What's Going to Replace the Dollar?

Recently, I've devoted most of my writing to a narrow range of topics, including the current unprecedented rate of inflationary activity by the Fed, and the looming failure of the dollar. The issues have brought a lot of debate from those who agree, as well as from those who think I'm crazy. Yet despite support or opposition, three questions seem to come up more than any others:

1. Will the collapse be an absolute failure of the dollar and the U.S. economy, or will the dollar retain some value?
2. Regardless of the answer to the last question, will some other form of currency compete with, or even replace the dollar completely?
3. What am I doing to prepare for the events I predict? Am I shorting the dollar, or is there a better way to capitalize on the move?

Before I begin answering some of these questions, I want to point out that most of my critics tend to cling to the notion that the economic and military dominance the U.S. has enjoyed for the last century are immutable conditions -- that is to say, the U.S. and the dollar will last forever. Ergo, I point to any number of empires that have fallen prey to the exact same form of arrogance and aggression -- including (but not limited to) Rome, Spain, France, England, and the Soviet Union.

Moreover, if I were forced to predict an outcome based on either the immutability of the U.S., or the immutability of basic economic principles, I would vote irrevocably for the latter. Every single one of the aforementioned defunct empires can thank inflationary money-creation for much, if not all of its downfall. The United States is proving to be no wiser, and it is extremely naïve to think that 50 quasi-independent entities – each sporting its own constitution and government – will sit idly by as Washington flies the dollar into the ground.

I don't want to digress too much into the likelihood of mass secession, having visited that topic ad nauseam last week. But what I should point out, in pursuit of an answer to the first question above, is that I do not subscribe to any theory postulating absolutes. While I do believe the dollar is on the verge of a tragic, extreme, and irreversible downward course, I do not believe it will simply disappear from the face of the earth as a medium of exchange. It is much more likely the dollar will collapse and then level off as a weaker monetary unit. It will not retain its status as "global reserve currency."

And that brings us to the next question: if the world flees from the dollar, what will it run to?

Those of you who read my articles regularly undoubtedly consider yourselves quite blessed to be regaled by my relentless assaults on the U.S. dollar. I despair, however, that my aggression against the greenback might offer the impression I am partial to its weakness. Let me assure you I am not; every major economic bloc on earth is implementing the exact same irresponsible policies of zero-interest-rates, quantitative easing, and massive government stimulus that cause me to fear for the dollar's future, and I am equally appalled by the prospects of all the world's major currencies – including the euro, the pound, and especially the yen. Indeed, even Switzerland -- once the world's last bastion of sound monetary policy – is now threatening to implement quantitative easing!

But there's yet another interesting variable in this equation.

The Chinese and other countries have been playing an interesting game with the U.S. for decades: they keep their currencies weak in order to make exports more attractive to the U.S., while at the same time lending the U.S. vast sums of money. The U.S., in turn, uses this borrowed money to buy cheap finished goods from these countries. The countries then use their profits to lend the U.S. yet more money. And so the cycle continues. Until now.

As I've noted so many times recently, U.S. creditworthiness is all but dead. The American consumer is tapped out. There are few people left to buy Chinese goods. Why am I bringing this up? As the dollar, the euro, and the yen start to give ground, the Chinese, for instance, will feel obligated to drive yuan lower in order to re-ignite exports. The whole thing is a tinderbox just waiting to explode. So if every major currency on earth faces the same fate as the dollar, what will people use as a medium of exchange when the bottom falls out? My answer is as simple as it is predictable: gold, silver, and other precious metals.

I know some of you are upset right now. I can almost hear you cracking your knuckles above your keyboard, preparing to launch into a vicious tirade about how abjectly stupid it is to think people are actually going to buy milk, eggs, and cereal with gold. What will they do -- chop Krugerrands into wedges, like modern Pieces of Eight? I suppose that is a solution – it certainly worked for the Spanish, whose coins were the "reserve currency" in the new world for a long time. But in our modern technological society, using coins – or even fractions thereof – is completely unnecessary, if also impractical.

