The surge in the dollar seems a little counter-intuitive, given the fact that additional monetary expansion is the likely source of the funds necessary to implement the rescue plan. The Treasury Department has essentially committed to provide as much as $100 bln to each of the GSEs. However, the government's commitment is really open-ended. If it takes more than $100 bln to keep either or both entities afloat, you can be assured that the liquidity spigots will continue to flow.

Fannie and Freddie together own or guarantee about half of the $12 trillion US mortgage market. Their combined outstanding liabilities are a staggering $5.4 trillion. The exposure to the government, and by extension to the US taxpayer, is huge.

Nonetheless, the FX market continues to reward proactive policy action with an improvement in risk appetite. You may recall that the banking sector got an initial boost in the wake of the Bear Stearns bailout, before shares subsequently tumbled into mid-July.

In recent commentary I have maintained that recent strength in the dollar is not supported by the fundamentals. The fact that the GSEs required rescuing is an extremely negative event, highlighting that substantial systemic risks persist.

It is unlikely that government intervention ends at this point. In fact, just the opposite is probably true. Many financial institutions hold shares of both Fannie and Freddie. Over the course of the past year, they have seen the value of these assets plummet and the rescue plan does not offer any relief.

Common shareholders are now at the bottom of the list when it comes to having a claim on GSE assets. Dividend payments have been suspended and if the government chooses to exercise its right to buy the common stock of either entity, those shares will be virtually worthless.

This obviously will put further pressure on shares and likely prompt additional writedowns on the part of companies holding these shares. Might this the proverbial straw that pushes other banks to the brink of insolvency? If so, the question remains, at what point is a bank to big to fail? Might additional bailouts be in the offing? There has already been talk that the US auto industry may require an additional $50 billion in bailout money.

Growth of the money supply is ultimately a negative fundamental for the dollar, raising serious questions about the sustainability of the recent gains in the greenback. Negative real interest rates are bearish for the greenback as well.

Fed funds are presently at 2.0% and expected to remain there following next week's FOMC meeting. While capital continues to flow out of Europe, the refi rate is still 4.25% there, more than twice the yield here in the States.

In the wake of last week's dismal economic news, we don't expect the Fed to start raising rates any time soon. In fact, Fed funds futures show there is only a 20% chance of a rate hike through year-end, even with the latest GSE inspired treasury sell-off. With no appreciable narrowing of interest rate differentials in the cards, there is no compelling fundamental reason to be holding dollars.

The trust of the matter is that all currencies are being debased to one degree or another and gold is the ideal hedge. That is why we believe that physical gold has become an indispensable component in the modern portfolio. That is also the reason gold is holding up remarkably well in the face of the latest surge in the greenback.

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