Why The Buck Just Don't Die

September 7, 2005

An innocent simple question came to my inbox the other day, an email from deep in cyberspace. Sometimes the best questions are ones lacking complexity, asked without multiple parts. This one was from an investor, curious as to why the USDollar simply hasn't died quickly like everyone expected within the precious metals community. Here is the full question, worth sharing, along with my answer.

Question: Jim Willy, I am new to PM investing and have done a ton of research prior to my taking positions in gold. While reading many of the great articles on the coming demise of the US dollar, I was shocked to learn that many of them were written as late as five years ago, some even longer. So many people, including yourself, have been calling for a dollar crash for so long, I wonder if it is probable. I have made my bets that the dollar will fall, but it is sure hard to watch Joe Six Pack make millions on real estate investments after making millions on tech stocks. I realize many lost their shirts, but not all. Is this PM bull / dollar crash just a bunch of hot air?

My answer to the person was brief, almost a full page in outline form. My agenda is busy. However, what an excellent topic for further development at a high level! Instead of providing my response verbatim, let's attempt to answer the question more fully, but briefly, as that agenda is still busy. What follows will conform to the outlined response from my email. A more comprehensive reply would take 50 to 60 pages of analysis, data, arguments, and a reported path on progress for the crash demise of the world reserve currency, the USDollar. In no way is my response complete, but it is surely of sufficient depth to make the point on why death is not sudden, or even within the timespan of just a few years.

Much has been written about how the USDollar has survived longer than any previous fiat currency. The previous record is 31 years, and the United States has attained 34 years in this futile sprint. The Bretton Woods Accord, written to enforce a gold-backed USDollar, was abandoned in 1971. A tie to gold required massive shipments of gold from the USA vaults to foreign central banks, a very unsavory punishment for running rampant national debts. So President Nixon ended the gold shipments, ended the gold backing for the USDollar, and sent the world on a certain path toward perdition and destruction. Up to the twentieth century, the world had never witnessed the USGovt before, never been subjected to the extraordinary bond leveraged machinery. With extraordinary response measures come extraordinary longevity. Couple the machinery weapons with subversive institutional weapons such as the International Monetary Fund and the World Bank, and you have a recipe for profound longevity. Many are the tools and agents for the USGovt to defend the USDollar.

Start with the acceptance of a crippled set of fundamentals for the United States economy, exorbitant federal deficits, even more magnificent and growing balance of payment deficits (trade gap), an absent manufacturing base, escalating debt levels both public and private, dependence upon asset inflation for debt collateral, outsourcing to foreign lands for low-cost solutions, magnificent unbridled growth in USDollar money supply, dangerous growth in foreign-held US Treasury Bond debt, a central bank whose professional competence badly lags its unwarranted icon status reputation, and an economic council whose dedication to sound policy and reliable indicators is so far astray that any reasonable man would conclude their heads are squarely lodged up their rectums.

The world will not descend into financial oblivion without a fight. The world reserve currency is so widely held, so well entrenched, that its death must echo the death of the world banking system. A new banking system must emerge from the financial rubble. The human response from sovereign governments and their central banks (some operating independently, others far too compromised and connected), can be very effective at buying time for the current system. Many are the response mechanisms:

  • tax cuts (to the brackets paid by taxpayers)
  • tax refunds (to the population of consumers)
  • official monetization of federal bonds (use of printed money)
  • foreign central bank bond support (often coordinated intervention)
  • export of overvalued currency (to country which defends itself inadequately)
  • Asian oversized bond accumulation (called "flexibility")
  • rising US interest rates (to defend the USDollar)

Governments do not simply lie down and take lethal blows. They respond when they can, and the USA can respond emphatically and demonstrably. Many are their available weapons, since they control the rules and the change of rules. Heck, they can make illegal the ownership of bona fide constitutionally mandated money. The ordered forfeit of gold by President Franklin D. Roosevelt following the Great Depression was patently illegal. Foreign money deposited in US banks can be frozen and seized. When men overshadow law, we got trouble. Man oh man, what a dangerous and increasingly lawless world we live in!!!