I am not a futurist, and I am not willing to predict with any degree of purported accuracy the exact form currencies will take once the illusion of fiat money finally and irrevocably comes to the world's complete attention. In my book Discipline, however, I posited a scenario in which the world's major currencies fail, only to be replaced by private currencies backed by precious assets. In the book, the world's major powers try desperately to stop the flight from their inefficient, monopolistic currencies but because of the proliferation of credit and debit cards, the transactions in the new currencies are transparent and easily facilitated. Of course, this leads to the next question: what, exactly are these governments going to do -- punish their citizens for wanting to use a stable medium of exchange in response to a failed promise? Are these governments really going to hold guns to their citizens' heads, proclaiming, "Use our currency and starve, or use a private currency and go to prison."

Again, my prediction came in the form of a novel; maybe it will accurately represent the outcome, and maybe it won't. But is it so farfetched to think that the managers and purveyors of the SPDR Gold Trust ETF – which currently holds more gold than most sovereign nations – couldn't quickly and easily issue some type of certificates that might quickly and efficiently facilitate transactions, at even the grassroots level? Further, couldn't this fund quickly and easily supply debit or cash cards to the public?

Perhaps your response to my musings is to say, "It would never catch on," in which case my reply to you is this: have you seen the speed with which things like iPods and MySpace go viral? Do you really think that, if the world's major currencies were failing, people wouldn't flock to any form of stable money as quickly as possible? What would you do? If dollars were melting in your pocket, and someone offered you a liquid medium of exchange that just about everyone was accepting – backed by all the stability and consistency of precious metals – which would you choose?

We've addressed the first two questions I started this article with, so let's get to the third: if you want to prepare for a collapse in the dollar, should you short it, or is there a better way to benefit? The answer is that the only real way to short the dollar is simply not to own it. You can certainly short dollar futures if you like, but when you do that, you're shorting the dollar against specific currencies, and we've already established that all the other major world currencies are going to fall with the dollar. Even the dollar index is tied to other currencies.

As an aside, here's an interesting thought to ponder regarding the Dollar Index: the major currencies with which the dollar index is calculated could all be sliding with the dollar – relative to assets, goods, and services in the global economy -- and yet the dollar index could actually be going up, if the dollar is stronger than those other currencies. Just think about that. Every day on CNBC Rick Santelli refers to the Dollar Index as a true gauge of the dollar's strength, but in reality, the dollar might be weakening tremendously against assets, and if you only watch the Index, how would you know?

Anyway, if we assume the dollar is weakening with all other major world currencies, what do you do in response? Well, if you don't already know my thoughts on Treasuries, I've written plenty recently about how far I think they have to fall as faith in the U.S. government and the dollar wanes. Certainly, once it becomes clear the Fed can no longer realistically defend the long end of the yield curve, shorting Treasuries is going to be the play of a lifetime, so keep that in mind when you're trying to figure out how to prepare for failing global currencies.

In one of my recent articles, I also pointed out that in times of rising prices caused by the expansion of the money supply, it isn't so much the case that assets are becoming more valuable, due to demand. No, it is much more accurate to say that the currency is becoming less valuable.

When you begin to think about it in those terms, it becomes easier to consider how you might prepare against currency collapses. Think about the things that people will consistently need or want in precarious economic times – especially times of rising prices. Historically we know that precious metals have done well, but commodities in general also do well. Agriculture tends to keep pace. Also, as silly as it might sound, anything durable that you know you're going to use in the future is an excellent hedge against inflation. If you know the currency is going to be worth half as much in a year, and you know your infant son is going to need diapers in a year, then diapers are a good investment in today's currency – not only because you have use for the good, but also because you free up future, higher disposable income for investment.

Another idea? If you can maintain an income that rises with prices, being a debtor at a fixed rate is a great position to be in. Your salary is increasing, and yet your mortgage payment, for instance, is not.

One more thing to think about: while the historical consistency of precious metals is important, the psychological aspects of gold give it an edge as an investment in times of rising prices. Silver and palladium are certainly rare and precious, but they don't seem to have the same cachet – and indeed the poetic impact – as gold. How many country songs, for instance, have been written about palladium? What I'm trying to say is this: when gold rises, it tends to rise more than other precious metals simply because people are more passionately drawn to it.

