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Dollar Sniffers- by Greg Strid

Crude oil futures swooned to a hair above $105 a barrel
before closing at $109.71 yesterday. At the same time,
the US dollar rallied and held most of its gains against
major currencies. (The greenback is trading at a seven-
month high against the euro and a two-year high versus
the British pound.)

As far as the US dollar’s rise is concerned, many websites,
including that of the NY Times, are quoting pundits
and traders who feel that commodities share a strong inverse
link to the US currency. (The price of gold, industrial metals
and agricultural commodities were slammed as well.)

This inverse link, except in the case of gold which is a
traditional dollar hedge, makes little sense to me. The forces
of supply and demand determine the price of commodities
that are consumed. Therefore, if the price of oil and soybeans
fall, it is due to a reduction in demand, which is caused by a
slowdown in economic activity.

Why then, does the dollar continue to rise? (It is already old
news that economies in Europe and Japan are slowing rapidly.)
A currency’s value is in large part determined by the strength
of the economy that it represents. If oil tanks, due in large
part to shrinking US demand, as has been the case over past
few months, why is the dollar rallying?

The boost in spending that traders expect from lower oil prices
will not deliver a boom in consumption. This calls into question
the premise of the long dollar, short commodities trade.

The US economy is still working its way through a nasty
hangover due to the bursting of the housing and credit bubbles.
The economy is shedding jobs and consumption is slowing. On
top of this, the baby boomers are retiring in waves, which will
swell government borrowing, and many states are facing budget
shortfalls that will further reduce consumer’s disposable income
(taxes will have to rise and spending on disbursements and
investment will fall).

The false engine of lower commodity prices and America’s
relative strength versus other faltering developed economies will
not sustain the dollar over the long haul. The strains of a
stagnant economy coupled with fiscally challenged federal and
state governments will eventually drag the dollar lower.

©Greg Strid 2008

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