Why the Dollar Will Eventually Crash, Part 3: What Will Be Left When Our Current Dollar Crisis Ends…
Will You Be Prepared?

If you’ve ever wondered what “hot” sounds like, just walk around these parts end of July early August: cicadas. I say “these parts” because apparently in the south — as opposed to the New York metro area — cicadas are an occasional phenomenon. Tennessee, for example, hosts 13-year and 17-year varieties. We should be so lucky.

Then again, down there the creatures apparently can be seen hatching and flying about. Yuck. I’ve only rarely seen them, thank goodness, being the big, ugly critters they are. Fortunately they seem to mostly hide in the trees, out of sight. I think there’s some kind of deal around here where, if they don’t show their ugly faces, we put up with the strange hissing (actually the male’s mating call) and just leave them alone. After a few weeks, the hissing stops and the cicadas gear up for next year.

Contrast the cicadas’ noisy hissing with another hissing noise you’ve been reading about these past few months: the dollar losing its value. Of course, you can’t actually hear the dollar’s hissing, but unlike the cicada, the dollar’s hissing keeps going on and on; it never stops. And while the cicadas hissing presents no danger to humans, the same can’t be said for the dollar. Maybe it would be better if you could, indeed, hear the dollar hissing as its value declines. The way things stand today, it’s become mere background noise for too many of us.

And so, these past months, these letters have tried to, shall we say, vocalize that silent hissing of the dollar. We started with an analysis of our current monetary system and how we’re set up for a fall. Next, we explained not only why the dollar may crash, but also that — in real dollars and cents — the dollar has been slowly crashing since 1971. Today we begin to look down the road a bit: What can we expect the world to look like when the crisis ends?

But first, a quick comment on this whole “debt ceiling” crisis.

The Truth About the Debt-Ceiling “Crisis”

The debt ceiling debate has been all about politics. You know that, right? It’s got very little, if anything, to do with how much the government spends, or how fast they’re digging us into a debt-hole with no bottom in sight. Nothing that has been proposed by either side will do anything of any significance to address the government’s deficit or its debt.

So if all the drama isn’t about the government’s deficit or its enormous outstanding debt, what is it all about? Power — and nothing else. And please remember this: nothing that you’ve seen, heard or read during the “debate” about this “crisis” will help you in any way to prepare for a crashing dollar. When the debt ceiling is raised (the deal is being sealed while this letter is being finished) we’ll be no better off — in fact probably worse off — than we were before the debt ceiling circus came to town. Don’t worry, some will put a nice spin on the deal; others will claim it’s a disaster. It’s really neither. It will soon fade from memory, like every other debt ceiling debate in recent decades.

Enough said: now on to important matters.

If it’s OK with you, I thought we’d start with something upbeat, a theme we introduced last month:

Why Things Aren’t as Bad as They Seem

If you’re unemployed, or worried about your job, things seem pretty bad right now. If you’ve noticed your weekly gas and food bill steadily creeping up, the price squeeze may be starting to choke you. And if you own a house, and the value of that home has slowly — maybe quickly — deteriorated, it’s perfectly understandable that you might not agree that things aren’t that bad.

The fact is what’s going on right now makes life difficult for a lot of us. Simply put, we’ve entered hard times. That’s one reason why the University of Michigan Consumer Survey — watched like a hawk by businesses, especially retailers — keeps disappointing everyone, most recently wallowing in the low 70’s. And now it looks as though GDP — which only months ago so many economists expected to average between 2.5% and 3.5% in 2011, just came in at 1.3% for the 2nd quarter, far below expectations, as the 1st quarter number was revised down from 1.9% to 0.4% — talk about anemic.

Of course, any slight glimmer of good news still gets pumped up into a story about the economy “turning around” or some market segment “bottoming.” A recent example of those sorts of stories would be a report in the Wall Street Journal about a “bright spot” in housing. Sales of homes rose 3.8% in the second quarter compared to the first quarter. Of course, in order to achieve that increase, home prices had to fall over 25% to begin with, mortgage rates had to drop, and foreclosures had to rise, putting more houses into the available pool (thereby causing prices to drop even more). Oh, and let’s not forget the tax credit available to first-time buyers. So it took all that to get a rise in sales. That’s good news?

Instead of this sort of phony trumped-up stuff, let’s take a deep breath and put our thinking caps on. Okay?

If you look carefully you may find we’re still living in what is arguably still the most blessed nation in history. When we referred to this last month, it was in the context of the 4th of July, but it wasn’t just patriotic emotion that inspired us then or now.

The history of the U.S. shows us that our past economic success is, in fact, based on the recognition of a person’s right to life, liberty, the pursuit of happiness, which still — in spite of some serious slippage over the years — includes secure property rights and the rule of law. Many of these concepts are reputed to inspire every “freedom” demonstration or movement in the world today. In fact, if you don’t hear leaders of these movements speak of right to life, liberty, the pursuit of happiness, specifically including secure property rights and the rule of law, the chances are their talk of freedom will prove to be mere propaganda and their countries will likely wind up either in tyranny or chaos. Just watch the Middle East in the coming months and years; we’ll find real examples to verify this — one way or the other.

