The U.S. dollar will start 2012 on an upswing – but don't let it fool you.
What we're seeing is only a short-term rally inspired by Europe's travails. In the long-term, the U.S. Federal Reserve's loose monetary policy and the United States' own debt burden will drive the greenback back down.
That's the consensus among experts who follow the global money markets and the leading currencies, including several of Money Morning's own analysts.
"The dollar is going to rally in the short-term so long as the primary liquidity mechanism (used by the world's central banks) continues to be dollar swaps," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "How long that is going to last is uncertain – perhaps March, April or beyond – but once it abates, our own enormous debt problems and inflationary policies will return to the spotlight and the dollar will quickly give up its recent gains."
Indeed, the dollar rallied in the second half of 2011, as Europe's debt battle dominated the headlines. The U.S. Dollar Index, which measures the dollar's value against a basket of foreign currencies, ended about 10% higher than its May 2011 lows, gaining almost 3% in November.
That momentum is likely to continue for the first part of the New Year, but not long after.
Several economic factors will weigh far too heavily on the currency for the upward move to continue – although it's not clear exactly when the short-term surge will lose steam. And investors who understand what's really driving the U.S. dollar's value in 2012 can avoid getting burned by the currency's long-term decline.
Short-Term Help from Europe
"The ECB (European Central Bank) will be left with little choice in saving banks and their sorry sovereigns other than to print, print, print euros, and more of something almost always leads to a lower price," said CNBC News' Brian Sullivan, who thinks the U.S. dollar will reach parity with the euro in 2012.
The euro fell to a 15-month low against the dollar in the last week of 2011. It traded yesterday (Monday) as low as $1.2930.
U.S. dollar value has also been driven higher recently by increased demand, since the central banks in Europe, the United States, Great Britain, Japan, Canada and Switzerland have all agreed to lower the interest rates on dollar swaps.
"Dollar swaps – you know, those little arrangements that allow foreign banks to swap their unloved currencies for dollars – … really come in handy when there's a panic and a flight to the safety of U.S. Treasuries," Money Morning Capital Waves Strategist Shah Gilani explained. Since U.S. Treasury securities must be purchased with dollars, increased demand boosts the currency's value.
However, the overwhelming long-term outlook for the U.S. currency is still bearish, mostly due to the weak U.S. economic outlook for 2012.
"The dollar is enjoying a safe-haven status, but long run I'm not a fan of the U.S. dollar," Dr. Allen Sinai, chief global economist at Decision Economics, told Forbes. "Our country has too many problems – with long run growth forecasts, deficits and how the politics of our country operates are all a negative."