Volume XI, No. V

Why the Dollar Will Eventually Crash:
Will You Be Prepared?...Part 2

Our letter's a bit late this month because I'm writing to you from sunny Italy...wait, what's this...It's cloudy and raining. But what about that weather.com prediction that told us it would be a sunny day? Ah, so much for predictions.

But didn't we just make our own prediction last month when we said:

Isn't this a prediction? Not really. Not like weather.com or that Protestant radio personality who called for the end of the world this past May 21st. Predicting the future is tricky business. That's why we're more in the "educated guess" camp.

We educated guessers have an aversion to phrases like "will happen" or the stronger, muscle-bound "must happen." We dwell in the land of the humble – a land of modest opinions.

But don't think for a minute we're taking back what we've already said. In fact, continuing where we left off last month, you'll find out not just why, but...

But first, as we like to do from time to time, here's a brief update on what's going on in the markets along with some quick suggestions about holding on to your money.

Stocks

The "CAPE" or "PE 10 Index" created by Robert Shiller is (as of June 8th ) at 22.61. It is a P/E Ratio of the S&P that, instead of dividing the current index by the past year's earnings (trailing P/E's), uses the average earnings of the past ten years. The data used dates back to 1881. Prior to the mid-1990's market bubble, a multiple in excess of 24 was seen only once: between August and October 1929. So 22.61 is definitely up there.

Suggestion: Investing in stocks is a speculative game now. Stay on top of your stock investments and have an exit strategy. If you're familiar with how to use trailing stops on your stock positions, think about strictly enforcing your stops to make sure you don't give back most or all of the gains you may have gotten since March 2009, when the stock market turned up.

Bonds

Everyone is bearish about bonds these days. Every fundamental data point says interest rates should be going up (which means that the price of bonds will go down). Historical evidence points to the beginning of a new multi-decade bond bear market, to replace the bond bull market that's been roaring since around 1980. And with all that, bonds have strengthened. Naturally.

Suggestion: When everyone's on one side of a trade (in this case, the bearish side), proceed with caution. Chances are the tide will turn against the crowded trade until most of the crowd is wiped out. If there's going to be a bond bear market, we're still waiting. If you're going to bet against bonds, don't bet too heavily yet. Better to just keep your maturities short now – especially if you're not comfortable trading bonds.

Commodities

Commodities just corrected. For a few days there, it almost looked like catastrophe had hit commodities, as oil dropped 10% in one day – a drop rarely if ever seen before. But the catastrophe didn't really take hold – yet.

Suggestion: If you believe commodities will continue in a long-term bull market, get used to this sort of hysterical correction. If these dives take your breath away, only keep as much money in commodities as will let you sleep at night. The last thing you want to do is panic and sell out when these sorts of dives hit bottom, right?

Gold

Gold – along with its little sister silver, corrected too. As a matter of fact, silver really tanked – going down over 30% at one point. Again, though, things stabilized. Gold has now started up again; silver too.

Suggestion: See "Commodities" and do likewise. A good night's sleep is not only a terrible thing to waste, but lack of sleep will definitely cause your better judgment to fail you when the next jolt comes along.

Real Estate

Of all these items, real estate may be the most critical to the future health of the U.S. economy. The economy's not going to really pick up in any substantial way until real estate stops bleeding.

So we started hearing that real estate is bottoming now, and will soon be ready to head up. Good news, right? Well, the last time we heard this was in 2010, from economists like Mark Zandi of Moody's – just as real estate began its second (current) leg down. What gives? Please read the following carefully, because it's important.

Economist like Mark Zandi are employed by Wall Street firms, or firms that service Wall Street firms. Most of the economists hired by Wall Street firms, or companies that service Wall Street firms, tend to paint a rosy picture all the time because Wall Street firms - and therefore companies that service them, like Moody's - make more money when people feel good about the economy. When people don't feel good, they pull back and save money. When they feel good, they spend their money. Among the things they spend it on are the investment products that Wall Street creates. They do that because they figure they'll make more money than if they just keep their money in savings. When they don't feel good - optimistic that is - they just want to keep their money "safe" in something like a bank savings account.

Another factor to keep in mind regarding real estate is that when items correct, after a big run-up, they don't just settle back to where they were before they ran up, but they tend to "over-correct." In the case of housing, if prices were about where they were before the big run-up - as Zandi claimed last December – then, rather than think they would head up, you might have thought (as we did) that they simply hadn't declined enough – because they hadn't over-corrected. (If interested, you can find a more detailed discussion of this by clicking here.)

