Freedom Lawyers of America

By Thom Calandra, CBS.MarketWatch.com
Last Update: 11:01 AM ET Feb 7, 2003
SAN FRANCISCO (CBS.MW) -- Middle East war talk is distracting many investors from accepting the reality of an overpriced American stock market and flagging U.S. dollar.

"For weeks, we had been hearing that the dollar's bleak performance is because of fear of war in Iraq," notes Donald G. Coxe, a U.S. portfolio strategist with Nesbitt Burns in Chicago. "For weeks, we had been hearing that the run-up in gold prices is because of fear of war in Iraq."

So what happens? The dollar surges and gold loses $18 an ounce after Colin Powell makes a strong case for almost immediate action against Iraq, with backing from allies that include the British.

"War is nearer than ever," writes the strategist, one of several who see Iraq as just a smokescreen for a deflating American economy and depressed interest rates. "Iraq may well be the distraction that is keeping the dollar from breaking down decisively, and thereby sending gold through $400."

War and its influence on financial markets, of course, are subject to interpretations that often are tainted by emotions and history. Few of us can forecast correctly what will happen when the world's strongest military and economic power engages its enemy in a physical assault.

Coxe points out the dollar's rebound, and gold's decline, occurred this week even as the threat of war intensified. That was probably the "superpower effect," the rush to the dollar as a shelter from the storm. U.S. Treasury bond prices also benefited.

Not so for most of the past year, though. Foreign investors have been fleeing the dollar, and American assets. With the dollar having lost about 18 percent of its value against the euro since early 2002, and about 10 percent against the yen, nations with healthy balance sheets are looking attractive.

The American balance sheet, as measured by the current account, is in red ink to the tune of almost 5 percent of gross domestic product. It is said the United States needs about $1.4 billion of overseas capital each day to service the current account red ink, which stands at about $130 billion. Japan and most of Europe have a surplus in their current accounts, which include balance of trade with the rest of the world.

Some economists, led by Morgan Stanley's Stephen Roach, contend the $31 trillion or so of U.S. paper debt swishing around the globe, along with low interest rates that give eurodollar holders and others with American "cash" a mere 1 percent return, will continue to sink the dollar, regardless of war.

In the best analysis, war is a trick mirror, a blinding flash in the face of a circus economy. Fix the economy, and you fix the dollar.

"Businesses are already ratcheting down Wall Street's optimistic growth forecasts for 2003," says Frank Giustra, chairman of Endeavour Financial, a Canadian merchant bank. "And we're only in February. Erroneously, most economists -- and as of last week, Alan Greenspan -- seem to be citing concerns about a pending war with Iraq for everything from the lack of improved retail sales to the dearth of capital spending by corporations."

James Turk, the newsletter writer and gold researcher whose dollar and bullion forecasts have been on the mark for more than a year, says war, to have a lasting influence on the value of a financial market, must have a monetary consequence. Turk sees the dollar continuing its swoon, and gold's price rising to $430 or so an ounce by month's end from its current $370.

What is war good for? In the case of Iraq, financial consequences can follow from a shortage or excess of oil. Or a loss of air traffic across parts of the world. Most of the "war effect" likely will come months later, when the world's investors register the cost to the U.S. government, which is already seen pumping its spending deficit by $1 trillion in the next five years.

For people like Turk, who edits Freemarket Gold and Money Report, "War affects gold only if the war affects the money of the warring nation."

Turk sees the price of gold (38099902) benefiting from the collapse of a dollar that had, until early last year, been boosting the worth of American assets for almost 20 years.

"When gold jumped on Tuesday (to just short of $390), the market started to get a little frothy," Turk tells me. "So there's nothing like a little correction to shake out some weak-hands." See: Gold analyst forecasts $434 gold price.

Coxe, the Nesbitt Burns strategist, put it this way in his report: "Iraq may well be the distraction that is keeping the dollar from breaking down decisively, and thereby sending gold through $400."

The expensive stock market is also at great risk. I think we can count on a higher gold price in coming days and weeks as investors keep pulling the plug on their U.S. holdings.