LOWEST TAX REVENUE IN 50 YEARS-SIGN OF THE TIMES AND DEBASING OF THE US DOLLAR IS BAD NEWS FOR THE FUTURE

President Barack Obama’s effort to lead the world economic recovery by spending the U.S. out of its recession is undermining the dollar, triggering record commodities rallies as investors scour the globe for hard assets.

As threats of a financial meltdown fade, the currency is falling victim to an unprecedented budget deficit, near-zero interest rates and slow growth. The dollar is down 10 percent against six trading partners’ legal tender in Treasury Secretary Timothy Geithner’s first eight-and-a-half months, the sharpest drop for a new occupant of that office since the Reagan administration’s James Baker persuaded world leaders to boost the deutsche mark and yen by debasing the dollar in 1985. This year’s drop followed its best two quarters in 16 years.

“The dollar had been strong because the U.S. was a haven in the storm, and now that the storm is abating, who needs the dollar?” said Edmund Phelps, who won the 2006 Nobel Prize in economics and teaches at Columbia University in New York. “People got exasperated with the tiny returns on safe assets.”

Investors are sating their renewed risk appetites with developing nations’ stocks, currencies and the commodities some of them produce. Gold is up 19 percent this year, touching an all-time high $1,062.70 an ounce on Oct. 8. Copper has rallied 103 percent with the biggest three-quarter rise in at least 21 years. Crude oil, up 64 percent, just finished its steepest eight-month climb since 1999. Aluminum has gained 24 percent, propelled by its best two quarters in a dozen years or more.

Worst Since 1991

The MSCI Emerging Markets Index yesterday reached 950.34, the highest since August 2008, after the 22-year-old gauge’s biggest seven-month rally. The Dollar Index, which measures the currency against the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, dropped to its lowest level since August 2008 on Oct. 8 after its worst two quarters since 1991.

The nonpartisan Congressional Budget Office estimates that the budget deficit for the fiscal year that ended Sept. 30, which included some of Obama’s $787 billion stimulus package and the lowest tax revenue in more than 50 years, was $1.4 trillion, more than India’s gross domestic product. The administration will announce the final figure by mid-October.

Faced with administration projections of shortfalls totaling $9.1 trillion over the next decade, Obama and Congress have pledged to restore discipline. Fed officials have discussed how -- but not when -- they plan to reduce the central bank’s balance sheet, which has doubled to $2.1 trillion under emergency lending programs to unfreeze the credit markets.

‘Lofty Assurances’

“The most important thing coming from investors in Asia, where I am, is despite all these lofty assurances by U.S. officials that there’s a credible exit strategy from both fiscal and monetary stimulus, they understandably don’t believe it,” said Stephen Roach, chairman of Morgan Stanley Asia in Hong Kong.

Geithner, 48, has adopted the past two administrations’ policy of publicly favoring a “strong dollar.” It fell 24 percent in George W. Bush’s first four-year term, which ended Jan. 20, 2005, and rose 1.3 percent in his second.

“We are going to do everything necessary to make sure we sustain confidence” in the U.S. economy, Geithner said Oct. 3 in Istanbul.

Lawrence Summers, director of the White House’s National Economic Council, echoed Geithner’s statement in an Oct. 8 interview. “He made it very clear that our commitment is to a strong dollar based on strong fundamentals,” Summers said.

U.S. Interventions

Those words may ring hollow without direct government action to support the dollar or more evidence that the fiscal and monetary stimulus will be short lived. The U.S. hasn’t moved to shore up its currency by purchasing dollars since 1995. It intervened to weaken the dollar against the yen in 1998 and to support the euro in 2000.

“Currencies that have the lack of support of petroleum, metals, and have a liberal central bank posture toward printing money are currencies that will continue to be punished,” said Peter Kenny, managing director in institutional sales at Knight Equity Markets in Jersey City, New Jersey. “The U.S. dollar is a classic example of that.”

Commodities “insist on validation and validity,” while currencies “are subject to politics and perception,” he said.

HSBC Holdings Plc economists Stephen King and Stuart Green said in a report this month that the end of U.S. economic supremacy is at hand.

Their report predicted the “demise of the West” amid “ongoing struggles in the developed world” and said that “emerging market nations are set to dominate world economic activity in the years ahead.” Titled “The Tipping Point,” the report said currencies will be weak in countries “still pondering exit strategies and faced with multiple years of debt repayment.”