Let’s move on to our geography. Last month, we put it this way:

Add to this our location between the Atlantic and Pacific oceans. We remain at the cross-roads of East-West commerce. If our East-West connection appears less of an advantage in the world of jet travel, just look at a map; it’s easy to see how it’s still an advantage. And let’s not forget our North and South American trading partners.

Of course, in an age of intercontinental missiles, never mind individual terrorists creating mayhem in the form of biological, chemical and “suitcase” nuclear devices, we don’t feel quite as safe as we once did. You can’t ignore such real and frightening threats. But, think about it, how many serious attacks has the United States suffered since 9/11, compared with the rest of the world? While we face grave dangers — and will for the foreseeable future – don’t you think having the Atlantic on one side and Pacific on the other provides at least an extra hurdle for a foreign enemy to overcome?

And let’s not forget demographics. Among developed and developing countries, America still lives while so many others are dying or on life support. In varying degrees, Russia, Japan, China and most of Europe now suffer, or will soon suffer, declining populations. Even India has begun to experience shrinking birth rates. While the U.S. is certainly growing more slowly than it has at any other time, our relatively stable birth rate and continuing robust immigration provides good reasons to look to the future with greater optimism — assuming we can figure out how to stop getting at each other’s throats.

We could go on, but here’s the point: until proven otherwise, let’s not buy into the claim that the U.S. will inevitably descend into second-world — or even third-world — status for the rest of its history. We’ll talk more about this in future letters, but for now, let’s get back to this month’s subject.

So now that we’ve braced ourselves with our vision of a brighter future, it’s time to face what’s staring us in the face right now. You’re just not being realistic if you don’t ask exactly whenthis bright future will shine on us. And with that in mind, we need to understand…

Why Things Don’t Look So Great at the Moment

Our brighter future lies somewhere over the horizon — just how far, we really can’t say. We need to face the possibility that getting there may take more time than many think and involve more struggle than many are willing to face.

To be specific, I would contend that the length of our current crisis, and the intensity of the struggle we face depends greatly on what happens to our money: the U.S. dollar. Whether it continues its current “slow” collapse or does indeed crash and burn before our eyes, we should operate under the assumption that until we restore integrity and stability to the U.S. dollar, the economic and financial crisis that smashed our economy and markets with such violence in 2008 will not end.

This is, of course, an educated guess — albeit a pretty good guess. And it’s why these letters have spent so much time carefully explaining why the dollar will eventually crash. Indeed, we’ve covered:

• How We Know We Are Indeed in a Dollar Crisis Right Now
• Why This Dollar Crisis Could Wipe Our Your Wealth

We’ve even broken down exactly how you could lose your wealth as a result of the disordered state of the U.S. dollar. Specifically:

• 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.

To support these claims, we pointed to the undisputed fact that, since 1971, the U.S. dollar has lost around 90% of its value. And if you somehow thought these claims were inaccurate or exaggerated, we suggested the following:

Of course, if you understand the dangers inherent in a dollar that continually loses value, the logical next step is to try to understand:

What Will Be Left When Our
Current Dollar Crisis Ends

Our current dollar crisis will end — we just don’t know when. We can get some idea of when it will end by considering exactly howit will end. To do that, we’ll take a look at how the last major dollar crisis ended. I think you’ll see why the last crisis never really resolved anything. You’ll also see why this time we may be forced to find a real resolution — one that doesn’t just kick the can down the road for the next generation (our children and grandchildren) to figure out. We’ll get to that in a moment.

But first, let’s return to our earlier statement, that what the debt ceiling debate was really about was power. To prove this, just think about how much real debate or even argument (never mind discussion) was involved in the jockeying back and forth over the course of these last few weeks: very little.

And the resolution to the “debate” was more about the need of both parties to project some sort of “victory.” Little — I would say nothing — was resolved when it comes to our ballooning deficits or our exploding debt.

Do you think, left in the hands of politicians, that the “resolution” of our current dollar crisis will be any different?

Seen through this prism of power, let’s now take a look at the resolution of the last major dollar crisis that started in the late 1960’s — the one we described last March:

Sound familiar? What happened next will sound familiar too.

Except for the high inflation — which may lie somewhere down the road — we’re following the same script this time around. So how did that first dollar crisis end?

In his book Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, Barry Eichengreen picks up the story when Richard Nixon succeeded Lyndon Johnson as U.S. President, continuing the “guns and butter” policies that started the round of government deficits and money printing in the 1960’s:

At the time, the U.S. government still had plenty of muscle to flex. As previously reported, in 1971 Nixon reneged on the U.S. promise to exchange the dollar for gold. Then he devalued the dollar relative to other currencies — putting all our trading partners at a disadvantage. As the dollar’s crisis continued in spite of these unilateral actions, Nixon upped the ante and chose John Connally, his Treasury Secretary, to play bully boy. Eichengreen describes a typical Connally performance at a meeting of world finance ministers called after the U.S. imposed a 10% surcharge on all imports.

