The topic of this discussion is the possibility of the catastrophic collapse of the US dollar, leading to hyperinflation and the devaluing of the dollar. To start off, I would declare that I am not a professional economist nor financial analyst. I am a layman investor who keeps tracks of the financial signs of the times. My recent readings has found more than a few commentaries and articles on the precarious situation of US debt.
References
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Before going further, here are the links of the surprising number of books I found on the subject.
[1] The New Economic Disorder: Strategies for Weathering Any Crisis While Keeping Your Finances Intact
[2] Crash Proof 2.0: How to Profit From the Economic Collapse
[3] The Collapse of the Dollar and How to Profit from It: Make a Fortune by Investing in Gold and Other Hard Assets
[4]
End the Fed by Ron Paul
[5]
The Dollar Meltdown: Surviving the Impending Currency Crisis with Gold, Oil, and Other Unconventional Investments
[6]
Debunking the Hyperinflation of Peter Schiff and the Gold Bugs: A Guide for Investors
This subject of Financial Armageddon is pretty far fetched if this is the first time you have heard of it. I got seriously interested just last week after reading book [1]. That's when I hit Amazon to check out other books and was surprised by the others. Book [2] is by Peter schiff who claimed to have predicted the housing crisis leading to the Global Financial Crisis. To be balanced, I thought of providing the reference to Book [6] which aims at debunking Peter Schiff. But note that Schiff is hardly the lone voice on the matter. Book [4] is written by Congressman Ron Paul calling for the end of the Federal Reserve. Book [1]'s author was a Bank CEO as well as politician.
http://www.theage.com.au/national/joyces-armageddon-warning-20091210-km90.html
In addition, when a new, maverick, Opposition Finance Spokesman from Australia, warns about US economic collapse leading to worldwide collapse - it really caught my interest. He had to get his information from somewhere on such a matter, since he has no track record as an economic genius.
US Debt
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The US (public) debt stands at about 12 trillion, see:
http://en.wikipedia.org/wiki/United_States_public_debt
http://www.usdebtclock.org/ - cool website with real time Debt and Interest meters.
The foreign ownership of US Treasury Securities is about $0.8 trillion by China, $0.75 trillion by Japan.
This is just mind boggling. There is serious questions on whether the US can service the debt any longer. Two main options are:
i) Print more money - done by the Federal Reserve. Such actions would lead to inflation and the devaluing of the dollar. Simple thought - more money printed more inflation. The nightmarish scenarios are the Weimar Republic in the 1920s and the recent/current Zimbabwe inflation crisis.
ii) Declare Bankcruptcy - this is what happens when entities cannot pay their debt. In general, the consequence of this is creditors will come in carve out the assets of the bankcrupted entity. To US investors, this means their bonds may be worthless. To the outside world, the ramifications are enormous - feel free to add to this via comments.
In either case, if you are an investor with lots of US bonds, they will be wiped out. Or if you holds lots of cash, they will be worthless.
Risk Analysis
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The scenarios listed above are pretty extreme. In the world of Quantitative Risk Analysis, one method of calculating risk involve assessing an event in terms of
i) Frequency (Likelihood of occurring); and
ii) Severity (Impact).
The severity, without putting in dollar terms, is harsh. You'll see other words like meltdown and armageddon being used to describe how bad the situtation can be.
The frequency? Well, the US has never been bankcrupt or in hyperinflation before. From historical facts, the frequency would be 0.00000. But this does not mean it cannot happen. Say even if it has a frequency of 0.000000000001, then when it does happen, most people will still be wiped out financially. Would you be in this position? Can we be prepared for this? From recent readings, I would also suggest that to some economist / thinkers, they would put a frequency (probability) value as a very low number but definitely note close to 0.
Federal Reserve
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The Federal Reserve of The Fed sets the monetary policy in the US. This means it sets the US interest rates. Some facts about the Fed:
- Created in 1913 by the Federal Reserve Act in response to prior financial panics and bank runs.
- Suppose to function as and independent and Central Bank.
- Among its power is the ability to print money.
