After a temporary rally during the crisis that began in 2007 – 2008, we’ve watched the dollar wilt. And now the central banks of the world are openly backing away from accumulating dollars — reversing a trend that began after the end of World War II.

As the value of the dollar continues to sink relative to just about every other currency out there, not a day goes by when we don’t find yet another prediction of the dollar’s “demise.” Yet every time we go to spend our dollars, sure enough, we keep getting some product or service in exchange for those sinking dollars. And in spite of the prices of some items going up — especially food and gasoline — other items — like clothing and autos — have stubbornly remained pretty stable. So what’s really up with the dollar?

Are the “dollar-demisers” acting like Chicken Little? Chicken Little’s the character that ran around warning everyone, “The sky is falling! The sky is falling!” just because an acorn happened to fall on her head one day. Chicken Little convinced Henny Penny, Ducky Lucky, Goosey Loosey and Turkey Lurkey that they’d better come along with her and warn the king. Of course, the sky wasn’t really falling and, to their great misfortune, they ran into Foxy Loxy who took advantage of their fear and led them into his fox’s den instead of to the king, as he had promised them. And there they became items on Foxy Loxy’s menu, meeting the fate of all fearful fools — or so the story goes.

While some of the calls for the demise of the dollar come from Chicken Littles and others come from slick marketers, assorted scare-mongers and other Foxy Loxys looking to make a buck, we can tell you with some assurance that we are indeed smack dab in the middle of a dollar crisis — perhaps the worst dollar crisis in the history of the United States. And that crisis has the potential to undermine just about every aspect of your financial planning — unless you take measures now to prepare for what’s coming. So this month we’ll take a good look at:

• How We Know We Are Indeed in a Dollar Crisis Right Now
• Why This Dollar Crisis Could Wipe Our Your Wealth
• What Will Be Left When Our Current Dollar Crisis Ends

We’ve got a lot to cover, so let’s get started.

But the gyrations of the dollar don’t make the case for a real full-blown crisis — the one we’re in now. To really make the case, we turn to something we told you about almost a year ago.

At that time, we reviewed Carmen M. Reinhart & Kenneth S. Rogoff’s book This Time Is Different noting that, after sifting through 800 years of available data about these sorts of crises, they broke our current crisis into five stages:

1. Banking crisis
2. Domestic sovereign debt defaults
3. Foreign debt defaults
4. Currency crashes
5. Inflation outbursts

A year ago, we were between 2 and 3, heading into 4. Now we’redeep into the fourth stage, which the authors refer to as currency “crashes.” (You can read last year’s analysis byclicking here.)

And if you remember, that’s what we started talking about in last month’s letter. (You can find the letter by clicking here.) The dollar crisis of the 1970’s will help us understand our current dollar crisis. But in order to understand how that crisis occurred, we need to step back and take a quick look at the monetary system that existed back then.

Yes, we realize that most people’s eyes glaze over at the sound of those magic words, “monetary system.” But unless you already know what happened during that first great crisis — and exactly why it happened — you won’t be prepared for what’s about to hit us during our current crisis. So with that in mind, here goes.

But after World War II, that old way of measuring the value of currencies — it was known as the “gold standard” — was never reinstituted. For one thing, when the war ended, the world was a basket case, as you might imagine. Besides the physical destruction wrought by the practice of bombing cities and killing civilians, the Nazis had looted whatever treasures they could get their hands on in Europe — including the gold that countries held for the purpose of international commerce under the old gold standard.

While some of the U.S allies had shipped their gold to the U.S. for safe-keeping during the war, the Allied leaders decided going back to the gold standard wouldn’t be viable for a post-war world. The victorious Allied Powers looked ahead to a world which they hoped would rise from its ashes, even as most of Europe (and Japan) lay in ruins, their populations decimated and their industries destroyed. They focused on, among other things, getting back to the business of doing business.

(All except for the Soviet Union and China. The Soviet Union focused on enslaving their people and the people living in the countries surrounding them within a communist system that effectively isolated itself from world commerce. By 1949, the same would hold true for China. Guided by a communist ideology, their economies couldn’t produce enough goods for their own people, never mind produce enough to engage in international trade.)

