A question of monetary confidence

The Thinker by Rodin

In my last post, I was feeling a bit dazzled because on paper my wife and I became millionaires, although just barely. I found our new wealth somewhat suspect, in part because stock prices seemed surreally high and the dollar was steadily sinking in value. The dollar simply isn’t worth what it once was and the trends suggest it may never recover its wealth in relation to other currencies. In addition, prices for commodities are soaring. No wonder I felt deflated reaching the milestone. It’s not how much money you have that matters; it’s what it will buy. It won’t buy a mansion in Beverly Hills with a cement pool in the backyard, that’s for sure.

When communism fell in Eastern Europe, Yugoslavia experienced incredible hyperinflation. It currency essentially became worthless. In October 1993, the government tried to solve the problem by printing new money. One new dinar became one million old dinars. Not coincidentally, the country fell apart, but not before we observers got an abject lesson in the meaning of money, two lessons of which I opined on some years ago. My take was that a currency is only as valuable as people’s confidence in it. Attempts to prop up the dinar failed miserably and triggered a horrendous inflation and a depression. Once balkanized (literally) into separate countries, former Yugoslavians found their new country’s currency and leadership were more trusted than the old dinar and communists, and things began to recover. What didn’t recover was the country of Yugoslavia, which dissolved. It was always a country on paper more than in fact, and existed mostly due to Soviet support and because of the heavy hand of its military and secret police.

The steady decline in the value of the dollar against other currencies thus should be worrisome. For some, America is undergoing a slow loss of confidence. With enough rumored whispers, some official institutions will take notice. Standard & Poor took notice recently and issued a warning that in two years the U.S. would lose its AAA bond rating if it did not get its deficits under control. Right now, federal deficits are causing concerns about the solvency of our currency.

If investors are wary of the U.S. dollar, so far they don’t seem to be slacking off purchasing dollars via U.S. Treasury bills. If you have surplus you have to save it somewhere, and you also want some of it to be a stash of money, so you can spend it quickly if needed. The currency needs to be in something reasonably stable. The major choices are the dollar, the Euro, the Yen and the Chinese Yuan. It’s unclear if the Euro will be around in a decade. The Japanese Yen looks suspect, particularly since their devastating nuclear accident. The Yuan is as stable as the Chinese government, but in part because they own so many dollars, inflation is becoming a serious problem that could discount their currency and maybe take down the government. The dollar is not a perfectly safe bet anymore, but it is still safer than other currencies. So many want to buy dollars as a monetary hedge, and that it is keeping interest rates artificially low, likely exacerbating the dollar’s fall.

Most commodities are priced internationally in dollars. Oil is the most prominent example, and oil recently topped $110 a barrel. A good part of its price rise is uncertainty in the oil market, but it is also due to oil being traded in dollars. If oil is in demand and the dollar is cheap, oil will cost more dollars. The same can be said for most traded commodities, particularly food. Rioting in Egypt, Yemen and elsewhere may be due in part to the high cost of foodstuffs priced in dollars and the inability of people to afford the inflated prices. The same is true here in the United States. One reason obesity is epidemic in this country is that unhealthy food is much cheaper to buy, in part due to subsidies.

Loss of confidence in the dollar is also probably pushing up stock prices, and helps explain my millionaire status. Why would this happen? What do you do if you are concerned that the dollar you have today may be worth ninety cents next month, but you have enough cash for an emergency? You try to invest that dollar today in something tangible and profitable instead. That is my suspicion. While a recovery is underway, it is a weak recovery and there are no real signs that it is going to turn into a roaring recovery. How to explain exorbitant stock prices? I explain it as we are bidding up the price of businesses because we have more confidence in their retaining long-term value in than than in the U.S. government.

This works fine unless instead of a currency decline there is a currency collapse. Is there a way to anticipate a currency collapse? Porter Stansberry sure thinks so, and he says he is spending his own money to try to warn others. Others think he is just running another scam. I spent about an hour listening to his pitch over the weekend. Unfortunately, there is no fast forward button and he likes to reiterate his points endlessly. I ran out of time and interest, but if you are patient enough and paranoid enough, he has suggestions on how to protect yourself from what he feels will be a major collapse of the dollar and the economy over the next few years. The “good stuff” apparently requires purchasing his report. So I doubt he is acting out of the goodness of his heart.

I agree with Stansberry on one point: if the dollar really did collapse, it would take down not just the U.S. economy but also most of the world economy, at least for quite a while, probably for years. Having a ready supply of Yen, Yuan and Euros to pay for life’s expenses instead of using dollars probably won’t help that much. We’re all tied together now; there are no safe harbors. If the U.S. dollar goes on life support, my suspicion is most other currencies will as well, because so much commerce is traded in dollars which are traded for local currencies. The good news is I have a third of an acre for my lawn. I could become my own farmer until the depression caused by a dollar collapse is all over, providing of course I can rent a tiller and enclose my backyard in twelve feet high fencing with barbed wire to keep out hordes of desperate and hungry people. Or I can do what everyone else will do and procure things with possibly hyper inflated dollars.

Can a dollar currency collapse really happen here in the USA? Perhaps. No one really knows if such a scenario will happen, but it can be triggered if enough people think it will happen. The dollar is as solid as our faith in it and our institutions, which at the moment is low. Arguably people, like Porter Stansberry are rooting for it as a way to acquire wealth by spreading fear. A dollar collapse is possible, of course, but so many have so much currency valued in dollars that no one really has incentive to root for its collapse, except, possibly al Qaeda. Which is probably why Standard & Poor issued its warning. It is trying to make politicians do their jobs.

My suspicion is that the root of investors’ concerns is not the deficit itself, but the underlying problem the deficit exposes. Until now, when parties could not compromise, the difference was charged to the future in the form of deficits, because there was always agreement to extend the debt ceiling. That seems to be changing. What would normally happen in dire circumstances like this would be we would find our better nature, and move toward compromise and shared sacrifice. So far, there is not much evidence that this will happen. My suspicion is that if we can affect a meaningful compromise where all parties have real skin in the game, it will remove most of the financial jitters underpinning the drop in the dollar.

Unfortunately, what’s much more likely to happen is a high stakes game of poker that ends badly. It is already well underway. I am no more prescient than anyone else how it will play out with a vote to raise the debt ceiling. I suspect it will get raised, with much wailing and gnashing of teeth, and in small, tortuous increments and play out like a bad horror movie. I can say that if we reach a point where the United States cannot come together politically to raise the debt ceiling and find real middle ground on raising taxes and reducing expenses (and yes it will take both), I will need my own vegetable garden with its twelve foot fence and maybe even a gun or two and a bulletproof vest. If that happens, unfortunately, it will be too late for all of us.

Leave a Reply

Your email address will not be published.