Contrast this with our current Treasury Secretary, Timothy Geithner. On June 2nd, 2009 Geithner met with Yu Yongding, an advisor to the Chinese Central Bank. Yonding said “You should try not to inflate away your debt burden.” He also said, “The borrower should keep their promises.”

On the same trip, Geithner spoke to a group of Chinese students at Beijing University. He assured students that Chinese holdings of treasuries were safe. They laughed out loud. Not winced or snickered. They laughed so that you could hear the laughter.

How times have changed! But in spite of that the playing of power politics goes on. China must know that the U.S. may very well inflate away its debt burden — leaving China holding billions in devalued U.S. debt. As for treasuries being safe, the Chinese surely aren’t counting on that. (Theories vary on exactly why they continue to hold so much U.S. debt.)

And yet, each time a crisis erupts around the world, money does, in fact, flow into U.S. treasuries. A couple of weeks ago, when Italy’s debt swooned as the European debt crisis heated up yet again, U.S. treasuries jumped in value as people bid up prices for the right to buy them. Of course, now that this latest moment of crisis has passed, they’ve reversed course.

But many of us forget that even back in the day when U.S. power ruled the free world, things didn’t quite go the way Nixon planned. Eichengreen explains:

Remember, this was when the U.S. could play the power game without resistance — or derision.

Looking at our situation today, how will the rest of the world react if the U.S. continues its current fiscal and monetary policies? What happens if the government continues to run up huge deficits, adding to an already gigantic national debt? Will the U.S. government deal with its fiscal and monetary crisis using its “power tools” as it has in the past?

The answer to this question will determine how and when the dollar crisis ends. How the dollar crisis ends will determine whether our current economic crisis is fully resolved, or whether that old stand-by — kicking the can down the road — succeeds in calming the waters before the next storm hits shore.

So how exactly did that last dollar crisis end?

Some say it ended with the election of Ronald Reagan as President. They see Reagan’s election as having restored confidence in America, hence confidence in America’s dollar.

Others point to Jimmy Carter’s appointment of Paul Volcker as Fed Chairman. They claim it was Volcker’s raising of interest rates that restored confidence in the dollar — even before Reagan took office.

Perhaps those changes at the top (the president and the Fed chairman), helped to end a decade of stagflation (high inflation/slow growth/high unemployment) caused by the government’s mismanagement of fiscal policy and the Fed’s mismanagement of monetary policy. But most of us have forgotten just how close the dollar came to catastrophe, in spite of those changes. The fact is, the dollar came within a whisker of collapse. And after a decade of high inflation, slow growth and high unemployment, a collapse of the dollar at that time could arguably have caused a round of social unrest and political upheaval most of us today have never seen or even imagined.

That’s why I think it’s important for us to turn the clock back and see what really caused that brush with catastrophe — especially those of us who want to be prepared for the uncertainties presented by this dollar crisis.

Summary and Comment

This month, we’ve taken our first look at what the world may look like when our current economic and financial crisis ends. We started on a high note by considering America’s strengths in terms of its history, its geography and its demographics. Based on those strengths, we may indeed be looking at a very bright future.

However, there’s no denying the tough times many of us face right now, as well as the probability that our current crisis may last longer than any of us might wish. Further, I’ve proposed the idea that the length of this crisis and the intensity of the struggle we face all depends on what happens to our money: the U.S. dollar.

To support that proposal we took a quick look back by reviewing the ideas and assertions we’ve made in previous letters:

• How We Know We Are Indeed in a Dollar Crisis Right Now
• Why This Dollar Crisis Could Wipe Our Your Wealth

I’ve further proposed that we look at how the last major dollar crisis was resolved in order to understand what the world may look like when our current economic and financial crisis ends. Finally we took our first look at that crisis and how the U.S. government attempted to address it then by the assertion of power.

Next month, we’ll let history guide us through the dramatic events of the 1970’s and early 1980’s that almost caused the dollar to collapse. I hope you’ll see why it’s so important to understand money, specifically the plight of the U.S dollar, if you have any intention of keeping your assets relatively safe from an uncertain future.

Meanwhile, there’s one thing I am certain of, and that’s a few more weeks of hot, humid days and hissing cicadas. And, don’t get me wrong, I do certainly appreciate the fact that God must have created such weather and such creatures for a very good reason. But being the true city-slicker that I am, I must confess an even greater appreciation for His creating those intelligent people who had the vision and creativity to invent air conditioning.

There’s nothing better than the wonders of nature supplemented (or if necessary supplanted) by modern technology.

Your dyed-in-the-wool city-born-and bred editor,

P.S — U.S. treasuries were once considered “good as gold.” Now there’s talk that U.S treasuries will lose their “AAA” rating— and it may happen sooner than you might imagine. For an explanation you probably won’t read anywhere else, click 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