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:
- Will the collapse be an absolute failure of the dollar and the U.S. economy, or will the dollar retain some value?
- Regardless of the answer to the last question, will some other form of currency compete with, or even replace the dollar completely?
- 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.