More Dollar Doom

IF THE DOLLAR WERE AN ANIMAL, IT MIGHT BE A LAMB…a fluffy, adorable little lamb…surrounded by a pack of wolves. The dollar is simply no match for the vicious influences that threaten to devour it — influences like a Federal Reserve that promises to combat every financial crisis with ample doses of additional credit.

Over the past year, I have spoken with numerous business and financial reporters in the U.S. and Canada. These reporters range from employees of small-town newspapers to my much larger hometown chronicle, the Pittsburgh Post-Gazette. I have spoken with representatives of industry trade publications like Oil & Gas Journal, as well as reporters from the Vancouver Sun, Canada’s The Globe & Mail, the Los Angeles Times, the Associated Press and the Dow Jones Newswires. In addition to the print media, I have also been interviewed on many different radio programs.

Part of a recent interview with an Orlando, Florida radio station focused on the immense losses announced by Merrill Lynch and Citigroup, and the departures of the top managers of both firms. Merrill wrote down over $8 billion of bad financial paper, leading to a quarterly loss of nearly $3 billion. And Citigroup has massive losses that may be in the vicinity of $13 billion or more. These are mind-boggling numbers, yet my view is that we are just seeing the tip of a few icebergs.

It seems that over the past few years, much of the financial industry loaded up on bad debt instruments. I will not even dignify this rotten paper by calling it some sort of “investment,” because there was and is essentially nothing to back it up. There are entire portfolios filled with subprime loans, initiated via “no documentation” loans against over-appraised buildings on the far side of the railroad tracks. In other words, these are worthless loans that will never see a dime of repayment. In many cases, these loans are evidence of economic crimes.

When the banks and investment houses acquired these bad books of business, the risk models that they used were pure guesswork. In the real world, engineering has made complicated structures like bridges and skyscrapers safer over time. But the so-called modern “financial engineering” has done nothing of the sort in the economic world. It all goes to show that just because the human mind can come up with an idea, it does not mean that people should act on it, let alone back it with their funds.

At this point, it is all but impossible to value much of what the financial houses have on their books. So the write-downs are just beginning. I believe that there are greater losses lurking in the shadows for both Merrill and Citigroup, and for many other banks and investment houses around the world. Several well-known banks in Germany, for example, are on the brink of disastrous write-downs. It is just a matter of time before these losses become public.

While on the air in Orlando, the interviewer and I cracked a few jokes about how Merrill Lynch’s Stan O’Neal is receiving a $160 million severance package for departing in the wake of his troubled tenure. This huge sum is surely far more than he deserves. After all, Mr. O’Neal took some big paydays over the past few years when things looked good at Merrill and he was firing 26,000 people to juice up the bottom line. So why does he get the big bucks again, on the way out the door, now that his ship has hit the rocks? Good question.

Then the interviewer asked what I anticipate for the U.S. economy and how the individual investor should protect himself from the coming turmoil. My reply was that I believe that the U.S. dollar is in a long state of decline. This is going to be an ongoing tragedy because so many people in the U.S. and around the world will be caught in the riptide as the value of the dollar washes away.

Do you remember when you would walk into a store and the owner might have the first dollar he ever earned in a frame, hanging on the wall behind the counter? People were proud of their money and trusted it as a long-term store of value. Not any more. Yet most people in the U.S. know only the dollar and understand only the dollar and their savings and investments are almost entirely in the dollar. So what happens when the value of the dollar just disintegrates? It is painful to think of the hardship that is coming down the road.

No one really knows how the decline of the dollar will play out. There is no modern precedent for what is about to occur as the world’s reserve currency evaporates in value.

Literally billions of people rely upon the U.S. dollar as the economic rock that holds up the foundations of the world economy. Yet that rock is turning into loose sand. How does one save, let alone invest, in a world where the value of the dollar is in irreversible decline? A declining dollar is the same as the destruction of capital.

My advice is to load up on gold and other precious metals and mining shares in companies that control real ore in the ground. While you are at it, also go for the companies that own or control real energy reserves, such as oil and gas, coal, uranium and renewable energy systems.

As if on cue, last month, the British newspaper The Independent launched a story with these words:

“A new phase in the credit crunch, one of ‘$1 trillion losses,’ seems to be dawning. The crisis at Citigroup and renewed doubts about some of the world’s leading banks disquieted stock markets on both sides of the Atlantic recently, with the fractious mood set to continue.”

So there are a trillion dollars of losses yet to be booked…and a company the size of Citigroup does not have the capital to manage itself as an ongoing entity…and the prices for gold and oil are skyrocketing as the value of the dollar declines.

My advice is to protect yourselves, dear readers. There are wolves at the door.

Until we meet again,
Byron W. King

December 11, 2007

The Daily Reckoning