PINR
As historically benign investment risk in the U.S. begins to rapidly increase during the next several months, foreign capital flight could intensify dramatically, prompting the dollar's devaluation against other major currencies. Weakening economic fundamentals, missteps by the U.S. Federal Reserve, increasing political instability and extreme global geopolitical instability are factors that could easily push investment risk in the United States to extraordinary heights sending foreign investors toward the exit.
Rising energy prices are finally beginning to push U.S. inflation indicators broadly higher. As summer begins, energy demand in the United States will increase, driving crude oil and fuel prices much higher. This will fan the inflation fire in the United States. At the same time, rising prices will begin to dampen the growth of both private consumption and investment, slowing U.S. economic growth. Although not seen in the U.S. since the early 1970s, stagflation could make a strong comeback bid in the months ahead.
The last episode of stagflation in the United States was the result of the 1973-1974 Arab oil embargo, which produced a prolonged increase in international crude oil prices. The reappearance of stagflation could accelerate foreign capital flight from the United States. How the U.S. Federal Reserve responds to the unusual combination of rising inflation and slowing economic growth could further accelerate foreign capital flight. With inflation already rising and U.S. economic growth far above sustainable levels in the first quarter of this year, one can easily argue that the Fed has been too timid in tightening monetary policy during the past several months.
This timidity can be blamed on two factors: the change in the chairmanship at the Fed and the approach of U.S. mid-term elections. The Fed's new chairman, Ben Bernanke, was appointed by President George W. Bush. Bernanke has undoubtedly come under some amount of political pressure to delay further tightening of monetary policy until after the November 7 elections in order to avoid a U.S. economic slowdown. The Fed's failure to act decisively in the face of rising inflation could damage the credibility of the U.S. monetary system, turning capital flight into a flood.
The flood of foreign capital from the United States could be further attenuated by political instability. Public opinion polls indicate that popular support for President Bush has fallen to about 30 percent. Popular support for Vice President Dick Cheney is below 25 percent. The exceedingly weak popular support for the president and vice president raises questions about the legitimacy of the entire Bush administration. This erosion of legitimacy has encouraged public rebuke of several administration officials including Secretary of Defense Donald Rumsfeld.
[...]Yet another factor that could produce a torrent of foreign capital flight from the United States is extreme global geopolitical instability. Historically, geopolitical instability has usually prompted a flight to the safe haven of the U.S. dollar. Geopolitical instability, however, has rarely been of such global proportion and so elevated. The Bush administration is simultaneously applying pressure on two very strong adversaries, Iran and North Korea. Military action against either of these countries will have profound long-term negative global economic and geopolitical consequences. Even the threat of military action or the imposition of economic sanctions against Iran or North Korea would have similar negative consequences. MORE
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