Suggestion: Don't jump the gun on real estate. If you really want to own a home to live in, maybe you'll find something at a reasonable, even a cheap price. On the other hand, if you're looking to invest in real estate, unless you really know what you're doing, it may be best to hold on to your cash for a while.

Now to the main event. We pick up right where we left off last month:

Let's get right down to business. Here are the reasons we think the current dollar crisis could wipe out your wealth:

• Most Americans have all their assets denominated in dollars.
• Most likely, the dollar will continue to decline in value.
• Most Americans don't know what to do to diversify out of dollars.
• Therefore, most Americans won't take any action until it's too late.

It might help if you quickly review last month's letter. (You can find it by clicking here.) That's up to you. We're just going to forge ahead.

Let's start with this simple assertion: If the value of the dollar continues down, the value of your assets will follow. So far so good...but notice we said "if." There's that old educated guess again.

Okay, so how did we get to the educated guess about how "this dollar crisis could wipe out your wealth"? Let's look at those four reasons.

#1 and #3 are based on fact. And you can save yourself the research. Just look at your own assets. Are they mostly dollar-based? Oh, you've got some of your assets outside the dollar. Great. How about your friends and family? How about your neighbors and co-workers? Want to guess what answer you'll probably get if you ask most people if they have any of their assets outside the dollar? And if that's true, then #3 – don't know what to do to diversify out of dollars – follows logically.

That leaves #2 and #4. We'll address them in order. First:

If you recall from our last letter, we explained how the dollar's tie to gold was broken once and for all on August 15, 1971. As a result, the value of the U.S. dollar has declined over 80%, if you use the government's official CPI (consumer product index) as a gauge. Other measures put the decline at over 90%! How come? Because once the tie to gold was broken, the government had no external restraint to its ability to create money out of nothing. And the more money they created, the less our money was worth. It's not that complicated.

(Remember our discussion of the Vietnam War and the Great Society? Remember how President Johnson printed money to pay for his war and his social programs? To refresh your memory, just click here.)

With government printing all that money, the great inflation of the 1970's followed. It was as inevitable as day follows night.

Of course, if you were young at the time, and didn't have much to begin with, and earned money for the next 40 years, investing a portion of it so that it would exceed inflation over the long run, you probably would hardly have noticed. On the other hand, if you were retired, living on a fixed income...well that's another story.

Imagine being in your late 50's or 60's, living on a fixed income for the next 30 or 40 years. Many people did just that. And over the years, many people wound up just about destitute. Without some form of outside assistance – public or private – many more would have been destitute. And it was all because those dollars that people had saved up from years of work were whittled away by a monetary system that allows governments to print money at will, and a government policy that let its own needs trump the needs of its citizens.

But wait. Does this qualify as a "crash"? It's really more like a slow-motion crash. But call it whatever you want. You lose either way. The thing with the slow-motion variety is that people hardly notice it, so it gets just about everyone one way or another. It's easier to see the problem when growing old on a fixed income in the face of inflation. It's less obvious to the young. With years of earnings—usually increasing earnings – ahead of them, most younger people remain completely unaware that they'd have a lot more money some day had inflation not whittled their assets down bit by bit, year after year. And that's exactly what's happened to many of those who were young in 1971.

Now, unless the current monetary system changes, and government policy changes, what do you expect will happen as a result of our current dollar crisis? Would you expect anything different than what's happened in the past? Do you expect that governments today will behave any more responsibly than they did in the 1970's?

So do you see why you don't have to be like that Protestant guy predicting the end of the world if you have a reasonable concern about a collapse of the U.S. dollar? All you have to do is make a good educated guess about exactly what we can expect in the coming years.

Now let's summarize the reasons we think the current dollar crisis could wipe out your wealth. Again:

• Most Americans have all their assets denominated in dollars.
• Most likely, the dollar will continue to decline in value.
• Most Americans don't know what to do to diversify out of dollars.
• Therefore most Americans won't take any action until it's too late.

We started out with how easy it is to show that #1 and #3 are true. We've just shown why #2 is true. That leaves us with #4:

If you understand why the dollar will continue to decline in value, the next logical step would be to seek alternatives. Isn't that kind of obvious? Yet we can tell you from experience that even in the face of overwhelming evidence, it's still difficult for many (if not most) people to exchange their dollars for any other currencies, never mind some gold or silver. Why is that? We can only speculate – another educated guess.

