Three Strikes Against the Dollar
The Daily Reckoning PRESENTS: The markets are winding down for the year-end holidays, and as a consequence, little consideration or attention is being paid to three events, each of which adds another nail to the dollar’s coffin. James Turk explores…
THREE STRIKES AGAINST THE DOLLAR
Though it has been given scant coverage in the United States, Iran’s decision to drop the dollar in favor of the euro has been receiving widespread attention in Europe. As reported by Agence France-Presse on Monday, Iranian government spokesman Gholam Hossein Elham told news reporters: “The [Iranian] government has ordered the central bank to replace the dollar with the euro…in commercial transactions,” repeating exactly what Saddam Hussein did in September 2000. Lest there be any misunderstanding, Elham went on to say: “Foreign income sources and oil revenues will be calculated in euros, and we will receive them in euros in order to put an end to our dependence on the dollar.”
This change will lessen the demand for dollars, which will cause the value of the dollar to drop. Strike one.
The second strike is the U.S. ban on melting and export of coin
The U.S. Mint implemented a new regulation that bans the melting down and exporting of pennies and nickels. It is sound economics to harvest the metallic value of these coins, because the value of their base metal content is greater than the coin’s face value. Here’s what Lee Rogers, editor of the Funny Money Report, says about it. His analysis is spot-on:
“They [i.e., US Mint officials] claim that they are imposing these rules because they don’t want certain individuals who melt down coins taking advantage of the American tax payer. It isn’t the people who are melting down the pennies and nickels that are taking advantage of the American taxpayer. Those people are just trying to protect themselves from the stupidity of the Federal Reserve that continues to destroy our currency. The Federal Reserve is the very reason why the melt value of these coins has risen beyond their face value. Federal Reserve Notes have lost over half of its value in terms of gold and silver since 2000 because they have dramatically increased the money supply over this period of time. The Federal Reserve has taken advantage of the American taxpayer, not the people who are melting down these coins. It is complete rubbish that the U.S. Mint would make scapegoats out of individuals who melt their coins to be the ones who are screwing over American taxpayers. The press release should be blaming Alan Greenspan for taking advantage of American taxpayers because he was responsible for creating the excessive amount of credit that has since decreased the value of the currency.
What is going on with pennies and nickels is an exact repeat of what took place in the late 1960’s. Back then the U.S. Mint made melting silver coins illegal. At that point in time the melt value of silver coins became worth more than their face value. As a result, these coins began to disappear from circulation because people realized what was happening and kept them. Why would people use a coin to pay for something if the face value of it is worth less than the melt value? That’s why the coins stopped circulating. I believe that the same exact thing is going to happen to the currently circulating forms of pennies and nickels.”
There are many lessons that we can garner from monetary history, but one of them is unmistakable. When debasement becomes so extreme that even the base metal content of circulating coins is greater than the coin’s face value, that country’s currency is headed for the currency graveyard and will soon be buried there. Strike two.
3) Increasing government control
There is a corollary to the lesson from monetary history explained above. When a government interferes with commerce by imposing restrictions, commerce suffers. These restrictions impede economic activity, and that is a bad outcome because it is economic activity that is the backbone of society as each of us strives to meet our needs and wants.
There is perhaps no better account of this principle than the one penned in 1912 by Andrew Dickson White in his classic book, Fiat Money Inflation in France, which describes the horrific monetary debasement the French people suffered prior to Napoleon. He explains the adverse consequences that are caused by government controls and how successive controls by the French government inflicted increasing damage to that country’s economy.
We have this week seen the principles expounded by White at work. The Thai government announced the implementation of foreign exchange controls, and one immediate response was the stock market there dropped 15%. Untold and unknown at this early stage is how severe the repercussions will be on that country’s capital flows, both domestically and in its relations with the rest of the world.
Lest you think the actions taken by the Thai government are an isolated event that could not happen in Europe or the United States, I suggest you read the following article published 3 weeks ago in the online version of London’s Daily Telegraph.
