Eric Fry

“On the threshold of a crisis,” we observed in our essay “Investing Ahead of the Curve” in the July 19, 2011 edition of The Daily Reckoning, “a fertile imagination can be an investor’s most valuable asset.”

“During normal times,” we continued, “investors can focus only on buying quality stocks one by one from the bottom up, without also trying to envision what tragedies might befall them from the top down… But it may be time to begin imagining the unimaginable.

“It may be time, in other words, to begin considering that the next phase of the global monetary system might not include the US dollar as its reserve currency…or that the next two decades of life in America might not look anything like the last two decades.”

Here in the US of A, life is still pretty good, even if the economy isn’t perfect. A true crisis seems unimaginable. After all, even the 2008 crisis wasn’t that bad. Today, the Apple store in the mall is always packed, most of the restaurants in town are full…and the dollar is still strong enough to buy a nice vacation almost anywhere in the world.

A currency crisis that triggers an economic crisis — or vice versa — just feels like a bunch of wacky doom-and-gloom stuff. And it may well be. In the context of America’s legendary resilience and economic might, a catastrophic currency crisis seems almost unimaginable… But the time has arrived to begin imagining it…not because it is certain, but because it has become less unimaginable.

The best way to defend against a currency crisis is as obvious as it is emotionally difficult: Don’t hold the currency that is hurtling toward a crisis.

There is nothing mechanically difficult about this remedy, but it can be very difficult emotionally…and tactically. An individual who trades dollars for some sort of “safer” currency, for example, risks looking like a fool for a long period of time. Not even gold is a sure bet over short-to-medium-term timeframes. This safe-haven asset tumbled about 40% against the dollar during the 2008 crisis.

In short, being “safe” can sometimes feel very dangerous…and foolish. And no one wants to look as foolish as Noah building his Ark…unless, of course, it starts raining.

When the rain started falling on Brazil in 1990…or Thailand in 1997…or Russia in 1998, investors who had traded their local currencies for US dollars or gold were able to sail through the crises relatively unscathed. As their economies tumbled into deep recessions and asset values collapsed, the folks who had parked their wealth in dollars or gold were able to preserve their wealth…and also to take advantage of the resulting bargains.

But these folks had to be both forward-looking and patient if they were to succeed in protecting their wealth. Even so, their mission was infinitely easier than the one we Americans face today.

Throughout the serial currency crises of the last several decades, individuals everywhere throughout the world knew they could protect their wealth simply by trading their local currencies for US dollars. They didn’t even have to think about it. Just a wee bit of imagination enabled some investors to steer clear of these crises. The dollar was a sure thing.

But now that the “sure thing” itself is the thing that is becoming less sure, the appropriate course of action is very difficult to determine. Today, the looming potential crises are not unfolding in banana republics or in chronic economic basket cases, but in the world’s largest economies.

Investors required almost no imagination to envision the Argentine currency crisis of 2002. Argentina, Brazil and Russia all possessed a rich history of monetary incompetence and chicanery. Today, however, investors will require an imagination so vivid and wild that it would border on hallucinogenic. They must not merely imagine that an Argentina might have a currency crisis…again…but they must try to imagine that the euro might splinter apart…or that the dollar might suffer a disastrous hyperinflation.

If, in fact, the foundations supporting the dollar’s strength are eroding, how should the forward-looking dollar-holders protect themselves? Should they swap dollars for a few select foreign currencies? Maybe, but what if they select the wrong “select” currencies?

Singapore, Norway and Chile, to name just three examples, issue currencies that have been appreciating against the US dollar for many years. Broadly speaking, their currencies are strong because these nations operate in a much more fiscally responsible manner than the US government. Yet, when the euro crisis reached a boil last summer, the US dollar was still the world’s go-to currency. The Singapore dollar, Norwegian krone and Chilean peso all fell at least 10% against the US dollar.

All three of those currencies have since recovered most of their losses. But the point remains: Trying to preserve wealth by swapping US dollars for some other currency is a terrifying and risky quest…even if that strategy may be absolutely correct over the long run.

Eric Fry
for The Daily Reckoning

Eric Fry

Eric J. Fry, Agora Financial's Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling.  Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling. 

Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry  supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts.  His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.

  • Jim

    Hardly any other currency is large enough to substitute for the dollar. And the Euro and Europe in general is even more structurally unsound long term than the dollar.

