The Untrustworthy U.S. Currency

The risk of recession is increasing, according to a Bloomberg report. Both business and personal spending are being curtailed by tightness in the credit channel. At the top end, some half a trillion dollars worth of deals are said to be stuck…unable to get financing. At the bottom, ordinary homeowners are facing up to ‘life without refinancing’. It’s not exactly that they are being forced to live within their means; instead, they are just discovering what their means are.

GDP in the United States is growing at a reasonable pace, but the growth is not showing up in paychecks. Our old friend, Scott Burns, reports that wages grew less than inflation during eight of the nine years between ’88 and ’96. Then, in the most recent 10 years, wages beat inflation in almost two of every three years. But the gain was so slight – just $10.61 per week for the whole period – that is was probably erased by rising health care premia. Incomes have been stagnant for at least a generation, says Scott.

Recession is inevitable. And with recession will come a lower dollar, say George and Helen Pardee, writing in the Financial Times.

"Now is the time to sell the dollar," they say.

"One of the surest bets over the last 35 years was betting against the U.S. dollar," wrote our old friend Gary Scott recently. Gary reminded us that he practically invented the carry trade; more than three decades ago, he began borrowing in one currency and putting the money on deposit in another, pocketing the difference. He called it the ‘multi-currency sandwich.’ He continues to do it today…using fairly low risk, long-term placements and working with a Danish bank. The way Gary does it, the ‘carry trade’ looks less like wild speculation and more like prudent money management.

Why would the dollar be an especially weak currency? "Because its issuer is especially strong," is our answer. The dominant imperial power always has a financial advantage. In the modern world, it provides the reserve currency that is used for international trade and global banking. Oil is still (mostly) priced in dollars. So are gold and other key commodities. People use dollars like they use English, to get around in the world. Other nations have to support their own currencies. But the dollar gets much of its support from abroad. Foreigners use it to make billion-dollar multi-national LBOs…and to buy illegal drugs on the street corner.

Americans are also the biggest shoppers in the world…which gives every exporting economy on the planet an incentive to hold the dollar up against its own currency, lest a rival steal a march on it. There is a bias in favor of the dollar, in other words, that goes beyond its actual financial strength.

Our general rule here at The Daily Reckoning is that a man will always seek to hustle something for nothing – as long as he can get away with it. Having the world’s reserve currency permits the United States to get away with the grandest larceny in history. It has spread its paper all over the globe, and as the dollar goes down in value, the foreigners lose money. Too bad for them; they should have known better.

Charles de Gaulle, aided by his sharp economics advisor Jacques Reuff, did know better. Back in the ’60s he noted the ‘exorbitant privilege’ that the dollar enjoyed. He instructed his treasury officials to lug their dollars to Washington and ask for them to be redeemed in gold. This action by the French led to what looked to the Nixon Administration like a run on U.S. gold. On August 15th, 1971, the Nixon government effectively reneged on nearly two centuries of good faith and promises, refusing to honor its paper. Henceforth, it told the world – you’re on your own; your dollars are worth only what you can get for them on the international market.

For a while, it looked as though Americans wouldn’t be able to get away with much more inflation. The world was on to the scam. The dollar was falling sharply. But then Paul Volcker came along and restored faith in the greenback. Soon the coast was clear again.

Still, the dollar slips and slides. You could buy a euro, soon after it first came out, for just 88 cents. Now, it will cost you $1.36. A gallon of gas…a bushel of wheat…a year at Yale…everything is rising against the dollar.

Are you Thinking Long Term?

One of the best long-term bets you can make is to bet against the dollar…and holding gold is the safest (and most profitable) way to do it.

The dollar is perhaps the greatest source of ‘easy money’ the world has ever seen. The U.S. Treasury can create almost as much of this ‘money’ as it wants – at negligible cost. Ben Bernanke said so!

The feds no longer give out the news, but private analysts continue to track M3 – the broadest measure of U.S. money supply. According to the latest figures, M3 is increasing at about 13% per year – or about four times as fast as GDP.

Nothing destroys an economy more thoroughly than easy money. It multiplies the mistakes people make and magnifies the damage. Yesterday’s paper tells us that Venezuela is beginning to suffer the effects of easy money. In Venezuela’s case, the money came from the oil boom. Venezuela is an oil exporter. As the money came in, it permitted President Hugo Chavez (who claims to be an admirer of Trotsky and Guevara) to indulge his fantasies. Now, consumer prices are rising at 16% per year, with certain staples becoming hard to find at any price. The bolivar is falling at nearly 30% per year…and on the black market a U.S. dollar fetches 4,750 bolivars.

Put a Stock In It…

"Warren Buffett, investor extraordinaire, offers two ways for you to protect your purchasing power against a weakening dollar," our friend Chris Mayer tells us. "The first is your own earnings power. The second is ownership in a wonderful business, which an individual investor can get by holding onto great stocks. A stock is, after all, a share of ownership in a business."

Stock prices, generally, are about where they were eight years ago. For all his risk and trouble, the average stock market investor has almost certainly lost money – after commissions and inflation – over that period. Still, corporate earnings have gone up – for the various reasons we have discussed in these reckonings.

Without once again examining the unreliable and perverse nature of these increased earnings, we merely note that higher margins may be a good reason to pay more for a single company, but not for an entire market. In a single company, higher margins may reflect efficiency, good management, or a near-monopoly franchise.

"While I have nothing against owning gold or silver – in fact, I think it’s good to own some – it’s also helpful to think about solving the problem of dollar erosion more creatively," continues Chris. "In the stock market, you can own many great companies with valuable tangible assets that will probably be worth much more in the future than today."

P.S. This is the worst possible time to lose faith in your faith-based currency. With gas and food prices rising like there’s no tomorrow, today is the day to start making your money go further. Imagine seeing your cash flow right into your gas-guzzling SUV…imagine eating 50 cents with each bite from your morning bowl of corn flakes…now imagine getting rich for less than you would spend on either one of those things. Greg Guenthner can tell you how. To read more click here .

Bill Bonner