On the more mundane side of typical governmental response are what we come to expect, anticipate, and demand from the USGovt. Tax cuts are ordinary at the onset of economic slowdown, especially recession. Lower tax percentages within defined brackets invite a positive response toward revived economic activity. To be sure, with inflation and its gradual rise in income without a rise in purchase power, reduced tax percentages remove the dreaded "tax creep" which enables a hidden increased tax burden.

When more immediate response is necessary, a tax refund is the best policy action. Taxpayers receive a sudden check in the mails. No need to wait for a full year, for business decisions to exploit the new tax policy, and for a sixteen month delay. A tax refund puts money into the consumer hands right away. Early in 2001, a tax refund was enacted, based upon the recorded activity and tax bills of 2000. Easy as pie. Both tax cuts and tax refunds encourage spending, which keeps the boat afloat and buys time. These human responses all buy time.

If interest rates threaten to rise, and foreign buyers fail to show up at US Treasury auctions where our voluminous bonds are sold, then more drastic action is required. The Dept of Treasury gives the orders to print money out of thin air (don't you just love that phrase?) so that the freshly minted money can be used to purchase US Treasury Bonds. The end result is that interest rates are kept from rising, and the US Economy is kept from suffering a higher cost of money. The sad joke nowadays about our lopsided, inflation driven economy is that it cares far more about the cost of money than it does the cost of any particular commodity. Well, except perhaps oil and natural gas.

When the USDollar goes into temporary tailspins on the foreign exchange markets (FOREX), even more radical action is urgently called for. The FOREX markets endure a truly gigantic flow of funds, far more than any single nation can withstand and fight off. So the USGovt calls on the Bank of Japan typically as its first line of defense. Some regard the BoJ as the Far East Outpost for the Federal Reserve. Those days might actually be experiencing a sunset of sorts, as Japanese officials have come to harbor more disdain for American leaders and our policy than meets the eye or hits the printed word on news stories. Often at the same time, the European Central Bank coordinates efforts to rescue the USDollar by means of its primary vehicle, the USTBond. When just the US Federal Reserve and Bank of Japan work in concert, or just the USFed and the Euro Central Bank work in concert, often the coordinated central bank intervention succeeds to forestall a USDollar plunge. It is all about buying time and instilling fear among FOREX traders not to grapple with powerful central banks. After all, DON'T FIGHT THE FED. And yes, the Fed has many powerful formidable friends.

Ludwig von Mises warned about currency wars, a vicious practice which can be likened to tossing a "hot potato" from one nation to another. One of the principal challenges for a widely used currency to find its true much lower value is the progressive response effect on other currencys. A feedback loop is created, whereby for instance the euro currency rises in value as the USDollar declines in value. The euro does not rise in an economic vacuum though. Germany and France lose much of their export trade, jobs are lost, incomes fall, federal budgets jump to meet the social safety net needs. Precisely this has happened, as the European Union has witnessed a sudden fall in their exports. The EU has suffered over 10% joblessness. Federal budgets have surpassed the limits on their stabilization pact. In short, the European economy has been damaged by a currency assault from 2003 and 2004 as the euro rose over 30%. The United States in effect exported to Europe its over-valued currency, but did so indirectly via the FOREX markets. Despite the chronic weakness of US Economic fundamentals, Europe now has lost some appeal. The USDollar cannot careen downhill around the next bend in the road until the USA begins to look as bad as Europe. In the words of some analysts, "it becomes a race to the bottom."