    It is difficult to over-estimate the support that being the world currency provides. You can still walk down a dog track in Bolivia or Moldova and buy lunch at a family owned diner in American dollars.

    And a viable substitute would require some years to establish. India or China could eventually do it, but that would take awhile, and currently it is not in their best interest to aid in the collapse of their largest trading partner.

    While we are talking scenarios, someone, somewhere will introduce a ‘free’ currency backed by a basket of commodities. I suspect they could offer a fixed exchange rate and still be totally successful.

    Perhaps a new currency will be driven not by nations, but by people tired of watching the dollar fall and driving up energy prices across the world.

    Whoever does so will bury Keynes once and for all. All it takes is an agreeable country. Such a move could power the development of a new bank with global reach.

  • John Smith

    The value of the dollar is like a pest, which needs only the removal of a strong force opposing it to propagate. The Federal Reserve has stated that it intends to inflate the currency at least 2% per year, yet core inflation in two of the last four years has been negative, and this year will probably be flat. That means that if the Federal Reserve was relatively neutral towards the money supply, we might be seeing 5 or 6% per year increases in the value of the dollar. And that’s if it was neutral. If it was for strengthening the dollar, instead of weakening it, you might see 9 or 10% returns on the dollar–which, quite obviously, is unsustainable, because who can compete with such returns? But, if I’m not mistaken, that evidences an underlying strength, not an underlying weakness, to the dollar, which should be pretty obvious, because there is nowhere in Saudi Arabia, Brazil or China safe from internal political factors.

  • Bennet Cecil

    All it will take is for China to make their currency convertible to gold. Everyone wants to do business with China, just like they used to want to deal with Americans. Socialism, public schools, crony capitalism and our obese government are cosuming American prosperity. Voters continue to believe lying politicians who promise impossible benefits for free. America is failing now. Will it change course or implode? As the Euro unwinds Americans are getting another chance to reverse course.

  • Larry Bernard

    Bennet: Except they don’t have enough gold to cover their debt, and if their currency was valued in gold people would take all their gold because their currency is insanely over-valued

  • gman

    won’t happen.

    1) not only is no other currency in the world large enough to act as a world reserve, there’s nothing even remotely close to being large enough. and everyone knows it.

    2) most of the world’s economies are export oriented, specifically at the united states. if the dollar collapses then that market collapses followed by the rest of the world economy. and everyone knows it.

    3) besides the united states no other nation in the world is capable of defending the house of saud against its enemies foreign and domestic. any nation that becomes capable of doing so is more likely to seize saudi arabia than defend it. and everyone knows it.

    4) if any other currency ever becomes the world reserve the owning nation will manipulate that status to its own benefit far and away more aggressively and punitively and gratuitously than anything the united states could or would do. while everyone would like their own currency to be the world reserve no-one else anywhere else will agree. and everyone knows it.

    any one of these alone is sufficient to guarantee that the dollar remains the world reserve. and not only do none of these show any sign of any possible change in any short- or mid-term view, in fact any crisis in the dollar will work against any replacement of it.

    it’s the dollar or bust. and everyone knows it.

  • Arthur

    This article doesn’t really tell me anything I didn’t know already. Since *I* seem to be the one who’s better informed of the two, allow me to expand on your comments; the U.S. dollar is toast and so is the USA. Europe at least has the option of breaking-up the eurozone and going back to their original currencies whilst the USA would need another civil war in order to do the same.

    Moreover, when the SHTF the USA will discover that all those decades of murdering and invading and torturing and bombing other people has not gone unnoticed. Don’t expect ‘help’ to line-up amongst the International Community, America will find it has very few friends left.

    As for gold, I bought into that 2008 dip you referenced …and have since *doubled* my investment.

  • GMB in Oz

    The USA has few friends, mostly serfs that hate your killing folks, and they’ll be leaving in droves when you lose all you have through DEBT.

    Seems Arthur is the only one with sense here.

  • hshumate

    If the Europeans can do it with the Euro, why can’t a group of the larger countries do the same thing with the basket approach? You don’t have to have a currency replace the dollar, all you need is a few countries to stop accepting the dollar as payment. Isn’t China already thinking about that? Other than moving your money to a different country, what other methods does the average person have to protect assets?

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