While acknowledging that “currency controls” would be the “nuclear option”, the article says that “Brussels may lawfully freeze capital flows in and out of the EU, and within it, and that this could be done by a “qualified majority” of EU finance ministers.” It goes on to say that this authority is already in place in Europe and was granted “to enable Europe to stem the rise of the euro if the dollar goes into free fall, the underlying argument being that Washington should not be allowed [to] export the consequences of its own reckless spending policies through a “beggar-thy-neighbor” devaluation. The idea was to stop money coming in, though it could equally be used to stop money leaving.” The really interesting question is why would the EU want to stop money from leaving?
Simple. If capital controls are imposed, they would come with compliance from other countries, particularly the United States and Japan, which would impose controls complementary to those implemented in Europe. In other words, though the above quote implies that the EU would pursue its own interests, the reality is that these countries’ central banks are joined at the hip. Therefore, it is likely that the United States and the EU (with Japan as well) would pursue a common agenda. Namely, they would drop the value of their fiat currencies more or less in concert so that they all end up losing purchasing power against gold and other tangible assets, but more importantly, these currencies would drop in unison against the Chinese yuan. In this way the yuan’s exchange rate would rise, in theory bringing down its trade surplus and also reducing the investment money flowing into China. It seems probable that the EU may justify taking this dire step toward capital controls on the spurious grounds that they need to prevent their monetary union from unraveling. So strike 3 is against the U.S. dollar, the euro and Japanese yen.
In summary, the outlook for the U.S. dollar is worsening, which is a conclusion that can also be reached by looking at what happened during last week’s trip to China by Treasury secretary Paulson and Fed chairman Bernanke. They came home empty handed, without any concessions from the Chinese or commitments by them to help the United States by continuing to hold dollars, which the United States is recklessly spewing throughout the world as a consequence of its ongoing trade deficits.
for The Daily Reckoning
December 21, 2006
Editor’s Note: James Turk has specialized in international banking, finance and investments since graduating in 1969 from George Washington University with a B.A. degree in International Economics.
He is the author of two books and several monographs and articles on money and banking. He is the co-author of “The Coming Collapse of the Dollar” (Doubleday, December 2004).
In addition, James Turk is the Founder and Chairman of GoldMoney.com.
Since 2001, thousands of individuals and companies have used GoldMoney(r) to buy gold to protect their wealth from today’s financial uncertainties.
Many of them have also found GoldMoney’s patented process of digital gold currency payments to be an ideal payment solution for online commerce.
Today, we lead with a question from a dear reader:
“I am a happily married man…I love my wife; she’s beautiful, smart and she loves me. But here’s the problem – she is an actress. I’ve always heard that actresses make bad wives, so I’m thinking about divorcing her. Am I being an idiot?”
Answer: Yes, you are an idiot. We don’t see what your wife sees in you. You’ll be lucky if she doesn’t leave YOU.
OK…the actual question is a bit harder…but not much. Our reader is wondering whether he should stick with a good investment, or speculate on the housing market.
“I know you do not give advice but I was just curious what you think about my financial position and/or what you would do in it.
“I own a 14-unit apartment building in Huntington Beach, California. I bought it a couple of years ago. There has been about $1 million in appreciation. My wife wants to sell, but I bought it before we were married and had our first child. I always considered it as my retirement after paying for 30 years.
“The problem with selling would be:
1- capital gains taxes,
2- what to do with the money, and
3- the fact that we live in the front owners’ home of the same property.
“We would have to move and my wife would want to buy a big, expensive house.
“I feel stuck because my property taxes are relatively low as I purchased the building from my father and I was able to benefit from a California tax law that basically lets me keep his tax rate.
“I have a feeling that the bottom is going to fall out of our real estate market. Would you rather be the owner of an apartment building that has historically always been at 100%, cash out the building and buy a home, or sell and just rent?
“I don’t think my wife would want to rent for long, however. We are looking to find a home for long term so we can grow our family.
“Sorry for the rambling, but what is your position?”
We are glad you asked…because it gives us a chance to make a point.
In both the cases, the man is caught between a rock and a soft place…between the private world he can understand and master, and the vast public spectacle, with its frauds, conceits, and wild guesses. In both cases, what he knows from his own personal experience is at odds with what he thinks he knows from reading the paper.
The husband in our first example believes actresses make bad wives. Perhaps he is right, in general. Statistically, it could be true. But statistics do not make a man happy or rich. Instead, it is his individual circumstances that count. Actresses may be a vain and fickle lot; but he seems to have found a good one. The fact that other actresses may be more trouble than they are worth should be irrelevant to him.
