Pakistan Unrest and the Weakening Dollar

By Paul Hoffmeister

The assassination of Benazir Bhutto yesterday offers further proof that geopolitical events are significantly impacting the dollar-gold price and thus the real value of the dollar. A reading of the dollar-gold price yesterday morning shows that gold began to gradually rise by $1 around 7:15 am EST when news spread of a bomb attack at Bhutto's Rawalpindi rally, and then sky-rocketed $6 to $830 after 7:59 on the announcements that she was critically injured and in emergency surgery. Given the facts that a gunman directly targeted her and the bomb that exploded next to her van reportedly took more than a dozen other lives, news of Bhutto in the hospital likely meant she would not survive this second attempt on her life since her return to Pakistan in mid-October.

But the Bhutto/Pakistan story and its effect on financial markets is not new. The conventional financial press is playing catch up. The story arguably started on September 19 when Osama Bin Laden called on the people of Pakistan to overthrow the pro-Western Musharraf government. Since then, the gradual weakening of Musharraf's once-firm hold on power and the increasing uncertainty over upcoming parliamentary elections on January 8 have helped push gold to more than $820 from the $700 range. In a country where nearly half the population sympathizes with Al-Qaeda, the risk is the West's supposedly reliable Musharraf will be toppled and a power vacuum will ensue allowing for the Talibanization of Pakistan -- one of the world's eight nuclear powers.

Political chaos has been Bin Laden's objective, and the Bhutto assassination is undoubtedly strategic. Not only does her absence in Pakistan's political process remove a powerful pro-Western sympathizer, but her death has spawned mass protests demanding Musharraf resign for inadequately protecting Bhutto. But as Mahmud al-Durrani, Pakistan's ambassador to the United States, said Thursday evening, no amount of security could protect her from a suicide bomber at the massive rallies she attracted. And further destabilizing the country, the Washington Times' Arnaud de Borchgrave reports that the tribal areas along the Afghanistan-Pakistan border are now under Al-Qaeda and Taliban control despite the Pakistan army's military campaign there during recent months, which has cost at least 1,000 soldiers lives and wounded 3,000.

The 100 basis point decline in the fed funds rate since September is not the likely cause for the continued decline in the dollar, which has been marked by foreign exchange weakness and rising gold. The Federal Reserve's rate cuts do not appear to be characteristic of loose monetary policy because money supply growth since September has been relatively tame, and thus very unlikely to be the cause of the dramatic 17% rise in gold that translates to a 17% decline in the real value of the dollar. Instead, the recent dollar weakness is likely the consequence of declining dollar demand primarily caused by new geopolitical uncertainties.

Paul Hoffmeister is chief economist for Bretton Woods Research. He can be reached at

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