Now let's talk about something like oil for a moment. In real dollars, the price of oil has averaged somewhere around $25 a barrel over the last several decades. Is demand for oil going to pick up? Of course; populations are increasing, and China and India are becoming industrial powerhouses. Is the supply of oil going to diminish? I would argue that it probably isn't going to diminish as much as environmentalists would have you believe – especially with the onset of new technological innovations which improve the efficiency of extraction – but it is a finite resource, so I will give some credence to the argument that it is becoming scarcer. Therefore, all things being equal, the price should rise based on nothing more than the principles of supply and demand – and probably sooner, rather than later.

But what will happen when major currencies start to collapse? The price of oil will increase accordingly, right? Actually, no; the price of oil will likely inversely mimic the slide in currencies, but it should also increase beyond that to account for ever-increasing demand.

To wit, I don't believe the historical average price of $25 per barrel – even in real dollars – adequately reflects the demand for oil we will face in coming decades. The same argument could be applied to agricultural and commodity securities as well. So I'll say it again: the best place to be when the dollar falls is anywhere but dollars. If you really want your portfolio to shine, however, you need to find the investments that will outpace rising prices, and that means agriculture, gold, durable goods (that you'll need anyway), and fixed-rate debt. And, of course, there's always gold.

But if you can get in on the ground floor of a private, gold-backed currency, well, that might just turn out to be the best investment ever.

Disclosures: Paco is long gold, DXO, and UCD. Unfortunately he also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.

Copyright 2009, Paco Ahlgren. All Rights Reserved.

Comments

[Cesato]

So many thoughts in the same bag, but a broad, humble anaylis, I kind of like it. My view is USD down, USD Index up, Gold up, Treasuries down. if you hold USD by necessity, your Gold will hedge the loss of value on the USD. As far as inflation, remember that demand does not have to necessarily increase to produce inflation, if the offer of goods and services become limited and the US Government does have to keep on printing money then you have a scenario for inflation. You made the case, if treasuries sell-off, USD devalues, the stock market does not take off and the expectation of hyperinflation influences investors' long term strategies, then all is left is Gold. A book to read for eduactional purposes only "The Great Inflation and Its Aftermath" by Robert Samuelson.

2009 Feb 09 03:32 AM

[Alan Young]

I've been interested in the proposition put forth by another blogger that the main purpose of the US military in recent decades has been to enforce the dominance of the dollar. For example, the real reason for invading Iraq in 2003 was not its role in terrorism (there was none) or WMDs (which were long gone), but its threat to market its oil priced in Euros.

Bottom line, IOW, whatever wants to replace the dollar might have a war on its hands first.

I hope this is not true; but none of the wars promulgated by the US in the last 60 years have made any kind of moral sense--so, after all this time, no depravity in pursuit of economic power can surprise me.

2009 Feb 09 03:47 AM

[mrtaxx]

It's IDIOTIC to think WAMPUM (gold, silver etc.) will replace any currency.

2009 Feb 09 03:56 AM

[JohnAl]

"It's IDIOTIC to think WAMPUM (gold, silver etc.) will replace any currency."

Is it really? PMs have been used as money by many cultures throughout much of human history, and as the author points out, a modern PM backed money wouldn't necessitate carrying around metal. The conveniences of modern banking would still exist.

I do think it's likely that before we arrive at this juncture, though, there will be attempts to replace the dollar with other fiat currencies. Governments don't give up easily, and they need the fiat currency to maintain their power and their growth.

My guess is that the next step, which will come only after things get worse in the US and the government gets increasingly desperate, is that there will be an attempt at a world currency. This would necessitate the US giving up much of it's advantage though, which is why I don't see it happening until things are much worse here. They may even make a show at tying this new currency to PMs in some way. But it will be a sham. They will want to maintain their ability to create money out of thin air.

2009 Feb 09 05:38 AM

[Conan the Barbarian]

JohnAl: The current activity between Central Banks worlwide enhances the possiblity of a World Currency. The USD would be a part of same.

This would replace the Dollar in International Trade though not necessarily internally.

