I am posting this article with the permission of its author, Christopher Laird. Chris maintains a newsletter service and a website of his own at www.prudentsquirrel.com. You may want to click through and check it out.
I STRONGLY BELIEVE THAT EVERYONE WHO HOLDS THEIR WEALTH IN DOLLARS SHOULD CONSIDER ALL POSSIBLE SCENARIOS WHEN PLANNING FOR THE FUTURE.
Chris eloquently details his idea of what a potential “worst case scenario” might look like for the U.S. dollar and those who hold their wealth in it. He also describes why he thinks this may happen. Many thanks go out to Chris for his generosity in allowing me to post his article on my blog for the benefit of my readers.
Now that the US election is over, we get to think about the Future. And, no matter how you look at it, the entire world, the West particularly, is in for tough sledding financially.
First, we will continue to battle an emerging economic slowdown. Then, later, we will be battling world currency instability – we already have signs of this now.
Even though gold and commodities have taken a big hit because of a general liquidation in everything, there is one thing none of us should lose sight of, and that is what happens when the USD finally lets go.
Why the USD is presently rallying
Just because the USD happens to be rallying now (with weekly fluctuations) does not mean that its fate is not bleak. There are many reasons the USD is rallying right now. They include flight to cash in general during market liquidations in all areas, but also cash hoarding because businesses cannot roll over the short term credit they use to do payrolls and ongoing operations. Then we have the usual end of year cash surge for businesses and financial institutions. Then of course there is flight to the USD for safety, and then finally, other countries currencies are adjusting to the slowing world economy, and the once hot foreign markets are cooling and there is lots of money moving out of the ‘emerging’ markets.
But, we are going to be facing two particular problems in 09 that none of us is really used to, that we really have never seen. The world is going to have a severe recession bordering on an economic depression. Essentially no one alive today knows what that is like. Only the oldest of us have lived through that experience.
But then, on top of that, at some point later the USD will finally collapse. This is not something way way out there in the future. This issue is becoming a near term threat.
What has held the USD up and why that’s going to change
The primary reason the USD has held up so well in the last decades, in spite of ever worsening US trade and budget deficits that add to over $1 trillion a year combined, is that the US was an export economy’s dream customer. Because the US was such a good customer to the world, they bought our US Treasury bonds, and lent trillions in other ways to the US consumer. As long as the US consumer could carry that process out, our trade partners could make bank on the US and USD.
However, once the US consumer is tapped out, and cannot effectively make a return on investment of our trade partners, the rationale for the continuation of the USD goes away. All that remains after that is a budget busted US Federal government. At that point, why would our trade partners continue to buy all the US treasury bonds and such, and debase their currencies, if the US cannot be such a good customer anymore? At that point, the USD will rapidly fall into a devaluation crisis.
None of us in the US has ever dealt with the twin threats coming our way in the next few years. The first is a real economic depression. The second will be the demise of the US dollar, or at the very least, its severe devaluation like 70% or more (at first).
I would like to point out that in the last great depression in the US in the 1930’s, we did not have a combination of a currency crisis with the economic crisis. The USD, although it fell compared to gold, held up well. Deflation increased the value of anything called cash, including gold.
This time, the outcome will be different. This time, the US faces an economic depression AND a currency crisis soon after. How far off is this?
Well, first, we are already well into the beginning of the economic depression. The damage done to the world credit and financial markets has been stunning since August 07. Over $35 trillion of value has been lost in the world financial markets. That has spilled over into the real economy now, and we will start to see bigger and bigger layoff notices. Economic demand will decline and we won’t see any mere one year recession, like all the pundits say ‘we foresee 5 quarters of economic decline in the US…’
This time we are talking on the scale of 5 years of economic decline and unemployment getting over 20%. The Great Depression lasted ten years, and the US had well over 25% unemployment. US economic production was halved!
The China situation
The rest of the world fared worse. And, we hear that China has this great economic growth, still on the order of 8% a year, a number any nation would kill for. But, China needs to ADD 15 million jobs a year merely to keep up with population growth, having 1.3 billion people!