Growth Prospects

“The most obvious candidates are the U.S. dollar and sterling,” they wrote. Emerging-market economies will expand 6 percent next year, more than three times the 1.8 percent growth in developed economies, they said.

China’s 9.5 percent economic growth and India’s 7.2 percent increase will lead all nations next year, the HSBC economists predicted. In contrast, GDP will expand 2.8 percent in the U.S., 1.2 percent in Japan and 0.7 percent in the 16-nation euro zone, they said.

“Asia is taking its place again on the world stage” and the wealth shift is occurring “more rapidly than anyone would have thought,” said Stephen Green, HSBC group chairman, in an Oct. 6 interview in Istanbul.

As the dollar slips, silver and gold have outperformed all major currencies since the Sept. 15, 2008, announcement of Lehman Brothers Holdings Inc.’s collapse as investors favored the metals over legal tender.

‘Sniff of Inflation’

“Gold serves as a hedge against inflation, and even though we are in the midst of a recession worldwide, the sniff of inflation is already in the air,” said Richard O’Brien, chief executive officer of Newmont Mining Corp., the largest U.S. gold producer, on Oct. 2.

The dollar is suffering even as American stocks rebound from a 13-year low reached in March. One reason: the 19 percent increase in the Standard & Poor’s 500 Index this year is trailing gains in stocks in most other nations.

Of 82 countries’ benchmark stock indexes tracked by Bloomberg, 60 performed better this year than the S&P 500 as of yesterday. Peruvian stocks lead the world with a 120 percent gain. The U.S. edged out gains by Bangladesh, New Zealand and Finland. Ghana, down 41 percent, is in last place.

Even measured against the March 9 start of the S&P 500’s biggest rally since the 1930s, the U.S. index’s 59 percent gain puts it in 39th place worldwide.

Highest Unemployment

With excess production capacity in the U.S. near an all- time high and unemployment at 9.8 percent, the highest in the Group of Seven, restoring the world’s largest economy to the 3 percent growth rate of the past two expansions may take years.

“The U.S. recovery is not yet clearly under way and other parts of the world, particularly emerging markets and commodity- based countries, are ahead of us,” said Michael Mussa, a senior fellow at the Peterson Institute in Washington and the International Monetary Fund’s former chief economist.

Niall Ferguson, a Harvard University professor, said that “it would be extraordinary” if the dollar didn’t weaken in the next year.

Obama administration officials are likely to tolerate a decline unless it “gets to an extent where it’s causing trouble,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in an interview in Istanbul.

Excessive Drop

In an e-mail response to questions from Bloomberg News on Oct. 9, O’Neill said he considers the dollar’s recent drop excessive and predicted the currency will be stronger in a year, especially against the yen.

The dollar slumped to a postwar low of 80.63 yen in April 1995, only to rally 26 percent in the following two years. The Dollar Index reached a 10-year low in December 2004 on concern the U.S. current-account deficit was unsustainable, then rebounded 13 percent in 2006.

“We’re in the midst of a classic overshoot of the dollar,” said Michael Rosenberg, former head of foreign- exchange research at Deutsche Bank AG and a Bloomberg consultant. He said the U.S. outlook next year is more favorable than Japan and the euro area, the country’s current-account deficit is narrowing and the bond market isn’t reflecting inflation fears.

Rosenberg cited the 16 percent rise this year in the Reuters/Jefferies CRB Index of 19 commodities as evidence that the flight to raw materials isn’t widespread. Natural gas is down 49 percent and wheat has lost 31 percent.

Shorting the Dollar

The dollar is succumbing to momentum in a market that’s “lost its anchor,” Rosenberg said. “From 2001 to 2009, the best strategy was to close your eyes and short the dollar.”

The rebalancing of global wealth away from the U.S. as reflected in the dollar is likely to take years if not decades, said Carmen Reinhart, a University of Maryland economist who co- wrote a 2009 book with former IMF chief economist Kenneth Rogoff on the history of financial crises.

After World War II, the U.K. currency’s downfall was predicted “long before the sterling crisis of 1967 put the final nail in the coffin of the British pound as a reserve currency,” Reinhart said.

The dollar’s share of reserves in countries that report currency allocations fell in the second quarter to the lowest level since the euro was introduced in 1999. Reinhart predicted the dollar will remain the world’s most widely used currency for years and that any slide will be gradual until a viable alternative comes along.

