In A Post-Dollar World

The Daily Reckoning PRESENTS: If today is any indication, the U.S. dollar is just going to keep traveling slowly down the road to ruin…and that’s good news for gold. Justice Litle asserts that the world may be on its way from the dollar standard – to the gold standard. Read on…


On our way to a post-collapse, post-dollar world, Asia will likely transition from a de jure dollar standard to a de facto gold standard. This will happen in stages as the dollar crumbles; Asian countries and consumers will accumulate gold reserves surreptitiously at first, and may eventually formalize the transition through some sort of pan-Asian IMF-type arrangement.

Asia has the “second mover advantage” of being privy to all the Western World’s mistakes. They are able to see where profligacy and runaway entitlement programs have led. Their top-down orientation will enable them to rein in expensive entitlement programs or, better yet, curtail young ones before they grow bigger. Not being as mentally and emotionally tied to the workings of empire and the capitalist welfare mentality, Asia will successfully cut the cord faster.

In doing so, Asia will also rely on its citizens’ natural propensity to trust precious metals and hoard them as a store of value in the first place. Last but not least, Asia’s relative lack of capital market structure – its underdeveloped backbone of lending networks – will make a de facto gold standard that much more attractive. By going straight to gold, Asians get the “trust” that is already built into the metal… they can skip all the financial engineering, or get to working it in later.

While Keynesians see the rise of gold as temporary – and will continue to assert their naysayer views as gold rises further – it will soon come to light that the “world reserve currency” idea was the temporary thing, an anachronism of the industrial age. The world reserve currency concept is tied to the notion of a single all-powerful superpower. That is a 20th-century idea that is going away. It is also tied to the idea of a single economic powerhouse striding atop the rest of the world. That idea is going away too. Even if China becomes the new manufacturing Boss Hoss of the 21st century, it will not wield the same economic heft as America did in the 20th or Britain did in the 19th.

There are too many competitors for that now. To the degree that China’s power comes as a cheap manufacturing destination, it will always be one price cut away from noncompetitiveness with India or the rest of the Asian nations, and eventually the Middle East, South America, Africa, etc…. economy of scale is simply no longer the powerhouse edge that it used to be. The agglomeration of industrial and political power seen in the 20th century will likely vanish into the pages of history. The concept of “world reserve currency” may well vanish with it.

Gold is also a contender because the alternatives for replacing the dollar look so weak. The euro has its own set of long-term problems, in some ways more severe than those of the dollar. Over the next decade or two, Europe will be dealing with a declining population, a lack of defensive capability, social unrest due to immigration and cultural segregation and the fiscal cement shoes of an out-of-control welfare state. Nor is the yen ready for prime time, with Japan’s economic behavior erratic and the Bank of Japan viewed as incompetent. China’s yuan is not yet supported by a fully functional financial infrastructure and has too long been pegged to the dollar to suddenly go it alone.

Gold, on the other hand, steps up with a number of advantages. It is already regarded as a hard asset safe haven and a key barometer of financial anxiety. Its value is easily understood and appreciated by the masses. It can function without the need for a complex financial system to guide and regulate transactions.

Asia could well be the vanguard for a new gold standard because of internal dynamics. China is exemplary in this regard in that Chinese citizens regularly save as much as 40% of their personal income. This is in large part due to the lack of a safety net in China. There is no Social Security, no guaranteed medical care, no pension benefits and so on. Many of China’s less-connected citizens seem as likely to bury their wealth in a shoebox as put it in a bank. This mindset strongly favors a physical, storable asset, like gold.

Einstein once said, “Everything should be made as simple as possible, but not simpler.” That could well be a capitalist adage, with “small” substituting for “simple.” The less bureaucracy, the better; the more flexibility, the better. Both are attributes of being lean and small, not fat and huge.

As Peter Drucker observed shortly before his death, the savviest way for future companies to go is probably to outsource all functions that do not lead to a position in senior management. The big players of the current age are getting small as fast as they can. Even traditional behemoths like the oil majors are becoming less like behemoths and more like raw capital allocators. When BP announces plans to invest $8 billion in alternative energy, it is acting more like a hedge fund trading on its industry knowledge than a lumbering giant exploiting its size. Similarly, Wal-Mart is essentially an information network, utilizing its knowledge and its clout to bring tens of thousands of suppliers together in a profitable collaboration.

The edge is in getting smaller and leaner, outsourcing nonessential tasks and jettisoning excess baggage entirely. This will apply to governments as much as companies in the long run; rather than enjoying captive capital, governments will have to go out and win it. In the new post-collapse environment, the number of competitive jurisdictions will thus multiply as large governments lose their capital accumulation edge to smaller ones. Successful governments in this hyper-competitive environment will be customer service providers rather than shakedown operations; they will have to provide more value for money as capital flows become all the more mobile and hard to pin down. This shift will naturally favor sound money.

