devaluation

All posts tagged devaluation

According to a quote in the Telegraph, HSBC has issued a new report stating that the Federal Reserve’s ultra-loose monetary policy is forcing China and other emerging countries to create a new global currency “order”. According to David Bloom, HSBC’s currency chief, the dollar looks like the sterling did after World War I.

For those a little dusty on their history, the British pound sterling (so called because it’s value was backed by sterling silver) was the world reserve currency until the 1930’s. After that, the sun set on the British Empire and the sterling was replaced by the US dollar. Now it seems the dollars time in the sun has come to end as well. The Telegraph article states:

Crucially, China and rising Asia have reached the point where they can no longer keep holding down their currencies to boost exports because this is causing mayhem to their own economies, stoking asset bubbles. Asia’s “mercantilist mindset” of recent decades is about to be broken by the spectre of an inflation spiral.

A monetary policy of near zero rates – further juiced by quantitative easing – is completely incompatible with circumstances in most of Asia, the Middle East, Latin America, and Africa. Divorce is inevitable. The US is expected to hold rates near zero through 2010 to tackle its own crisis.

Mr Bloom said regional currencies would emerge as the anchor for their smaller trading partners, with China, Brazil, or South Africa substituting the role of the US. Australia is already linking its fortunes to China through commodity ties.

This is nothing new, but it is the first time a major bank has openly stated this. But the important question hasn’t been answered.

What does it mean to the average American?

In order to obtain the necessary financing to fund the multi-trillion dollar stimulus/bailout package the government needs to sell bonds. Traditionally, the Chinese and other foreign governments have used their excess reserves of US dollars to purchase these bonds. If we switch to some other currency (or mixture of different currencies), the amount of US dollars held by foreign governments will decrease and the demand for US treasuries that yield next to nothing will decrease substantially. In order to entice the buying of these treasuries, the interest rates will have to jump substantially higher. And when this happens, the cost of the US government’s debt will start to rise. As will the cost of borrowing for US citizens and businesses. The government already pays nearly a billion dollars a day in interest payments (hat tip: Silver Bars Direct: Why $1,000 gold is now significant). If this cost were to double, and we add in the additional $9 trillion in debt the white house has admitted it is likely to borrow, we’re looking at over a trillion dollars a year in debt payments.

In order to repay this interest (and maybe the original principle too), do you think the government is likely to raise taxes or just print more money? If it prints more more, its just fueling the debt spiral which will lead to Zimbabwe-type hyper-inflation.

So what should you do?

Invest in hard assets that have been proven to keep their buying power during inflationary times.  Along with gold and silver bullion, buy some cheap land to either farm, hunt or bury your precious metals! And if you’re one of those people who think buying gold and silver is useless then hold on to your dollars and watch them become even more worthless. Since 1900, when the dollar coin actually contained silver, the dollar’s purchasing power has dropped to only4 cents. This trend is only like to get worse.

Purchasing-Power-of-the-US-Dollar-1900-2005

Disclosure: I own gold & silver bullion, numismatic coins and mining stocks.

In the previous post on Peter Schiff, some of the commenters suggested diversifying out of the US dollar and economy and instead investing in natural resource rich countries like Canada and Australia. One person who supports this theory is Marc Faber. He thinks there’s a strong possibility that the US might see 200% inflation. Right now he says its reversible “in theory”, but he’s confident that we’ll follow Zimbabwe down the road of Mugabe economics and devaluation of the dollar (which will be bullish for gold!).

“In the US, we have a totally new school, and it’s called the Zimbabwe school. And it’s founded by one of the great leaders of this world, Mr Robert Mugabe, that has managed to totally impoverish his own country. And that is the monetary policy the US is pursuing.”

Faber also thinks that US government bonds should have junk bond status!

Another person who’s bullish on gold (and therefore by default, bearish on the dollar) is David Einhorn of Greenlight Capital, who correctly predicted the fall of Lehman and other financial companies. In his recent newsletter to his shareholders, he was almost apologetic about investing in gold mining stocks right now.

We never thought we would ever buy gold or gold stocks. David’s grandfather Benjamin was a goldbug… And it was a lousy investment. Being a patient investor is one thing. Being ‘wrong’ for three decades is quite another.

To everyone’s dismay, we believe that some of Grandpa Ben’s predictions are playing out. Our current chairman of the Federal Reserve, Ben Bernanke, is an ‘inflationist.’ … The size of the Fed’s balance sheet is exploding and the currency is being debased… Our instinct is that gold will do good either way; deflation will lead to further steps to debase the currency, while inflation speaks for itself. We have bought gold, calls on gold, an index of gold mining stocks (GDX) and calls on higher long-term U.S. interest rates.

You can read his entire shareholder letter here. It’s informative and very easy to read.

[Note: I’m bullish on gold and own GDX.]

The media has been going on and on about deflation. Long-term bond prices have also been trending up and long term yields have been dropping, which means that the market thinks there will be long-term deflation. Even the Consumer Price Index numbers that came out claim that inflation is under 2% annually!

(Of course, if you’re one of the unlucky 533,000 people who lost their jobs last month, you really couldn’t care less about deflation).

Let’s first look at the Government reported numbers.

