FX: The final front in the war on terror

They [the US] get our oil and give us a worthless piece of paper. Iranian President Mahmoud Ahmadinejad
God willing, with the fall of the dollar, the deviant U.S. imperialism will fall as soon as possible too. Venezuelan President Hugo Chavez
If people would look at the strength of our economy, they'd realize why, you know, I believe that the dollar will be stronger. US President George W. Bush

A friend of mine currently stationed in Iraq kindly sent me this photo. I wish him a safe return

During my absence from posting (for which I apologize, I've been putting the finishing touches on my new house before the snow flies) Gold finally managed to break over $800, initially without much comment. "Whew," I said to myself as the $800 level was breached, "so long as Gold can stay under the media radar, its price can really fly."

But, my relief was short-lived. As $800 quickly led to almost $850 US Treasury Secretary, Henry "The Hammer" Paulson and President Bush began to talk up the US$. This was followed by the twins of terror, Iranian President, Mahmoud Ahmadinejad and Venezuelan President, Hugo Chavez, gleefully cheering the death of the US$. "Damn," I said to myself, "so much for being under the radar. Now we have a new front in the war on terror- the US$."

This got me a bit nervous as I'd hate to discover that betting against the US$ was considered an act of treason. Fortunately, or so I hope, the fact that a good number of senior US officials, including one former Fed Governor (who shall remain nameless) have heavily bet against the US$ using Gold, should keep such anti-anti-US$ trading sentiments from becoming law.

Further reflection led me to speculate that FX was not just a new front in the war on terror, but its final front.

President Chavez is, I believe, correct, in part, when he links the stability of the US$ with my country's ability to project its military might as it does. It is by virtue of the US$ being the world's reserve currency that the current wars in Iraq and Afghanistan can be financed on such good terms. If the US$ loses its status as the reserve currency financing future military endeavors will not be cheap and will likely require cutbacks in domestic spending- a difficult trick given our looming demographic problems.

If the decline of the US$ was solely a function of the comments from the twins of terror I wouldn't expect further declines. But the US$'s decline has little to do with their views. Rather, as I have been commenting for years, its decline is a function of an over leveraged US economy and our external imbalances.

If I was in President Bush's or Hank Paulson's shoes this is not a fight I would choose, as it is a losing battle. But (thankfully) I am not in their shoes. My sense is that these comments from the twins of terror has and will continue to invigorate the defense of the US$- via intervention, mind you, not via policy changes that might change the underlying fundamentals.

The twins of terror are not, as you might suspect, the only heads of state to link the US$'s status as world reserve currency and the US' ability to project military might. Former Malaysian Prime Minister Tun Dr Mahathir Mohamad said, last year, "When the demand for the dollar falls, America will be weakened and it will lack the ability to act as a bully in the global stage." This suggests to me that $ supportive intervention might be met with $ negative intervention- and the battle at the final front in the war on terror will begin.

To the extent my analysis is more or less accurate, defending the US$ by intervening in the markets sets the stage for: 1) much greater volatility 2) a significant decline (and surge in the price of Gold) when the battle is lost in somewhat similar fashion to the decline of the GBP or ITL when the ERM came apart in 1992.