Maybe some people just don't like change. What can we say to that? Not much really.

For others, perhaps we haven't made our case strongly enough. All we can say to that is that the loss of 80% - 90% of purchasing power since 1971 isn't something we made up. You can look all this up for yourself. If you're not sure, and you don't pursue the matter to verify what we've asserted, there's not much else we can say. The evidence is there. We presented it. The rest is up to you.

Our final educated guess is that most Americans will stick with their dollars because most people prefer the comfort and assurance of sticking with the crowd. In the end, the comfort and security of standing with the majority will override any evidence. It's just the way we humans typically behave.

That's why we believe most Americans won't take any action until it's too late.

But if you do decide to take action by stepping away from the crowd and diversifying out of dollars, just remember one last thing: Diversifying out of dollars doesn't necessarily mean you run like the dickens from anything having to do with the dollar. In fact, most of us probably need some dollars. Diversify means just that: make or become more diverse or varied. Capisce?

Now, don't think we're done yet. After all, we started this whole train of thought last month intending to cover three points:

• How We Know We Are Indeed in a Dollar Crisis Right Now
• How We Know We Are Indeed in a Dollar Crisis Right Now
• What Will Be Left When Our Current Dollar Crisis Ends

Last month, we covered the first point. This month we covered the second point. So that leaves the third point for next month:

Next month we'll start looking down the road a bit. And we think you'll find that – as with so much of life – things aren't as bad as they might seem. Of course we don't know for sure. It'll just be our educated guess.

Memorial Day Recollection

There's a tall monument in a local park honoring those who died in the "Great War" (World War I). Back when the monument was built, people called it the Great War because they could never have imagined that a bigger, more horrible war (World War II) would break out a mere 21 years later. Hard to believe, isn't it?

This Memorial Day, I managed to walk by and say a special prayer for the poor souls who lost their lives in our country's wars. While I enjoy our family barbecue, the holiday does have a serious purpose.

One of the things that came to mind as I passed by the monument was that those who carried the burden of the fight against the German Nazis and the Japanese Imperialists, the so-called "greatest generation," are quietly leaving us. About 1,000 veterans of World War II pass on per day without much fanfare. Of the 16 million who served, a bit more than 1 million remain. And remember that besides those who served in the armed forces, many, many more worked to keep the home-fires burning in their absence. Memorial Day is an opportunity to think about and honor such folks.

My father was one of those who served in the armed forces during WWII. You could sometimes coax stories about the Marines out of him. I remember stories of Parris Island basic training, tough sergeants, silly high jinks, missing his wife and kids – stories laced with humor, usually unassuming and self-effacing. There was never any talk about everyone being a hero. He just kind of took it in stride. Maybe that's because he and his family and friends lived through the Depression in the 1930's and World War II in the 1940's. It's almost unimaginable to us Boomers, Generation Xer's, Millennials, or whatever other generations we've got now. The greatest generation lived in a very different world.

There was much my Dad taught me over the years. And this time of year, I'm grateful for him and others who shared with us their perspective of how things were – how life was lived in a much more difficult and challenging time. Yet I still remember how he would talk wistfully of that time as a better time. A time when there was, in a sense, more time: for family, for simple pleasures, having fun with friends, knowing neighbors; no long commutes, no planes to catch, no worry about how much weight you want to lose this week.

He knew that we are all given life, but not the same life. You worked with what you were given, however much that might be, and did your best – which is what he did. And it's funny how I don't remember him ever fretting about whether his retirement would support his "life-style" – a phrase we financial advisors bandy about all the time. Somehow, things would work out; God would provide. He even managed to get through life without ever driving a car.

The next time I unduly worry about the economy, the price of gas, market volatility, asset bubbles, or whether I've negotiated the best price on a car, I will think of him.

Until next time,

P.S. – I've been following the TED Spread lately. Ever heard of it? Well, it may be heating up again. The last two times it did were in 2008, before the financial crisis blew up, and in 2009, when the stock market last corrected. You can find a recent post on the TED Spread by clicking here. If you're not sure what the TED Spread is, you can find out while there's still time by clicking here.

Richard S. Esposito, ChFC
Lighthouse Wealth Management LLC
405 Lexington Avenue, 26th Floor
New York, NY 10174
Tel: 212-907-6583/Fax: 866-924-1952

Email: resposito@lighthousewm.com