So, this 8% growth in China is mandatory, not merely a luxury since China still has 800 million peasants in the rural areas all clamoring to move to the cities for better pay. Even at the lowest levels, Chinese city pay is three times the basic rural income which is starvation wages.
And then consider that there are 130 million undocumented Chinese who flocked to the cities for work (not residents of the city) who have nowhere to go now that their export dependent economy is slowing rapidly. The recipe here is for a revolution in China if they cannot keep 800 plus million people working… and this is just beginning to happen. And this issue is widely known to scare the hell out of the Chinese government.
But, to avoid a revolution, they MUST have 8% economic growth indefinitely? That is not going to happen. The party is about over in China.
The point here of emphasizing China’s demographics is that, without big exports to the West, they cannot sustain stability economically or politically. They are the poster child to what happens when the export economies slow drastically when the US export markets slow significantly.
Not going to stop economic contraction this time
But, getting back to the issue of economic depression and the USD. The whole point here is that the world economic engine is grinding to a halt and there is no way to stop it. The US Fed and other central banks have found out they cannot reflate the world economies this time, like they did after 2001 and 911 and the Tech bubble. This time reflation efforts are failing. Things are slowing down too fast this time, and that is combined with the imploding credit markets in every nation of the world.
Without credit, the world economies contract badly. Everything is credit based. Businesses need it to merely do daily operations, and people need it for purchases. The only other way is to have cash and pay as you go. The world economy is not structured to operate that way (things don’t have to be credit based but our world economy is inextricably addicted to it, and credit collapse equates to a world economic depression if the credit does not come back right soon).
And the credit is NOT coming back. Sure, we hear that Libor rates (interbank borrowing rates that is the lifeblood of financial institutions for short term funding needs) have improved. But, these lenders are not lending it out, they are merely covering their own needs and hoarding cash, just like businesses are being forced to since the short term credit markets are still frozen, and there is little chance of that improving for a good while.
So what does all this mean for the USD?
Now, what all this means for the USD is that, as the world loses its economic engine and goes into an economic depression, the highly abused USD will lose its reason to stay strong.
At some point all the US trade partners of the world will find the US is abusing the currency too much. With all the bailouts now, that starts to become more certain. Then, as an economic depression makes its way, the US fiscal deficits, which are already $1 trillion a year, will cause flight from the USD. At some point, our trade partners will simply stop buying the US Treasury notes/bills. This is going to happen, friends.
Then, the USD goes to hell fast. Now when is this? Well, a few years ago I wrote several articles which stated that, when the US consumer reached a point of not being able to give our trade partners a return on their massive subsidies to the US government and buy our bonds, then the USD game is over.
The only reason the USD has managed to avoid a huge devaluation, and even a currency crisis, is because since 1945 after WW2 ended, every time the US economy contracted the US was able to grow out of it. Or, in many cases the US was able to lower interest rates (meaning borrow out of it) and stimulate the economy.
Now, that stimulation process is broken, to say the least. Lower interest rates are not working this time. This time, we are not going to stimulate out of an economic depression. This time we get a depression. Why?
Because, we have two irresolvable problems to avoid a depression this time. This time, we are in the same situation generally as what happened in 1929, and then the ensuing world deflation.
The Two insoluble problems that will lead to a depression and ultimately the final USD collapse
* Deleveraging cannot be stopped, there is too much
* The USD is only supported by a healthy world economy and is subsidized
The world is deleveraging in totality and we have a breaking world finance bubble. I estimate that way over $1000 trillion of world financial markets alone are deleveraging. That number is calculated by adding up all the leverage out there, and the biggest one is the derivatives of all types that are really only big HUGE leveraged bets. They are nothing more than that. The BIS states that world derivatives alone are over $1 quadrillion worth – that’s 1000 trillion. Even if central banks move heaven and earth with their now $7 trillion of infusions to every market imaginable now, that’s a drop in the bucket compared to what’s out there. So, the deleveraging will continue relentlessly this time.
Why did that happen? Quite simply, the Western consumers got tapped out. They borrowed more than they can sustain a return on. So, for example, we see the housing bubble collapse and then all the mortgage bonds collapse, and then all the banks collapse – get the idea? Then all the credit disappears everywhere and we get an assured economic depression. And that will lead to 20% unemployment or worse in the entire world – mark my words.