Some surprising facts about The Fed:
- Contrary to public assumption The Fed is in fact owned by a number of commercial banks . So whose interests are they really caring for?
- The Federal Reserve Act was drafted in a somewhat secretive manner at Jekyll Island, Georgia with big names like J.D.Rockefeller Jr. and J.P. Morgan.
Deliberate Inflationary policies
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Some writers suggested that policies (eg printing money to pay debt) that ultimately lead to inflation may even have a hidden motive to bring about a change in the currrent system. Recent example of Zimbabwe's currency crisis begs the question: is it mismanagement or an attempt to exert further control.
Quote from "The Economic Consequences of the Peace", by John Maynard Keynes, Ch VI
http://www.gutenberg.org/files/15776/15776-h/15776-h.htm#CHAPTER_VI
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Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers,", who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
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Dethroning of Gold - Gold is Dead, Long Live the Dollar
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Most people in this world have lived within the period where the US is the international currency. But for thousands of years before, it was Gold which is the widely accepted standard. Through a series of government policies in the 20th century, Gold has been steadily but surely dethroned.
What is Money - Paper money is a represenation of assets. It is a convenient medium of exchange of wealth. It should be backed up by something tangible.
Back in 1935, a one-dollar "Silver Certificate"(1935 series) clearly spelled out the terms of the contract by stating: "THIS CERTIFIES THAT THERE IS ON DEPOSIT IN THE TREASURY OF THE UNITED STATES OF AMERICA ONE DOLLAR IN SILVER PAYABLE TO THE BEARER ON DEMAND"
Today, the US dollar belongs to the Federal Reserve. It is called a Federal Reserve Note (FRN), not the US government nor the people. The FRN paper money makes no promise to let you exchange it with any real asset. It is referred to as an IOU Nothing.
From 1882-1933, US Gold certificates paper money are redeemable in gold - they have intrinsic value.
In 1934, the FRN came into being to replace the Gold certificates.
Also the Gold Reserve Act 1934 outlawed US citizens from owning gold and gold certificates. It forced everyone to sell gold to the US Treasury such that only the US government has the right to hold gold. At the same time, one troy ounce of gold was pegged to US$35 (devalued from US$20.67). So, despite outlawing gold domestically, the US dollar still had a fixed intrinsic value overseas.
Only from 1975 can Americans own and trade in gold.
Bretton Woods agreement 1944. Besides establishing the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), it setup a system of fixed exchange rates with the US dollar as the Reserve Currency, given that the US dollar was fixed to the gold standard.
In 1971, the fixed exchange rate between Gold and the US dollar was abolished by Nixon. This finally removed any kind of intrinsic value of the US dollar.
Since the US dollar is no longer tied to gold, and the more it is printed, the more it loses its value. The extreme scenario of hyperinflation is that the currency becomes worthless. Already there are signs of a lack of confidence such as:
- Mar 2009 - China calls for the creation of a new standard currency. http://online.wsj.com/article/SB123780272456212885.html
- May 2009 - Russia replacing the US dollar with the Euro as its basic reserve currency. http://www.globalresearch.ca/index.php?context=va&aid=13691
What to do
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In the unlikely event of catastrophic financial collapse, investment in stocks (except a few perhaps) will plunge. Property is in general illiquid. Cash and fixed income will be wiped out in the event of hyperinflation. So how exactly can we prepare before such a thing actually happens?
Somehow the most common answer always point back to gold, although there are suggestions of other precious metals like platinum. Only be wary that legislation may outlaw the ownership of precious metals like the Gold Reserve Act. Yet there are always exceptions, such as collectible gold coins. Feel free to share your ideas on what is the most affordable and practical ways of holding gold.
Given that such a dire scenario is almost unimaginable, there is still good reason to prepare for it since the consequence are so drastic. So how much should we put aside, perhaps translate into gold? My current thoughts are the equivalent amount of money enough to buy your family food and shelter for one year.
Disclaimer
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As with all articles in this blog, this is not meant to be financial advice. Rather it is just an expression of thought.
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