Chairman Greenspan might boast of improved flexibility in world credit markets. Others might counter that the United States financial situation has taken on the look of a group of international welfare states. Since when does $2 billion per day of foreign funds dependence exhibit strength? Since when does such large infusion, like what can be described as a capital intra-venous to Uncle Sam, exhibit strength? So Japan owns $710 billion in USTBonds in their foreign reserves, eager to avoid further piles of questionable paper. So China owns $230 billion in USTBonds in their foreign reserves, eager to avoid further accumulation. So Russia owns $140 billion in USTBonds in their foreign reserves, eager to avoid further accumulation. Collectively, Asia owns at least $1500 billion in accumulated USTBonds, the net result of a worldwide disastrous experiment to test flexibility. Pull a strong rubber band way back, hold it, pull it further, subject it to the cold breeze of trade friction, then stand back. That boasted flexibility might not remain intact. The rubber band might break, from stress or else increased brittle. If your neighbor owns your mortgage and much additional debt, does not speak your language, has no indigenous roots culturally with your national birth formation, shares little culturally and religiously, and competes for a seat with a Boy's Club among the G-10 Finance Ministers, a truly dangerous situation arises. The old saying goes "give a loan, make a client; but give a giant loan, make a partner." How true, as Asia has become dependent upon the American consumer. In the next damaging stage, Asia is likely to weaken by some diminished business demand from the US export market.

Caught in the middle is the US Federal Reserve, which must raise interest rates in order to defend the USDollar. In my September Hat Trick Letter issue, this topic is developed more fully. We are near the end of the Fed rate tightening cycle. The US Economy has weakened from higher rates. Therefore rate hikes must soon end. The US housing market has weakened from higher rates. Therefore rate hikes must soon end. Eventually, retail commerce will weaken from higher rates. Therefore rate hikes must soon end. The rogue event agent is next the impact from higher gasoline and heating costs in the aftermath of Hurricane Katrina. Therefore rate hikes must soon end. A nation under siege from a declining currency, meted out in the brutal unforgiving FOREX markets, will respond by raising its interest rate just as the USFed has done. In time, experts will wonder why they continue when the domestic economy feels the pain. THEY WILL EVENTUALLY CONCLUDE: TO DEFEND THE USDOLLAR. Look out below when the USFed ends its business of tightening.

When the official rate tightening cycle ends, administered by a truly hapless Federal Reserve, whether this early autumn or this coming winter, the USDollar downpath trajectory will be more clearly visible. Gold will love it. Energy will love it. A stealth rally has begun with gold. A loud rally is underway with crude oil and natural gas. The stage is set for gold to make new long-term highs. With Gulf of Mexico oil production crippled, the stage is set for crude oil to head toward $80 per barrel. The draw from our Strategic Petroleum Reserve only temporarily relieves supply concerns. Shipments from Japan, Germany, Spain of oil tankers only temporarily relieves supply concerns. The constant in the equation is lost Gulf oil output. Insurance firms might dictate that relocation of deep-water drill rigs away from the Gulf be done. Potential sites are South America, the Caribbean, even Saudi Arabia. Last year, insurance losses from Hurrican Ivan were costly. They will not invite annual losses in a hurricane zone.

The US Economy continues to experience a hemorrhage of trade deficits. In the last 12 reported months, the national trade gap has averaged $55.8 billion, with a high in Feb2005 of $60.6 billion and a low in July2004 of $50.5 billion. The blood letting continues. So is US balance of payments in trade getting better? No, no way! If not, then the hemorrhage is still in progress, nothing has changed. If a man has a mild but worsening form of cancer, he might live 18 months. Unfortunately, he is forced to endure a death sentence, with sure degradation in quality of life. This is a long pathogenesis of demise. It is real, it is ugly, it is relentless, it is unforgiving, but it will take time. In a sense, the currency world represents a "zero sum game" wherein the primary currency can fall only if all other currencys tend to rise. As all paper currencys weaken further, from fundamental deterioration of their respective economies, look for gold and energy prices to rise relentlessly. Phony money is to be exposed as increasingly lacking value, of lessening worth. Real money like gold and hard assets will mushroom upward in value. This is not poppycock, not a false preach to the choir. Money is flooding the entire world, most of it with a US$ denomination. The effect on US$-based pricing structures is unmistakable. All commodities will rise in price.

