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This is the third article in a series called “Globalization – Where Is It Taking America?”
Summary
There’s a way to view a global currency crisis that brings into very clear focus what particular types of investments might do well besides gold. It involves looking at the situation through a scale that measures economic "needs" and "wants" -- what I call a SONAW scale.
When the American economy produced goods and services that went the full spectrum -- from necessities (oil, steel, food, etc.) to niceties (dog biscuits, powder puffs, etc.) – a "needs and wants" scale didn’t clarify much. When times got tough, sales of the essential products (needs) helped carry the economy through while the less essential industries (wants) suffered.
But times have changed this. Most of our necessities are now supplied or manufactured overseas and the American economy now provides the less essential things. Because of this, the America economy is particularly vulnerable if things get squeezed.
If the dollar crashes as we explained in a previous article, "Why a Dollar Decline and World Crisis Is the Rational Expectation," the cost for life’s essentials from overseas will surge. As more money suddenly goes overseas to buy the needed items, less money will be left over to buy the less-needed American products and services.
I think this approach to understanding the dollar issue leads to a clearer view of the threat and provides a better focus on what investments to choose and what to avoid.
A Scale of Needs and Wants (SONAW)
One can create a graduated scale of economic “needs” and “wants” for life in 2011. The relative position of the “needs” of life is rather clear-cut and hasn’t changed much; it’s the positioning of the “wants” that can vary and be debated. For example, food comes before clothing, but does an iPod come before a TV?
The graph below is my example of a SONAW scale which I cobbled together quickly for conceptual purposes. A better or scientifically-based one should be developed or found.
[Click to enlarge]
The graph displays the “needed” items at the bottom (the blue color) while the “want” items are at the top (red). Primitive societies are fully engaged in acquiring just the lower five items; advanced societies reach higher up on the scale. A scale like this is useful. One could contrast the standard of living of two countries by comparing the relative height their citizens can easily reach on a SONAW scale.
The scale is also very good when trying to measure how a sudden economic shock (like a dollar collapse) would affect either a person or a country; what industries would be affected the most; and what won’t be. A simple question highlights this: If your income suddenly declined by 25%, what would you give up first, second and third? They would be at the top. Similarly, any country producing a lot of items high up on the scale is particularly exposed. Countries supplying the lower items are more secure.
America Is Very Vulnerable
Forty years ago, the American economy produced an equal balance of goods and services which included production of the essential items. Now we produce 2/3 services and 1/3 goods. This ratio would be the mark of an advancing society if it still included the production of the essentials -- but it doesn’t. We now import most essentials, and this makes the America economy especially vulnerable if these essentials skyrocket in price due to a major dollar decline.
Yesterday, Sam Zell of Equity Group Investments stated on CNBC's Squawk Box that he thought the American standard of living will suddenly decline by 25% due to a dollar collapse. His seemingly outrageous and very alarming statement now makes sense. A sudden 25% decline in the dollar would probably cause an almost overnight rise of 25% in the price of imported essential items (oil, metals, food, raw materials, etc.). This would push the average American far down on the SONAW scale. Although most would cut back on everything, including the “needs” items, the lion's share would be cuts in the red items on the scale – the products and services we primarily make or supply. This negative aspect of our import-dependent service economy is not usually appreciated.
Finding Other Stores of Value Besides Gold
In "Why a Dollar Decline ..." I describe the crisis occurring over five phases. The worst phase is after the dollar declines and the world starts to abandon it as the global currency. I call it the “Confusion Period” because it is the period of global confusion, a period when the global economy has no agreed-upon basis of exchange. This is one (but not the only) reason why gold has been advancing.
In my opinion, however, while gold is an important piece of the puzzle, it is incomplete; it’s not broad enough in itself. One must realize that even with no global currency, life will still go on; six billion people will still need the daily essentials of life and will get and pay for them any way they can. As they say, people can’t eat gold. Because of this, I believe another store of value is also found in a broad currency mix of the global suppliers of the lower five items on the SONAW scale.
Global ETFs of the lower five items such as PHO, CGW, KXI, VDC, XLE are very good examples. Likewise, the areas to avoid would be American and global companies and industries that supply the Red type items on the scale.
There is still a lot of work to be done on thinking through this major transition period. Static periods are easier to analyze; sudden and dramatic changes like a dollar collapse are much more difficult. In any event, this approach to understanding an event which I think will be the major economic event of our lifetime is helpful.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: What Else Besides Gold?