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The Morning Gold Report: The Vulnerable Dollar

Sep 24 a.m. (USAGOLD) — I keep coming in early in the hopes that I’ll have a free moment to write a morning report, but addressing the needs of our clients hasn’t afford me that opportunity since last week. In my latest attempt to get something posted, I am going to be purposefully brief.

Gold remains well bid in the wake of last week’s record gains, trading well above the 20 and 50 day moving averages. The 100-day moving average comes in around 878 today, offering support and attracting buying interest in overseas trading.

A breach of resistance at 908.47/909.70 would clear the way for a retest of last week’s high at 915.67. The later corresponds pretty closely with the 61.8% retracement level of the entire decline from 1032.20 (17-Mar high) to 736.22 (11-Sep low) at 919.14. A move through 915.67/919.14 would shift attention to 935.30 initially, but potential at that point would be toward the 988.00 peak from 15-Jul.

Over the course of my career as a market analyst I’ve had a front row seat to many a financial crisis. There was the S L; Crisis, Swedish Banking Crisis, British Pound Crisis, Mexican Peso Crisis, Asian Financial Contagion, Russian Ruble Crisis. Those are just the major ones that leap to mind and most of them center on the collapse of one or more currencies.

Which raises the question: Is the dollar vulnerable to a collapse?

Throughout the recent dollar rally, I repeatedly noted that there was absolutely no fundamentally underpinning to the greenback. In fact, the opposite was true. US interest rates are less than half what is available from most of the other G10 nations. The interest rate differentials were/are very dollar negative. It might affect the conversion dollar to euro because of the current situation of the global economy. The vulnerable dollar is something that the government and economists might pay attention to. Foreogn exchange is also an important scheme to consider.

The US stock market looked extremely vulnerable. In fact, we saw massive outflows of foreign capital in July. A bias that is likely to be repeated in Aug and possibly Sep as well. Very dollar negative.

As the subprime crisis morphed into the credit/liquidity crisis, the Fed began pumping massive amounts of liquidity into the banking system. Those efforts have increased in recent weeks. Also very dollar negative.

Despite all their efforts, the house of cards began to fall. First Bear Stearns, then Fannie and Freddie, then Lehman, then AIG, then…well everyone. The latest bailout proposal; that Treasury be provided with a $700 bln budget to begin buying questionable assets from just about any financial institution holding them sparked a gold buying frenzy the likes of which we have never witnessed here at USAGOLD – Centennial Precious Metals.

The debate about the rescue plan rages on in Washington and it seems to be centered on this particular line in Treasury Secretary Paulson’s plan:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Whoa, whoa, whoa…hold on just a second! The banking system is brought to the verge of collapse as a result of grossly underpriced risk. Now Mr. Paulson, the former CEO of Goldman Sachs, wants to provide a $700 bln bailout to the system — shifting the risk to the American taxpayer — with virtually no oversight?

What would make us believe that the system would handle the $700 bln any more responsibly? I also don’t know anyone who believes for second that $700 bln will ultimately be the final cost of the greatest financial debacle since the Great Depression. In fact, the cost for various liquidity schemes and bailouts was already approaching $1,000 bln before the ‘stuff’ really hit the fan last week.

I think I know what Secretary Paulson is hoping to accomplish by attempting to dodge oversight: He wants to be free to react to financial conditions, unhindered by the thought that he might be pulled before Congress or into a court of law to answer for his decisions.

The key word there is “react.” Both the Fed and Treasury have been incredibly reactive, rather than proactive in dealing with the crisis from the beginning. Hence, the crisis is becoming as much a crisis of confidence as anything else.

There has been speculation that Treasury would be buying much more than mortgage debt. Corporate debt, derivatives of various pedigrees, credit card debt, auto loans. It’s all in play. If I end up with higher taxes because some student with no credit history bought an iPod with a credit card he received in the mail — with no intention of actually paying for it — I’m really going to be peeved. Okay, chances are I’m going to be peeved no matter how this all shakes out.

There have been reports that Treasury is already considering paying above fair market value for assets. The truth is, aside from the $700 bln budget, there are no limitations on what they might buy or how much they might pay.

A currency crisis is more often than not a crisis of confidence: Confidence in the ability of a government to manage monetary policy. Confidence in the overall debt position of the nation and the instruments issued to finance that debt. Confidence in the economy as a whole. Confidence is sorely lacking…

As the debate over the bailout proposal drags on, the systemic risks persist. Without the infusion of capital, we could see more financial institutions driven to the brink. Certainly if there is an impasse with Congress, the situation could turn extremely dire very quickly. The sense of urgency seems to have waned significantly since last week already.

If the bailout, in one form or another is approved, the long-term implications for the dollar are extremely negative. Banks are likely going to have to take substantial additional writedowns, unless of course Treasury is prepared to pay above market prices for their bad assets. A bailout does not mean the crisis is over by any stretch of the imagination.

Either scenario favors physical gold ownership as a means to preserve the wealth you have already accumulated. That point has really been driven home over the past week, which is why we have been so incredibly busy. Having said that, I need to get back to the phones…