I doubt Gold will ever surface as a Standard anywhere or even be included in the newly Created World Currency because it would distort the value of that WC. (Gold demand/supply outside of the framework of the WC.)

I'm not a futurist but looking into the available possibilities for future investment comes part and parcel with the territory.

Regarding Agriculture, I am looking for big upside moves in DBA and DAG. Being a futurist doesn't mean you ignore the present.

Currently in progress, Major Droughts in China, Australia and Caifornia, with an assessment of Winter Damage in the middle of the US yet to come. Weather is always the big threat when it comes to agriculture.

2009 Feb 09 06:32 AM

[lady_knight_in_london]

I like the analysis here but find it very far-fetched, strething facts and imagination, such as the proposition that national-currencies will cease to exist. Even if that might be on the horizon its not a strong possibility in the next 10 years for sure!
So what would be more useful is to develop & present an understanding of what will replace the dollar in teh next 6months to 1year. Or where will the dollar be? How will the Yuan be positioned...
Sorry, but your article, esp the last bits read more like a preamble to the economic look alike of lord of the rings! Promoting some prophecy...
Pls dont do this to seeking alpha!

2009 Feb 09 06:34 AM

[Roger Knights]

I like the idea of GLD issuing certificates that could be used as currency between consenting parties. But wouldn't anyone who stated he would accept only such certificates, or even would give a discount price on such certificates, be in violation of our "legal tender" law? (OTOH, maybe the law making fed notes legal tender is in violation of the Constitution's requirement of "specie payments.")

2009 Feb 09 06:59 AM

[ROLEX18]

I would like for more precious metal coins to appear in circulation, but prices must be fixed, 250$ for ounce of Gold and 5$ for ounce of Silver.
So we can have nice shining coins in circulation, but it is impossible to implement as Gold/Silver are trading instruments and their values can't be fixed, they can only crash.

2009 Feb 09 07:19 AM

[Whitslack]

> Are these governments really going to hold guns to their
> citizens' heads, proclaiming, "Use our currency and starve,
> or use a private currency and go to prison."

Actually, yes. Check out the FBI raid on the Liberty Dollar:
www.reason.com/blog/sh...

The raid occurred in November 2007. The government is still holding onto the $3.5M in gold and silver that it confiscated. To date, no arrests have been made. The whole thing is totally bogus.

Big government doesn't like the sheeple having choices it doesn't control.

2009 Feb 09 08:09 AM

[john s. gordon]

collapse of stalin's soviet union was due to its own internal rottenness, not to 'excess money creation'.
> jack

2009 Feb 09 08:20 AM

[Tetrapod]

Rolex,
Do you mean they need to be fixed like the US Dollar or Euro that fluctuate everyday against other currencies and gold?
If there's any reference point at all in currencies, gold is it.


On Feb 09 07:19 AM ROLEX18 wrote:

> I would like for more precious metal coins to appear in circulation,
> but prices must be fixed, 250$ for ounce of Gold and 5$ for ounce
> of Silver.
> So we can have nice shining coins in circulation, but it is impossible
> to implement as Gold/Silver are trading instruments and their values
> can't be fixed, they can only crash.

2009 Feb 09 08:33 AM

[Tetrapod]

Paco,
What do you think of the outfits like goldmoney or bullionvault that basically establish the gold-gram as a standard currency and allow it to be instantly converted to any of the other major currencies or metals?
Payments can even be electronically sent to anyone in any currency.
It seems to me that that is a valid private currency. I don't think it's necessary to give the currency a brand name -- GoldGrams says it all and allows multiple issuers. I guess the only thing missing is a "Note" that can be carried on your person, but unless HYPER-inflation catches on, Dollars or Euro's, etc. should be fine for pocket change.

2009 Feb 09 08:40 AM

[JudeJin]

nothing needs to replace dollar. dollar lost 90% against gold in the 1970s. dollar is still here today.

no need to talk about gold standard. no need to talk about which currency to replace gold.

market price of gold will converge to its theoretical value as can be calculated from the money in circulation and the amount of gold held the fed. of course, the money in circulation will go up dramatically as the crisis unfolds further.