Sound money naysayers argue that a gold standard cannot work in today’s modern global economy. They declare the gold straitjacket too fiscally restrictive. They warn that there is not enough gold in the world to properly grease the wheels of commerce. But the naysayers wrongly assume that a gold-based system cannot contain leverage.

Leverage is like nitroglycerin – dangerous in the hands of idiots, but highly useful to the skilled. The whole reason fiat currencies came about is because 20th-century governments realized the power of leverage as applied to existing assets. Giving politicians free rein to leverage the moon via fiat currency was stupid, but the baby need not be thrown out with the bathwater. Leverage can be a good thing if applied in the correct fashion; when an entrepreneur borrows a small sum and turns it into a much larger sum by using it wisely, he has made beneficial use of leverage, and added value to society at the same time.

The use of leverage itself is not a bad thing except when abused. An example of a model system for preventing abuse of leverage is the modern-day futures industry. Through rigorous self-regulation and mandatory self-insurance against financial accidents, the futures industry has shown how leverage can be applied sensibly, with a focus on two key elements: transparency and mutual responsibility.

Governments cannot be trusted to apply leverage responsibly, but private entities could – under the watchful eye of investors and deposit holders, who would have a personal interest in maintaining vigilance and bear direct financial responsibility for any failure. Remove the moral hazard of a federally subsidized blank check to cover losses and you immediately reintroduce private-party vigilance.

The same logic applies to banks and bank panics. Historic bank panics of the past were largely fueled by two things: 1) a lack of fiscal transparency, making it hard for investors and depositors to be aware of unsafe habits and practices, and 2) the moral hazard of guaranteed government bailout, allowing banks to go wild knowing Uncle Sam would step in if things went bad.

A sound money system policed by private creditors – without the moral hazard of government influence – could make use of leverage responsibly and well, without undue political pressures. A transparent rate of exchange could be maintained at all times, giving depositors assurance that their electronic balance could always be exchanged for physical metal. Total leverage levels of the institution could be posted and observed by all, allowing the market to police itself in real time. And the institution could voluntarily maintain membership in a mutual-responsibility insurance system, similar to the futures industry clearing system that provides a pool of assets for emergency situations. These types of advances could only be implemented through a combination of investor savvy and advanced technology, both of which are developing here and now.


Justice Litle
for The Daily Reckoning
May 9, 2006

Editor’s Note: Justice Litle is an editor of Outstanding Investments, ranked number one by Hulbert’s Financial Digest for total return performance over the past five years. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall).

“More Americans join pool of ‘near poor’,” runs a headline in today’s International Herald Tribune.

Over the weekend, Warren Buffet provided the evidence. He said that when he looked through the financial statements of lending companies he noticed that the entry for “interest accrued but not paid” was rising. What this means, he explained, was that people were having a hard time servicing their debt. And worse yet, the real estate casino on which they were depending, is cooling off. Toll Bros., one of the nation’s largest homebuilders, says new orders fell 33% so far in the second quarter.

And so, we return to a familiar theme, but one not quite exhausted: savings are available to serve you; debt is always your master.

“The debtor is slave to the lender,” says the Bible.

Dear readers may wonder whom we are arguing with…or what question we are answering. It is an obvious one; you may want to neither borrower nor lender be, but if you have to make a choice, it is better to be owed than to owe.

That is the big difference between a trade deficit and a trade surplus. In the former, you gradually become a slave to your trading partners. The larger the deficits, the more you tend to owe them. In the latter, they gradually become slaves to you. That is what is happening with the Chinese and Japanese. They have now become our creditors; they can enjoy income from their U.S. paper while we struggle to keep up with the debt.

But who will turn out to be the greater fool, the one who buys what he can’t afford, or the one who lends what won’t be repaid?

Americans, consciously or unconsciously, are betting on inflation. They are hoping their favorite swindlers at the central bank will continue to engineer a gradual devaluation of the dollar so as to ruin their creditors rather than themselves. The dollar lost half its value during the Greenspan years alone. And now, the Bush administration is adding more debt than all the other administrations in U.S. history combined. Inflation looks like a sure bet…a “done deal.”

Commodities are rising. Health care, education, housing, energy – everything measured in dollars that the Asians can’t produce and Wal-Mart can’t put on its shelves, is soaring. Gold is rocketing. Gold is outperforming stocks, commodities, bonds, the euro, housing – everything.

How nice it would be if the empire’s creditors would go gently into that good night! They must read the papers. They must see the dollar going down and gold going up. Imagine yourself in the same situation; wouldn’t you be tempted to shuck some of that green paper in favor of the yellow metal? Wouldn’t you want to protect yourself?