                      May   June  July  Aug.  Sep.  Oct.  Nov.   ended     ended                      
                             2008  2008  2008  2008  2008  2008  2008 Nov. 2008 Nov. 2008

All items..........    .7   1.2    .9   -.2   -.1  -1.2  -2.1     -12.9        .7

Food and beverages    .3    .8    .9    .6    .6    .3    .2       4.2       6.0
Housing...........    .5    .5    .7    .0   -.2    .0   -.1       -.8       3.1

Apparel...........   -.2    .0    .8   1.0    .0  -1.2    .2      -3.9        .2
Transportation....   2.1   4.0   1.8  -1.7   -.7  -6.0 -10.9     -52.1     -10.4

Medical care......    .1    .2    .1    .3    .3    .1    .2       2.7       2.7
Recreation........    .0    .2    .4    .5    .2    .0   -.1        .8       1.9

Education and
  communication..    .3    .5    .5    .2    .0    .2    .2       1.6       3.4

Other goods and
  services.......    .5    .6    .5    .2    .2    .3    .1       2.4       4.4

Special indexes:Energy............   4.5   6.8   4.0  -3.2  -1.7  -9.0 -17.8     -70.8     -14.3

Food..............    .3    .8    .9    .6    .6    .3    .2       4.1       6.2
All items less
food and energy    .2    .3    .3    .2    .1   -.1    .0        .1       2.0

Lets start with the largest expense for most people, housing.

Yes, house prices have decreased. However, if you’re already a home owner or a renter then you’re probably not seeing any benefit. The only people who’re benefiting are those people who can actually qualify for a home loan and have enough cash for a down-payment. The 100% financing loans have disappeared as a result of the tightening of the lending standards. As I mentioned in the last post, it’s not the cost of credit, buts the availability of credit that is important.

Energy prices actually have dropped down from $147/barrel to around $40/barrel in the past 5 months. However, I heard billionaire T Boone Pickins on the radio today say that OPEC is going to keep cutting production until oil is back up at $75/barrel. In the long run, I agree with him. While a global recession might reduce the demand for oil, there are 3 billion people in Asia who are getting a little richer every day and want air conditioning, cars, motorbikes and other luxuries that consume oil. Without alternate energy sources, oil prices have to rise. The current price drop is likely to be short-lived.

According to official numbers, education costs have only gone up 1.6%-3.4% in the past year. However, my MBA program has seen a much higher percentage increase in tuition than last year, and it might see another increase next year (according to a letter I received from the Dean of my Business School).

Likewise, medical costs have also gone up only 2.7%, but my health premiums and medical costs seem somehow higher than that.

And while food and beverage prices have only seen an official 4.2-6% inflation, prices of food items that I consider my staple diet like Tyson Chicken Wings and Sirloin Steak Burgers at Costco have gone up about nearly 50% in the past 2 years.

Meanwhile, the Federal Reserve is printing money like its going out of style. (And at this rate, it actually might). In theory, increasing the money is inflationary. That’s one reason why a house that cost $30,000 in the 70’s costs $300,000 today. More money in circulation means every existing dollar is now worth less. At least thats the theory. Increases in productivity and technology have managed to improve our standard of living despite this inflationary pressure, but there must be some point at which you start seeing inflation. Maybe we’re at that point now.

The government has committed to more money on financial bailouts than its ever spent in its history. According to an article in the SF Gate, the Financial Bailout may end up costing the taxpayer $8.5 trillion dollars.

According to an article on CNBC, that’s more than the cost of almost everything else the US government has spent on even adjusting for inflation!

Here are estimates for the major US government expenditures (all figures inflation-adjusted):

Hoover Dam: $782 million

Panama Canal: $7.9 billion

Gulf War: $98 billion

Marshall Plan: $115.3 billion

Louisiana Purchase: $217 billion

Race to the Moon: $237 billion

Savings & Loan Crisis: $256 billion

Korean War: $454 billion

New Deal: ~$500 billion

Iraq/Afghanistan/War on Terror: $597 billion

Vietnam War: $698 billion

NASA Budget since inception: $851.2 billion

World War II: $3.6 trillion

Total = $7.63 trillion

I thought this was the most interesting section of the SF Gate article:

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said [That’s Diane Lim Rogers, chief economist with the Concord Coalition, not Jim Rogers!]. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

In the past 10 years gold is up 300%+. That’s about 300% better than the return on the S&P500 over the same time period! This is not an indication of deflation.

And what does veteran investor Jim Rogers think about this? In a recent Bloomberg interview he predicted that the dollar is “going to lose its status as the world’s reserve currency,” adding, “It will be devalued and it will go down a lot. These guys in Washington, they want to debase the currency.”

“They think that if you drive down the value of your money, it makes you more competitive, now that has never worked in history in the long term,” said Rogers.

Paul Watson of the Prison Planet states:

The head of the International Monetary Fund, Dominique Strauss-Kahn, warned that advanced nations will be hit by violent civil unrest if the elite continue to restructure the economy around their own interests while looting the taxpayer. Strauss-Kahn’s comments echo those of others who have cautioned that civil unrest could arise, specifically in the U.S., as a result of the wholesale looting of the taxpayer and the devaluation of the dollar.

How long will it be before Americans realize the looming specter of hyperinflation spells disaster for their life savings? How long will it be before we see rioting in the streets on a par with the scenes witnessed in Iceland over the weekend, where the Icelandic krona has lost half its value in a matter of weeks?

I’m not buying the deflation argument. In fact, I wouldn’t be surprized to see 10-12% inflation for the next several years. I’ve been buying gold coins since gold was $500/ounce and I’ve adding to my position on pullbacks. Maybe in a few years time, $850 gold and $12 silver may look like a bargain!