“The euro hasn’t been fulfilling that role. The yen? Forget it. And the yuan is not convertible,” Reinhart said of the European, Japanese and Chinese currencies. “This is not something that’s around the corner here.”

THE DOLLAR WEAKENS AS A WORLD RESERVE CURRENCY; PREDICTIONS OF CONTINUED DECLINE BASED ON TRILLION DOLLAR DEFICITS AND WEAK ECONOMIC DATA

The "tiny dollar" may be more than just chatter as world currency reserves are quickly and quietly adding to their reserves not dollars, but other currencies. This is the start of a trend that is NOT likely to be reversed.

Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two- quarter rout in almost two decades.

Policy makers boosted foreign currency holdings by $413 billion last quarter, the most since at least 2003, to $7.3 trillion, according to data compiled by Bloomberg. Nations reporting currency breakdowns put 63 percent of the new cash into euros and yen in April, May and June, the latest Barclays Capital data show. That’s the highest percentage in any quarter with more than an $80 billion increase.

World leaders are acting on threats to dump the dollar while the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors. The diversification signals that the currency won’t rebound anytime soon after losing 10.3 percent on a trade-weighted basis the past six months, the biggest drop since 1991.

“Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it,” said Steven Englander, a former Federal Reserve researcher who is now the chief U.S. currency strategist at Barclays in New York. “It looks like they are really backing away from the dollar.”

The dollar’s 37 percent share of new reserves fell from about a 63 percent average since 1999. Englander concluded in a report that the trend “accelerated” in the third quarter. He said in an interview that “for the next couple of months, the forces are still in place” for continued diversification.

America’s currency has been under siege as the Treasury sells a record amount of debt to finance a budget deficit that totaled $1.4 trillion in fiscal 2009 ended Sept. 30.

Intercontinental Exchange Inc.’s Dollar Index, which tracks the currency’s performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, fell to 75.77 last week, the lowest level since August 2008 and down from the high this year of 89.624 on March 4. The index, at 76.104 today, is within six points of its record low reached in March 2008.

Foreign companies and officials are starting to say their economies are getting hurt because of the dollar’s weakness.

Yukitoshi Funo, executive vice president of Toyota City, Japan-based Toyota Motor Corp., the nation’s biggest automaker, called the yen’s strength “painful.” Fabrice Bregier, chief operating officer of Toulouse, France-based Airbus SAS, the world’s largest commercial planemaker, said on Oct. 8 the euro’s 11 percent rise since April was “challenging.”

The economies of both Japan and Europe depend on exports that get more expensive whenever the greenback slumps. European Central Bank President Jean-Claude Trichet said in Venice on Oct. 8 that U.S. policy makers’ preference for a strong dollar is “extremely important in the present circumstances.”

“Major reserve-currency issuing countries should take into account and balance the implications of their monetary policies for both their own economies and the world economy with a view to upholding stability of international financial markets,” China President Hu Jintao told the Group of 20 leaders in Pittsburgh on Sept. 25, according to an English translation of his prepared remarks. China is America’s largest creditor.

Developing countries have likely sold about $30 billion for euros, yen and other currencies each month since March, according to strategists at Bank of America-Merrill Lynch.

That helped reduce the dollar’s weight at central banks that report currency holdings to 62.8 percent as of June 30, the lowest on record, the latest International Monetary Fund data show. The quarter’s 2.2 percentage point decline was the biggest since falling 2.5 percentage points to 69.1 percent in the period ended June 30, 2002.

“The diversification out of the dollar will accelerate,” said Fabrizio Fiorini, a money manager who helps oversee $12 billion at Aletti Gestielle SGR SpA in Milan. “People are buying the euro not because they want that currency, but because they want to get rid of the dollar. In the long run, the U.S. will not be the same powerful country that it once was.”

Central banks’ moves away from the dollar are a temporary trend that will reverse once the Fed starts raising interest rates from near zero, according to Christoph Kind, who helps manage $20 billion as head of asset allocation at Frankfurt Trust in Germany.

“The world is currently flush with the U.S. dollar, which is available at no cost,” Kind said. “If there’s a turnaround in U.S. monetary policy, there will be a change of perception about the dollar as a reserve currency. The diversification has more to do with reduction of concentration risks rather than a dim view of the U.S. or its currency.”

