Osama's death will not stop the dollar's decline

The news of Osama Bin Laden’s death will open new dimensions for the US dollar but only for a short while. The reason I say this is because while global financial markets are terming the news of Bin Laden’s as good news for the currency, the dollar will continue to stay weak in 2011.

Stock markets will rally in the US, Europe and Asia, but these efforts will all be short-lived and the status of the dollar will go back to its original position.

Analyses of the past

The bull market for the US dollar is like an invisible man. An important aspect of any bull market is psychology. Bull markets climb a wall of worry as they say. This means that the market will continue to climb despite all of the worries surrounding them.

However, to really understand the long term effects of the current political scenario on the dollar, we must analyse history and look at some facts.

From 1982 to 2000, when the Dow Jones Industrial Average soared from 777 to above 11,000, the world was embroiled in all sorts of worries. There were the inflation pressures, the collapse of the Eastern Bloc, the Savings & Loan crisis, the Mexican peso crisis and the Long Term Capital collapse of 1998. Throughout all of these crises and collapses, equity prices kept climbing. If you read the book "The Great Super Cycle” by David Skarica, you can see the logic behind these developments. One of the reasons is that markets take on a life of their own. Major cycles run 15 to 20 years and go on in the same fashion despite wars, recessions, drought, etcetera.

The same applies to downward cycles. Despite all of the reasons to buy the dollar in recent years, such as the financial crisis of 2008 and the Euro crisis of 2010, both of which caused a flight to the US currency, the dollar has continued on its long-term downward trend.

However, in the current scenario we are hearing more fervent calls for a rally for the dollar. People are citing the Middle East crisis as one of the reasons which is expected to trigger an investment flight towards safety - the dollar.

There are also predictions that the US economy will grow faster now, at a GDP growth rate of three per cent, in the short term due to the tax cuts of late 2010. Some say that the Euro crisis will show its ugly head again and once again result in the rise of the dollar. However, with so many calls for a dollar rally, I personally think this will not curb the downward trend of the currency. The dollar will continue to lose 9-10 per cent against the major basket of currencies.

Three reasons why the decline will continue:

1. The US is expected to have a near-10 per cent GDP deficit in 2011, which is higher than that expected from any other Western government including the UK, Spain, Portugal and even Greece (if its austerity measures pay off). This deficit will put the US in the danger of losing its reserve-dollar status.

2. As George Soros pointed out recently, the Euro crisis is all but over with the recent austerity and bailout measures being passed. The crisis this year has entered local municipalities and states in the US. An estimated $127 billion is required to rescue the failed states in the US. California, Illinois, Michigan and Wisconsin are all in the red and in bad shape. This will put further pressure on the US dollar in 2011.

3. If the Middle East crisis spreads, oil prices will continue to spike and might touch $137 per barrel this year. My prediction of $117 per barrel has already hit the market. The US is much more reliant on automobiles and hence on low oil prices, than any other Western nation - European nations have much better public transportation and train systems. Therefore, higher oil prices will pressure the US more than Europe.

Therefore, despite the calls of a dollar rally, I expect that the US currency is going to continue its bear market (9-10 per cent downfall in 2011) and continue to move lower against other major world currencies.

Short term reactions

- US markets will absorb the shocking news for equity and bonds, with equity markets already overbought or overvalued by 41 per cent, market consolidation in the short term will turn into a pull back in the long run.

- It is premature to say how Arab markets will respond as the situation is still quite uncertain and $31 per barrel is being charged on oil as fear premium.

- Prices of commodities, especially oil, will pull back in the short run with the dollar moving up. Other commodities are also expected to take the back seat as upsurge continues.