U.S. Dollar Has A Long Way To Fall

China's right, the U.S. government wants to inflate its way out of debt.

Gold is soaring Monday, trading at $1131 per ounce. President Obama is in China, calling for a new relationship. New relationship, indeed! On the surface of this visit everyone is smiling. Immediately below surface the dollar is falling--again.

There is tremendous global finger-pointing today. Liu Mingkang, head of China’s CBRC, said that the combination of a weak dollar and low U.S. interest rates has spawned: "A huge carry trade” that was having a “massive impact on global asset prices … [It] is boosting speculative investment in stock and property markets and will pose new, real and insurmountable risks to the global recovery and particularly to the recovery in emerging markets."

Mr. Liu implied that the U.S. was purposely inflating away its massive debt. On the other hand IMF head Dominique Strauss-Kahn suggested that China must float her currency to ease the pain of her Asian neighbors and the European Union countries.

There are no "best" alternatives. Raising interest rates in the U.S. would be extremely painful and would derail the recovery. The U.S. needs at least 5% growth in GDP to support its huge and increasing debt load. Raising U.S. rates to defend the dollar is political nonstarter.

Last Tuesday China said, somewhat begrudgingly, that it would allow the yuan to appreciate. China now pegs the yuan to the U.S. dollar. This announcement was likely in response to pressure from China’s Asian neighbors (Thou Shalt Not Beggar Thy Neighbor). The Euro Union leaders have also felt the pain of a jointly weaker dollar and yuan. Time will tell how serious China is about the floating the yuan. Today once again the dollar is weaker--across the board--except for the yuan, where the peg has been maintained.

Wednesday the press was full of "dollar strength" rhetoric. Treasury Secretary Geithner said the U.S. needs a strong currency. "I believe deeply that it’s very important to the United States, to the economic health of the United States, that we maintain a strong dollar … Because of the important role the dollar plays in the international financial system, we bear a special responsibility for trying to make sure that we are implementing policies in the United States that will sustain confidence."

How many times have we heard this statement from Washington? There is a growing global fear that the U.S. greenback is beginning a longer and inexorable slide and that the reserve position of the U.S. currency will come under pressure. There is no replacement for that dollar reserve role today, and there may not be for a long time.

Fred Bergsten recently wrote in Foreign Affairs (Nov.-Dec. 2009) that it is clearly "in the best interest of the U.S." to move away from its sole role as keeper of the reserve currency. Running large external deficits in a reserve-currency country continually ignites bubbles. Rising deficits combined with a reserve currency causes inflows and lower rates. Professors Kenneth Rogoff and Niall Ferguson (Harvard) suggested on Bloomberg (Oct. 29) that the fiscal imbalances in the world are now greater than ever. U.S. fiscal policy and the existence of the reserve-currency status of the U.S. dollar are igniting the next round of bubbles. There may be very good reason why China tied its currency to the dollar and encouraged its citizens to buy gold and silver. Professor Ferguson foresees a sharp 10% selloff in the U.S. dollar from this level (75.04) and then a long, gradual decline. He also sees an imminent "tipping point" because of the evolving fiscal situation.

The U.S. needs inflation more than any country in the world. Bergsten recently said that given current relentless spending plans in Washington by 2030 the CBO projects the net debt will rise to $50 trillion and servicing that debt will require $2.5 trillion each year. At some point this service is unsustainable. The dollar will fall, long rates must rise to attract new capital, and inflation will reassert itself.

Why does the Fed want inflation? It is very simple: If you carry a lot of debt, inflation is your friend. The dollar will not be. We like the currencies of the commodity countries. Once again we quote Professor Ferguson, who says we are on the cusp of a 500-year event. He believes that China will be the engine that eventually emerges. "China is in the early phase of a massive buying spree to get the commodities she needs. … Load up on copper, load up on anything the Chinese want … the safest one-way trade you can make."

We think that the long-term dynamics of a falling dollar combined with the Chinese commodity-buying spree are good reasons to buy hard assets, not only gold and silver. Mining shares in the Canadian markets are good places to start. The loonie--definitely headed back to par-- and beyond. Please act accordingly.

Where do gold and silver prices head from here? As you can see, gold has continued its tremendous breakout since Sept. 1. It has risen from $958 to $1130 this AM (17.9%). Silver during this period has performed about as well. Copper is above the $3.03 per pound range this a.m. The real question: Is this a dollar carry trade bubble or is this the result of the world seeking protection from fiat currencies in hard assets and perhaps the nascent beginnings of a move toward a new currency standard? Are we slouching to Bethlehem to be reborn?

We think the hard assets need a rest here. But why fight the trend--it is indeed your friend here. Until there is some clarity on the U.S. fiscal policy and the Chinese peg to the dollar the imbalances will continue to build in the global financial system.

In the meantime we think Goldcorp ( GG - news - people ) is significantly undervalued. We like the up and coming gold stocks such as Goldcorp, Ventana Gold, Galway Resources and Antioquiain Colombia's prolific gold districts. On the silver front Quaterra Resources ( QMM - news - people ) announced last week that it is now infill drilling its silver discovery at Nieves in Mexico. We think this could double Quaterra’s silver resources from its current level of 17 million ounces. We own shares of Goldcorp and Quaterra Resources.