The comments below were provided by Peter Greene of Fusion IQ.
In the midst of the longest and deepest, post World-War II recession, America's financial position relative to the rest of the world has deteriorated sharply. Three decades of massive trade deficits have turned the United States from the world's top lender into the world's largest debtor and as a result has made it dependent on the whims of so-called emerging nations, laden with huge foreign currency reserves, to finance the bailout of Wall Street Oligarchs, and President Barack Obama's social programs.
Foreigners own roughly half of the US government's publicly traded debt, or $3.47-trillion, representing nearly 25% of the size of the US economy - the highest level in history. If foreign lenders were to significantly reduce their purchases of US Treasury notes, without even dumping their current holdings, US long-term interest rates could zoom higher and the US dollar could crumble.
That would be a double whammy for the US economy. Higher yields on Treasury debt could translate into higher mortgage borrowing rates for homebuyers, which would weigh on the housing market, while a weaker US dollar could lift the price of crude oil to above $70 per barrel, resulting in an oil shock to the world economy. This nightmare scenario has been relegated to the den of doomsayers and fear mongers, yet is starting to become an increasingly realistic proposition.
Some of the biggest foreign lenders to the US Treasury, such as Brazil, China, India, Russia and Qatar, are grumbling aloud about the endless string of trillion dollar US budget deficits projected in the years ahead. Lenders are crying foul over the Federal Reserve's radical experiment with quantitative easing (QE) - the printing of vast quantities of US dollars, and monetizing the US government's debt.
The Congressional Budget Office (CBO) recently forecast the US budget deficit for fiscal 2009 to reach a mind-boggling $1.825-trillion or approximately 13% of GDP. Next year, the budget deficit is expected to total $1.43-trillion under Obama's budget plan. Furthermore, the CBO sees the US deficits between 2010 and 2019 totalling $9.1 trillion, thereby raising doubts about America's ability to finance its debt at low interest rates, and whether it can maintain its top-tier AAA credit rating.
Falling off a cliff - this would be a good technical description of what the US Dollar Index looks like. The risk of the dollar doing just that probably lies with what China decides to do. China's holdings of US Treasury debt have soared by $257 billion from a year ago to $763 billion today, exceeding Japan's holdings of $686 billion. Yet any precipitous move by Beijing to become a net seller of US Treasury debt runs the risk of igniting a US dollar selling panic, triggering massive losses in China's own portfolio of Treasuries and the collapse of its main export market, the United States. Technically the recent triangular consolidation (orange lines) looks like a bearish wedge. While there is a support band in the 78.22 to 77.40 range (green lines) a violation of this would trigger a renewed bearish move downward.
[PduP: For more on the most likely near-term direction of the US Dollar Index, Adam Hewison's (INO.com) short technical analysis also provides valuable insight. Click here to access the presentation.]
Source: Peter Greene, Fusion IQ, July 15, 2009.