The overall picture is that the world economic/credit bubble since 1945 has just burst before our eyes since August 07. That is one huge bubble.
And, as they say, for every Ying there is a corresponding Yang, or more simply, what goes up must come down. And it’s coming down hard. And… we haven’t seen nothing yet either. The down has a long way to go; we are merely in the first stages. And, boy is the world already suffering.
So then, follow along here, the next victim of this emerging depression will be the USD. As I said, the only thing keeping the USD afloat with the massive fiscal deficits has been an ever spending US consumer who bought trillions of dollars worth of exports. When they get tapped out there is no reason for our trade partners to keep that up is there? The USD subsidies (primarily our trade partners buying US bonds of all types) will end this time around (this economic cycle).
How can we get out of this mess?
Well, first I have to say I don’t think we will avoid a long, possibly ten years, depression. But there are some ways it might be avoided.
First, if the US abrogated the $60 trillion of promises to Social Security and Medicare, maybe that would save the USD. But that won’t happen. Probably, what the US will do is just pay it all, but with worthless dollars.
The second thing that might get the world out of this impending economic depression and a collapse of the USD later would be to forgive all debts. Possibly that would wipe out the USD too anyway. But that would set the stage for a huge world economic recovery.
The trouble with debt forgiveness is it never seems to happen. Believe me, I am not talking hogwash about debt forgiveness. The Bible, for example, talks about how every 7 years and every 70 years there is to be total debt forgiveness. It’s called the Jubilee. The idea is a legitimate concept that can work and has worked.
You don’t think that’s viable? Well it can work because all that happens is that the lenders who offer credit have to factor in either payment in full or forgiveness over a 7 year period. This can be done and would actually result in the biggest sustained world economic boom ever imagined. The thing that causes world economic depressions are debt and financial bubbles. The two go together.
But, getting back to the fate of the USD. The problem is, the lenders won’t forgive debt or make it amortize in a short time. They insist on ever bigger debts. They do things like making the bankruptcy laws far more stringent (recently done in the US). And thus, they guarantee that the world consumers ultimately will get tapped out (just a matter of time) and then a world bubble collapse and economic depression.
The interesting thing that happens is that there is ultimately dept repudiation in depressions anyway. Which leads us to the USD’s fate in coming years.
I don’t think we will have to wait for 30 years to see Social Security and Medicare to bankrupt the US. What will happen sooner is that, as the US enters economic depression this time , the return on investment for our trade partners will disappear. The US won’t keep our trade parnters’ hundreds of millions employed, and they will then stop buying US Treasury bonds. And then the USD devalues 70% in a year. Maybe going to zero soon after that. The US is then bankrupted.
When can this happen? Possibly mid way into the next US economic depression (not recession). And, since I think we are now entering the beginning of a US depression, then if it lasts ten years, that means we have about 4 years to go for the USD to finally give up the ghost.
Yes, I mean that. We have maybe 4 years left, maybe even only 2 years for the USD to remain anything at all.
What can you do about all this?
Well, aside from dealing with the certain political and social chaos and those dangers when the USD collapses, you need to move your money into a combination of other currencies and also into paid off real things. It’s conceivable that some stocks in real things like mines would do well too. But stocks and financial products in general, like annuities, will be destroyed in value because, in an economic depression, companies either go out of business or shrink.
And in a currency crisis (USD) that Social Security check, that bank CD, that Treasury bond, that insurance annuity becomes worthless. Sorry, but that is the reality.
So, to escape losing all your income and losing all your wealth in a currency crisis, you have to have money in other currencies, and also in paid off real things that are still there after the currency is destroyed. Obviously, gold and precious metals figure in here. The falling prices right now are quite beside the point. What really matters is what happens in the next 4 or so years to the USD. That’s the BIG issue.
The reason why gold and such are dropping now is because of the general financial and commodity deleveraging. When that bottoms, then gold will still be there. The only thing is, when this world deleveraging bottoms, I don’t think much else will still be there. The problem is how to survive it.
By Christopher Laird
Copyright © 2008 Christopher Laird
Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60’s to 80’s, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.