But, according to lumpen-American economic theory, the creditors just stand there, stock-still, while the big inflation bus runs over them. Not only do they not sell their U.S. bonds and dump their U.S. dollars, they continue adding to their inventory, like collectors of Cabbage Patch dolls long after the fad has moved on.

God bless ’em. But we doubt the lenders are quite as dumb as the borrowers believe. In fact, there could come a time – any minute, in fact – when the lenders wise up. The dollar could end its gentle decline…and drop like a stone. Then, the lending would cease, too. The U.S. economy would come to a halt, and all those people who are finding it difficult to keep up with their interest payments would suddenly find it impossible. The defaults and bankruptcies would multiply. American debt may be wiped out by inflation, but Americans will probably be wiped out first.

Over to our currency counselor…

Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis:

“From my view in the cheap seats, the move higher by the euro and other currencies had moved too fast, for comfort. Let’s see the euro hover around the 1.27 level a few days, forming a new base.”

For the rest of this story, and for more insights into today’s currency markets, see The Daily Pfennig


More notes from Bill Bonner…

*** Up, up, and away…gold jumps over $700, a price not seen in 25 years.

Iran’s refusal to back down from their nuclear program, inflation worries, and a weaker dollar have all influenced this rise in price, as investors often turn to the yellow metal in times of uncertainty.

Our friends in the Far East are helping boost gold’s price as well, as it has been reported that economists urged China to quadruple its gold reserves to 2,500 tonnes from the current 600 tonnes because its foreign exchange reserves had become the world’s largest.

Reuters reports: “James Moore, analyst with TheBullionDesk, said that a break above $700 in bullion was likely to generate fresh momentum as investors and speculators build on their bullish positions.

“‘While the charts suggest the metal is overbought, the scale of buying flowing into the market seems set to drive prices ever higher with the metal’s $850 all-time high now a realistic target.'”

*** We are in a late stage of empire…when pandering to the masses has degraded many of our most important institutions. Congress faces the biggest challenges of our time – war and bankruptcy – like a jackass staring at a computer screen. The dumb beast knows something is going on, but he is incapable of figuring it out. Do voters “throw the bums out?” Not at all. They re-elect them more often than ever before.

And over in the private sector, corporate managers live it up at shareholders’ expense, and no one seems to notice. Lee Raymond, former chairman of Exxon Mobil, was paid $686 million over 12 years – an amount equal to $144,573 per day. What did he do that was so valuable it couldn’t have been done by some other clock-puncher at 1/100th of the price? No one knows.

Or take William McGuire, former CEO of UnitedHealth Group. The man took shareholders for $1.6 billion during his stay in the executive office.

At this stage of decay, the masses cannot tell a decent politician from an ordinary one; nor control the pay of their own hired hands.

*** Et tu, Stephen?

We think the end is nigh, because Stephen Roach, who can usually be depended upon for a view of the world economy as gloomy as our own, has suddenly brightened up. What happened to him? Some kind of brain event? Something new in the water? We don’t know, but now that the last bear has capitulated, the collapse can begin.

“World on the Mend,” is the title of his recent essay. In it, he explains why the world is not going to hell in a handcart after all. “I am feeling better about the prognosis for the world economy for the first time in ages,” he writes. “No, I am not prepared to give an unbalanced world the green light. But it’s time to give credit where credit is due: First, to globalization for holding down inflation. Second, to central banks for collectively embarking on policy normalization campaigns.”

Roach sums up by saying, “I am delighted that the global economy finally seems to be taking its medicine. Let’s hope the cure works.”

What is this medicine the world is taking? What is this miracle elixir that cures debt and deficits? What panacea has been developed in the secret laboratories underneath the Fed’s headquarters in Washington? How does it heal the sick trade imbalances and wipe away the ugly debt that blemishes the poor in America’s suburban ghettos?

Roach does not exactly say. We presume he refers to rate increases in the United States and the lack of rate increases in Europe. Now, he claims, “the world is going to collectively alter its game plan and respond…to the problems.”

Oh, of course. That explains it.

Apparently, Mr. Roach has much more faith in public officials and public policy than we do.

We always turn back to the fundamentals…back to the essentials…back to basics. When a debt is run up, it must be paid off – by someone, somehow, sometime.

Sinning is more fun than repenting. A boom is more fun than a bust. Paying off a debt is likely to be less pleasant than contracting it.

Against those verities we have Mr. Roach’s newly found faith that the managers, manipulators, kibbitzers and regulatory parasites. The world’s central banks have found a way to coordinate their policies so as to “rebalance” the planet’s financial system and sustain its balmy growth indefinitely. Even if the Morgan Stanley economist had come to believe it, our guess is that he’ll regret having said anything.

[Correction: We made a slight error in yesterday’s issue. The correct price for fuel in England is 99.9 pence or .999 pounds per litre. Forgive us, dear reader.]

The Daily Reckoning