The median forecast in a Bloomberg survey of 54 economists is for the Fed to lift its target rate for overnight loans between banks to 1.25 percent by the end of 2010. The European Central Bank will boost its benchmark a half percentage point to 1.5 percent, a separate poll shows.

America’s economy will grow 2.4 percent in 2010, compared with 0.95 percent in the euro-zone, and 1 percent in Japan, median predictions show. Japan is seen keeping its rate at 0.1 percent through 2010.

Central bank diversification is helping push the relative worth of the euro and the yen above what differences in interest rates, cost of living and other data indicate they should be. The euro is 16 percent more expensive than its fair value of $1.22, according to economic models used by Credit Suisse Group AG. Morgan Stanley says the yen is 10 percent overvalued.

Sentiment toward the dollar reminds John Taylor, chairman of New York-based FX Concepts Inc., the world’s largest currency hedge fund, of the mid-1990s. That’s when the greenback tumbled to a post-World War II low of 79.75 against the yen on April 19, 1995, on concern that the Fed wasn’t raising rates fast enough to contain inflation. Like now, speculation about central bank diversification and the demise of the dollar’s primacy rose.

The currency then gained 26 percent versus the yen and 25 percent against the deutsche mark in the following two years as technology innovation increased U.S. productivity and attracted foreign capital.

“People didn’t like the dollar in 1995,” said Taylor, whose firm has $9 billion under management. “That was very stupid and turned out to be wrong. Now, we are getting to the point that people’s attitude toward the dollar becomes ridiculously negative.”

The median estimate of more than 40 economists and strategists is for the dollar to end the year little changed at $1.47 per euro, and appreciate to 92 yen, from 89.97 today.

Englander at London-based Barclays, the world’s third- largest foreign-exchange trader, predicts the U.S. currency will weaken 3.3 percent against the euro to $1.52 in three months. He advised in March, when the dollar peaked this year, to sell the currency. Standard Chartered, the most accurate dollar-euro forecaster in Bloomberg surveys for the six quarters that ended June 30, sees the greenback declining to $1.55 by year-end.

The dollar’s reduced share of new reserves is also a reflection of U.S. assets’ lagging performance as the country struggles to recover from the worst recession since World War II.

Since Jan. 1, 61 of 82 country equity indexes tracked by Bloomberg have outperformed the Standard & Poor’s 500 Index of U.S. stocks, which has gained 18.6 percent. That compares with 70.6 percent for Brazil’s Bovespa Stock Index and 49.4 percent for Hong Kong’s Hang Seng Index.

Treasuries have lost 2.4 percent, after reinvested interest, versus a return of 27.4 percent in emerging economies’ dollar- denominated bonds, Merrill Lynch & Co. indexes show.

The growth of global reserves is accelerating, with Taiwan’s and South Korea’s, the fifth- and sixth-largest in the world, rising 2.1 percent to $332.2 billion and 3.6 percent to $254.3 billion in September, the fastest since May. The four biggest pools of reserves are held by China, Japan, Russia and India.

China, which controlled $2.1 trillion in foreign reserves as of June 30 and owns $800 billion of U.S. debt, is among the countries that don’t report allocations.

“Unless you think China does things significantly differently from others,” the anti-dollar trend is unmistakable, Englander said.

Englander’s conclusions are based on IMF data from central banks that report their currency allocations, which account for 63 percent of total global reserves. Barclays adjusted the IMF data for changes in exchange rates after the reserves were amassed to get an accurate snapshot of allocations at the time they were acquired.

Investors can make money by following central banks’ moves, according to Barclays, which created a trading model that flashes signals to buy or sell the dollar based on global reserve shifts and other variables. Each trade triggered by the system has average returns of more than 1 percent.

Bill Gross, who runs the $186 billion Pimco Total Return Fund, the world’s largest bond fund, said in June that dollar investors should diversify before central banks do the same on concern that the U.S.’s budget deficit will deepen.

“The world is changing, and the dollar is losing its status,” said Aletti Gestielle’s Fiorini. “If you have a 5- year or 10-year view about the dollar, it should be for a weaker currency.”

That estimate is simply due to current dollar woes. If our nation continues the forecasted trillion dollar deficits, this view will become a reality much faster since nobody will be wanting to hold a weak currency that is decling in value on a forecasted and predictable schedule.