financial disequilibrium in history.” IE