The United States was the only power still intact after the war with a functioning economy that was big enough and vibrant enough to lead the post-war world in its struggle to recover and prosper. Anticipating the end of the war, Allied leaders gathered at Bretton Woods, New Hampshire in 1944 beginning their plan of rebuilding the world by reviving commerce. The U.S dollar would be the standard currency — rather than gold — for all international commerce. With the U.S. dollar as the new standard upon which to measure all currencies — think of it as the new measuring stick — the only thing left to determine was the relationship of each of the world’s currencies to the dollar.

Interestingly, even though the old gold standard had been put out to pasture, the Bretton Woods System — as the new monetary system came to be known — still used gold as a measuring stick to determine the value of the dollar. The dollar, the measuring stick of other world currencies, was measured in gold. So the old gold standard was partially revived in a new, modern form by pegging the value of the U.S. dollar to gold. Specifically, one ounce of gold would always be worth 35 U.S. dollars (the value of the U.S. dollar relative to gold before the war).

And to keep the U.S. government honest, the Bretton Woods Agreement stipulated that any country holding U.S. dollars — if it chose to do so — could receive, on demand, one ounce of gold for every 35 U.S. dollars it held. It seemed a fair and effective way to make sure the U.S. didn’t fall victim to the perennial temptation of all governments throughout history to print paper money without limit, whenever they thought they could get away with it.

So when the war finally ended in 1945, everyone was all set, and the world’s economy did indeed revive, with the U.S. leading the way — that is until the 1960’s and Lyndon Johnson’s “guns and butter” policies (which we discussed last month). With tax revenues no longer adequate to cover expenses, the U.S. began printing U.S. dollars without regard for how much gold was really backing them up. And as none of this money-printing escaped the notice of our trading partners, you can well understand that some of them began to demand gold in exchange for what they rightly saw as increasingly worthless U.S. dollars.

The demand for gold didn’t stop the U.S. from printing money, and as the printing increased so did the demand for gold in exchange for dollars. Finally, the President at the time, Richard Nixon, after watching U.S. gold disappear at an alarming rate, decided on August 15, 1971 to stop paying out gold in exchange for dollars. And so the Bretton Woods System collapsed.

(Interesting how, in spite of the pooh-poohing of the gold standard, accompanied by increasing calls for the total rejection of gold’s role as money, the U.S. didn’t want to keep shipping its gold to others. Why did the government care if the gold standard was, as the British economist John Maynard Keynes branded it, a “barbarous relic”?)

But there was a problem. Without a fixed way to measure the U.S. dollar, how could it serve to measure other currencies? Pegged to gold, the dollar could serve as a measuring stick, similar to a tape measure or a ruler. Without the gold peg, it was more like a rubber band that could be longer or shorter depending on the pressure one put on it. Imagine trying to measure your windows for curtains or blinds with a rubber band instead of a tape measure.

Confronting their dilemma, the world’s countries began to improvise. In December 1971, The Smithsonian Agreementdevalued the dollar by 7.9% against all other currencies. In April 1972, The Snake Agreement created fixed rates among European countries, but floating (i.e. constantly changing) rates relative to other countries. Then they devalued the dollar again, eventually giving up any hope of settling on any type of fixed exchange rate.

The one thing they could decide for sure was that they would not return gold to its function as a stable measuring stick for all other currencies. In fact, in 1976 they officially “demonetized” gold. Curious, isn’t it? After serving much of the world as money for thousands of years, the central banks of the world decided not only to drop the gold standard, but they decided that gold wasn’t money anymore. They banished gold to live out its life as a mere commodity, no longer to be considered money by anyone ever again. (At least that’s what they thought.)

The death of gold’s role as money was the final stake in the heart of currency stability. (Strange that our government would agree to this when you remember that one of the U.S. Federal Reserve’s objectives is to promote price stability, isn’t it?)

Eventually, they moved to the Floating Exchange System, soon to be followed by (we kid you not) the Dirty Float System.