2009 Feb 09 09:17 AM

[TeresaE]

Thanks for the article, but you forgot to mention Germany.

Hyperinflation caused massive poverty and starvation, which led to rise of extremist powers. Look hard enough and you can see we are already following that path.

2009 Feb 09 09:24 AM

[MichaelJ007]

The fall of the dollar is still far from today. The US military as well as the military of any other nation using it as a reserve currency have a direct interest in the dollar's survival. Gold and other precious metals will surely increase in value due to inflation, but they will not replace the flexibility and the control that comes with a fiat currency. The idea of a World Currency is much more feasible. The dollar is practically the world currency already. However, some other type of note could easily replace it. All of the world's GOVs and Banks could collude to set its supply, rules, rates, etc.

2009 Feb 09 09:36 AM

[Ferdinand E. Banks]

About this contribution. The dollar will be here long after Mr Ahlgren and the rest of this forum are blogging in another world. Of course it won't last forever, but as long as the president of the US is recognized as the most important man on earth, and his armed forces fill the role of an international gendarmerie, the dollar will be THE currency.

2009 Feb 09 09:39 AM

[patio]

I will say his fantasies are among the most absurd writing here at SA.
Even with our high debt, and not saying it is not a big problem that will take years to solve, the US is the worlds sole superpower- militarily, politically, and still financially.
Paco is a silly youn'un.



On Feb 09 09:39 AM Ferdinand E. Banks wrote:

> Ahlgren. That's Swedish, isn't it? Are you the guy who told me that
> I not only was the worst teacher in the world, but also I couldn't
> speak english? In the 15 or so years that I taught international
> finance in Sweden I only failed a handful of students, and I've always
> regretted that I didn't find out who that gentleman was, so that
> I could have failed him on the spot.
>
> About this contribution. The dollar will be here long after Mr Ahlgren
> and the rest of this forum are blogging in another world. Of course
> it won't last forever, but as long as the president of the US is
> recognized as the most important man on earth, and his armed forces
> fill the role of an international gendarmerie, the dollar will be
> THE currency.
>

2009 Feb 09 09:54 AM

[Paco Ahlgren]

Although my name is Swedish, I have never been to Sweden, and I don't think you ever taught me finance (or English). In fact, I don't think you and I have ever met, but if we do you are more than welcome to fail me on the spot at that point.

And I'll bet you a dollar I outlive the dollar.


On Feb 09 09:39 AM Ferdinand E. Banks wrote:

> Ahlgren. That's Swedish, isn't it? Are you the guy who told me that
> I not only was the worst teacher in the world, but also I couldn't
> speak english? In the 15 or so years that I taught international
> finance in Sweden I only failed a handful of students, and I've always
> regretted that I didn't find out who that gentleman was, so that
> I could have failed him on the spot.
>
> About this contribution. The dollar will be here long after Mr Ahlgren
> and the rest of this forum are blogging in another world. Of course
> it won't last forever, but as long as the president of the US is
> recognized as the most important man on earth, and his armed forces
> fill the role of an international gendarmerie, the dollar will be
> THE currency.
>

2009 Feb 09 10:05 AM

[Paco Ahlgren]

Well, that doesn't constitute much of a counterargument I guess.


On Feb 09 09:54 AM patio wrote:

> I will say his fantasies are among the most absurd writing here at
> SA.
> Even with our high debt, and not saying it is not a big problem that
> will take years to solve, the US is the worlds sole superpower- militarily,
> politically, and still financially.
> Paco is a silly youn'un.
>
>
>
> On Feb 09 09:39 AM Ferdinand E. Banks wrote:

2009 Feb 09 10:18 AM

[David Roskoph]

The better question is - What's going to replace gold as a monetary standard? The answer is the US dollar as a function of the value of the franchise. The world is drowning in fiat with a new tsunami guaranteed to occurr. The dollar will rise as the most secure of all the worlds' 'funny monies". Gold is fading as some magical place to avoid cataclysm. In fact central banks are probably selling it to a frothy public because things are so painfully extended (worlwide) that it's all or none.

2009 Feb 09 11:03 AM