It is my expectation and forecast that the next round of currency appreciation will come from Asia !!! The Chinese yuan upgrade announced in July has marked this upcoming event as clearly as graffiti on subway walls, or on city street billboards. The Chinese will upgrade their yuan currency "at a measured pace" (HA HA) over the next few years. Sorry, could not resist. USGovt officials will applaud the process in a mindless fashion, despite how China will transfer higher material costs to the United States. Imagine a 2% Chinese upgrade every 4-6 months for as far as the eye can see. The best description might be "Chinese water torture" for the process. The topic of Chinese yuan upgrade and its many effects will be continually developed in the Hat Trick Letter. Diversified foreign reserve purchases will take time in Asia, and not just China. All of Asia will mimic their new industrial leader, China. Continued quiet accumulation of gold is certain by the Peoples Bank of China. Ownership by its private citizens has been encouraged. Future yuan upgrades will render lower their huge cost for imported commodities. The years 2002, 2003, 2004 were all about Europe in the currency world. The years 2005 to 2010 will be all about Asia, led by the Middle Kingdom. China will demand and receive a respected seat on the geopolitical stage, now dominated by the United States. While the Western world weakens from excessive debts, lost jobs, and heavy reliance upon Asia for industrial production, the opposite will occur in Asia. Look for steady growth and increasing strength coming from Asia. Resurgent vigor and strength will be reflected in Asian currencys, even in Japan.

The USDollar is toast, that much is certain. However, its path to the bottom of the barrel is not well mapped out for the observer. In order for the USDollar to be declared dead & buried, the entire world banking system must undergo a severe crisis and near death experience. To expect otherwise with a fast profitable dollar demise is naïve, indicative of unreasonable impatience. Brief fits & spurts of promising activity might actually become evident in coming months within the crippled US Economy. Some economic so-called experts point to improved US exports from the cheaper US$ exchange rate. Well, not so fast. Imports to the United States have grown by 23.5% since the beginning of 2004, overwhelming the 18.6% growth in exports from the USA. Sadly, if not tragically, the US Economy is attempting to revive itself via imports of products, imports of capital, and asset inflation. Anyone with a semblance of economic training and business intelligence can easily conclude that the prescription written by the USFed and the White House Council of Economic Advisors is bogus, bound to fail. To gold and energy investors, stay the course.

Uncle Sam will stumble around for at least a couple more years. Who knows what he is capable of doing while staggering, listing, bloated, and out of control? Are we certain about the next steps for the Iraqi War, its troop deployment, its costs? Are we certain about no additional new war fronts? Are we certain about our official reaction to dramatic shortages of key commodities? Are we likely to trigger a trade war with China which shoots ourselves in both feet? Can we be assured of continued cooperation on Asian credit supply, our lifeblood supplied by strangers? We have begun a highly risky dangerous new phase. Any hunter knows that a wounded bear is to be avoided, perhaps the most dangerous situation in the wild. Its path is unpredictable. Its ultimate position of dead on the ground is the only certainty. Where it will lie breathless, who knows? In what position it will lie still, who knows? Who it takes down in the process, who knows?

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.

Jim Willie

Jim Willie

Jim Willie CB, also known as the “Golden Jackass”, is an insightful and forward-thinking writer and analyst of today's events, the economy and markets. In 2004 he launched the popular website http://www.goldenjackass.com that offers his articles of original “out of the box” thinking as well as content from top analysts and authors. He also has a popular and affordable subscription-based newsletter service, The Hat Trick Letter, which you can learn more about here.  

Jim Willie Background

Jim Willie has experience in three fields of statistical practice during 23 industry years after earning a Statistics PhD at Carnegie Mellon University. The career began at Digital Equipment Corp in Metro Boston, where two positions involved quality control procedures used worldwide and marketing research for the computer industry. An engineering spec was authored, and my group worked through a transition with UNIX. The next post was at Staples HQ in Metro Boston, where work focused on forecasting and sales analysis for their retail business amidst tremendous growth.

Jim's career continues to make waves in the financial editorial world, free from the limitations of economic credentials.

Jim is gifted with an extremely oversized brain as is evidenced by his bio picture. The output of that brain can be found in his articles below, and on the Silver-Phoenix500 website, on his own website, and other well-known financial websites worldwide.

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Nearly 40 percent of all gold ever mined was recovered from South African rocks.

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