The Coming Currency Crisis

The End of the Dollar Standard

Central banks won’t be the only players. The millions of people around the world who use the dollar as their second currency will join in. And for most of them, “the dollar” doesn’t mean Treasury bills, it means $20 bills, $50 bills, and $100 bills. The collapse in the foreign-exchange value of the dollar sparked by foreign central banks unloading their excess holdings will undermine everyone’s confidence in the dollar’s usefulness as a store of value. Private foreign investors will flee the dollar, further reducing its foreign-exchange value. And most of that privately held cash will flow back to the US as more fuel for price inflation. The dollar standard will be dead.

The consequences will be of historic proportions.

How “historic”? As you can see in Chart 7, if the world’s central banks backed their currencies with gold, it would send the price up (in current dollar equivalents) to many thousands of dollars per ounce – easily $5,000 or more.

(Click on image to enlarge)

But wouldn’t central banks fight against such a rise in gold? Wouldn’t they sell some of their tons of bullion to cash in on higher prices or out of a desire to keep the price from rising further?

Our friends at GATA make a compelling case that the central banks don’t actually have as much gold as they say they do. But even if that’s not the case, all the gold holdings the central banks report still are nowhere near enough to back their currencies. Note that, as a percentage vs. paper, gold now makes up only .04% of total central bank reserves.

Again, if the dollar proves to be unreliable as a backing for other currencies, what are central banks going to replace it with? Even if they move en masse to the euro, a global crisis is hardly a time for central banks to sell off the one hard asset they have.

And, as discussed in previous editions of IS, all modern currencies are empty promises. If the dollar is an “I Owe You nothing,” the euro is a “Who Owes You nothing?” What central bank would want to back its paper with more paper in the midst of such a world-wracking crisis of faith in paper?

With the political uncertainties that surround the other contenders – not to mention the object lesson of the spectacular collapse of the USD, when it happens – we believe the world will eventually stumble back onto a gold standard. That could happen in as little as a decade. In the interim, they may flirt with the euro, the yen, or other tissue papers, but not enthusiastically and not for long.

Virgins Are Safe This Time

Is there anything the US government can do to stop the train wreck? Earlier governments tried sacrificing virgins to the gods to ward off disaster, but the practice seldom worked and isn’t likely to be revived. The Federal Reserve could try raising interest rates still higher, high enough to convince foreign central banks to hold on to their dollar investments, but that has about the same chances of working as tossing gold-laden virgins into deep, water-filled sinkholes did. It might protect the dollar standard for a while, but it would turn residential real estate into a financial graveyard and trigger the depression the Fed is trying to avoid. Of course, the Fed could fight a contraction in the economy… by lowering interest rates. But that would bring on a flight from the dollar and a more rapid end to the dollar standard. There is no way out.

Future Uncertain?

If we’re right about a coming monetary regime change, it’s hard to imagine a future for the US that isn’t grim, with plenty of harm splashed around on its trading partners: inflation… currency crisis… dollar crash… government instability… internal conflict for scarce resources… welfare system collapse… skyrocketing unemployment… taxes raised on a population burdened with an uncompetitive US economy… dollar down 40%… 60%… 80%?… emergence of competitive economic battles on too many fronts: China, India, Japan, Russia – and on too many military fronts. End of empire/Fall of Rome redux… the Greater Depression.

We are already seeing extreme volatility in emerging markets as the hedge funds beat a hasty retreat for liquidity. Get used to it.

Remember, never before in history has the unbacked paper currency of a single country been used as the de facto reserves of the world’s central banks. We are truly in Terra Incognita, uncharted territory – and a hair trigger away from a currency crisis that, once begun, will quickly spin out of control.

Gold Is the Past… and the Future

At our recent Chicago conference we polled the audience to see if anyone of the 300 attendees could name the five natural reasons that Aristotle gave as to why gold is money. Despite having regularly mentioned those reasons in these pages – and offering a prize – not a single attendee had enough confidence in his or her understanding to stand up and recite the five reasons. So, here they are again: It has intrinsic value (it’s valuable in many uses); it’s convenient (houses are not easily portable); it’s divisible (the Mona Lisa isn’t); it’s durable (wheat rots); and it’s consistent (diamonds have different grades that are not always easy to see).

Even if the regime change we foresee takes decades to come about, the softest “soft landing” imaginable will still be very painful, with repeated flights from paper currencies. That is why we have been saying that gold isn’t just going through the roof, it’s going to the moon. And given the signs – particularly the housing bubble popping on the sharp point of higher interest rates and the increasing moves on the part of foreigners to distance or divest themselves of dollar-based assets – we believe the fireworks are going to start sooner rather than later.

As to what speculators – what anyone – should do, it doesn’t really matter whether the fall of the dollar precipitates the level of crisis we expect. The steps we advocate are reasonable for anyone who doesn’t want to get hurt by a currency crisis: buying physical gold (and silver – both are still relatively cheap in inflation-adjusted dollars); getting a useful portion of one’s assets into a stable country outside of the US (preferably one with no involvement in the “War On Terror/Islam”); and investing a fraction of one’s portfolio in gold stocks.

That these moves are also the same as those you need to make for realizing enormous profits is not a coincidence but a reflection on our times.

One More Observation

Government deficits, trade deficits, and losses in the dollar’s value tend to move together, a point made clear in Chart 8 which shows what happened after the US abandoned the gold standard.

(Click on image to enlarge)


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