To call these new innovations “systems” strikes us as absurd today. To understand just how absurd, consider this. If the world’s central banks couldn’t manage a system where the dollar was pegged to gold, and all other currencies were pegged to the dollar, how in heaven’s name would they manage a Floating Exchange System that called for them to determine the price of currencies based on the following factors:

– Demand for and supply of tradeable goods

– Relative interest rates in different countries

– Relative inflation rates in different countries

– Relative income levels in different countries

– International investments

– Speculation

(Of course, they couldn’t. And so they continued their tinkering, and continue tinkering today.)

So what did all this do to the U.S. dollar? The bottom line was, because of all the money printing, inflation took hold and drove the value of the U.S. dollar into the ground throughout the decade. Month after month, year after year, your dollar bought less and less. If you had all your money in dollars, it was a decade where your wealth disappeared — unless you took the trouble to buy gold and silver to protect your wealth. Sadly, very few did.

If you haven’t already figured this out, having all or most of your assets in dollars will leave you exposed to whatever fate awaits the dollar. With what we just learned about the 1970’s, we’d say you have to be concerned.

Well, we’ve managed to cover only one of our three topics and we’re running out of time, but we hope you see that only by wrapping our arms around the 1970’s dollar crisis can we get some understanding of our current monetary system — and why that’s so important. Unfortunately, most Americans — including most financial “experts” — know little to nothing about our monetary system, along with the danger it poses to all of us. And while they may have survived just fine until now, ignorance really isn’t an option anymore. Without at least some basic insight into what we can expect in the coming months and years, you’ll be making critical decisions about where to put your money wearing a set of monetary blinders. We don’t think it’s an exaggeration to say you’ll be gambling with your future.

So we’ll pick up next time with

• Why This Dollar Crisis Could Wipe Out Your Wealth
• What Will Be Left When Our Current Dollar Crisis Ends

A Final Thought: Bin Laden and JP II

Speaking of “demises,” I’d be remiss not to put in a word about the announcement on May 1st of the demise of bin Laden. Almost ten years ago, while walking a couple of blocks from the South Tower of the World Trade Center I heard a boom that sounded somewhat like a sudden deep clap of thunder. I looked up to see that first terrible cloud of gray smoke and fire that billowed from the tower, the deadly result of a plan inspired by the darkened mind of Osama bin Laden. The terrible memory of the sound of the crash, the vision of its aftermath and the events of the rest of that tragic day never fades.

Over the years, as images of bin Laden occasionally appeared, I wondered if I would have to watch this man simply grow old, without the justice that can and must be served on such people. And so I was grateful when I heard the public announcement on May 1st that Navy Seals brought him to a swift end — a clear, crisp example of justice in a world where morality is often muddied by shades of gray.

While we thankfully won’t get to watch bin Laden grow old, the same day brought fresh memories of another man we did in fact see grow old as his beloved Church publicly announced his journey to sainthood.

As a youth he defied and resisted the Nazis. As a man, he led the charge in his native Poland to defeat a brutal Russian Communist empire, at great personal risk. Yet, in spite of his credentials fighting Nazi and Communist totalitarianism, his strong condemnation of what he considered the greed of unfettered capitalism — an economic system that would ignore the cries of the poor for the benefit of the rich and powerful — brought harsh criticism from some of his otherwise admiring followers. He paid them no mind.

His was a calm yet steely courage tested first in the fiery devastation of World War II, then tempered in the long icy chill of the Cold War. After being elected Supreme Pontiff of the Roman Catholic Church, he brought his vigor and courage to what may be the most publicly scrutinized and criticized position in the history of the world. Early in his pontificate, he was shot and almost mortally wounded for his trouble and suffered greatly from that bullet wound for the rest of his life.

In stark contrast to bin Laden’s message of terror, hatred, and death, his was a message of peace, love and life. He brought that message personally to any place in the world that would have him.

And as he grew old before us, he fought with his last ounce of strength, to defend the dignity and the value of every human life by demonstrating the dignity and value of his own. Who can forget the images of this once vigorous, athletic man, publicly struggling against the ravages of illness and old age, living the fullness of life to the very end?

There will always be those individuals and governments who would abuse their privilege and power in order to destroy our spirit and steal our substance. Karol Wojtyla — whom most of us knew as John Paul II — stood up to them all. The 84 years of his life embody the human spirit standing free from the bondage of slavery, sin and death.

Sincerely,

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