Our dear reader, meanwhile, believes property prices will fall. Though we’ve said so many times ourselves, we claim no credit for giving him that idea. We’re hardly the only ones to think so. But at least we don’t take the idea seriously enough to ditch a good situation just to take advantage of it.
If we were thinking more clearly this morning, we’d have more to say about this. For now, we will let it go with the following advice: statistically, the average man may die at 73; but if we were you, we wouldn’t drop dead until we were good and ready.
Dan Denning, reporting from Melbourne, Australia…
“…The U.S. dollar is our proverbial door-frame. We occasionally bash our neural knuckles against the buck, trying to punch through the splintered remains of its abstract existence…”
And more thoughts…
*** The hottest new thing in capitalism is the rise of “private equity.” Groups of rich investors pool their money, borrow still more money, and buy companies. Ten years ago, these groups gathered together only about $10 billion; today, the figure is higher than $300 billion.
Michael Lewis comments:
“Even those gargantuan numbers fail to do justice to this peculiar financial event. Private equity is not served up without piles of debt – the typical debt-to-equity ratio of a company after it has been bought by a private-equity firm is two-to-one – and so the actual purchasing power in the hands of private equity fund managers is something like three times as much as they have in their bank accounts. It’s as if a giant and especially successful new stock market has been created alongside the old one.”
Our Australia-based correspondent, Dan Denning, adds this:
“The tech bubble may turn out to be a dress rehearsal for an even bigger bubble and threat now. Why do I say that?
“Here’s the difference between today and 2000. Seven trillion dollars was wiped out when the tech bubble burst, proving that it was largely fictitious wealth. The real economy didn’t really miss a beat…because the money people lost was not money people really had.
“It was paper gains, never realized, and ultimately lost…So all in all, for the most part, it was easy come, easy go.
“Today is much different. People have more at stake (the roof over their head), and less margin for error (fewer real assets on the balance sheet, more liabilities) and there is a connection between private equity/money shuffling capitalism and the housing markets…the connection is debt. And the debt is what makes this bubble different and worse than the last bubble.
“All that is at the household level. If the private equity boom continues (as I believe it will), it will also leave a mountain of debt rubble after the bubble bursts at the corporate level. It’s odd, of course, that something as ephemeral as a bubble can leave real debt. Yet because the private equity guys are paying 40 cents for a $1.20 worth of future earnings (making up the difference with borrowed money), the newly-private companies are saddled up with debt they wouldn’t have otherwise taken on before. This is, as the article notes, not real investment in new productive assets. It’s debt that merely facilitates the transfer of ownership of the company’s assets.
“And if all these smart, well-paid, even better-tailored, and perfectly coiffed money shufflers get it wrong – synergies not realized, profits not optimized, value not extracted – then you get a company performing worse than before, with considerable liabilities, and no recourse to additional sources of capital.
“This is probably when the private equity guys will try to re-float the company on the gullible public (if they are not fired or jailed first). But who is going to buy a freshly disorganized, debt-ridden company as a new public offering? It’s like expecting to see a brad new baby boy come out of the womb…and seeing Frankenstein instead…a not-quite stillborn abomination of corporate parts, crudely reassembled (after) being disassembled, and presented as a new life.
“Some schmuck or lump will ante up. There’s always an idiot. But there is something different about this bubble that’s sinister and dangerous. And it does remind me that Mary Shelley was making a good point with Frankenstein…science in its hubris sometimes forgets that there’s a lot it doesn’t know. It messes with the laws of nature and the results are invariably bad. Financial innovation may have reached that point too…where we’ve disfigured the institutions of capitalism so badly that we are bound to get a monster in short order.
“We’ve gotten used to thinking financial crises can happen and be ameliorated with more liquidity. Peso Crisis, Russian default, Amaranth…none of them brought down the house. We have become desensitized…or blasé about real risk. For most of us, the riskiest thing we do in any given week is cross the street or drive a car. We’re not going to starve, or be killed by a neighboring tribe (unless you are in Iraq), or fall victim to cholera.
“Of course we are not immune to the effects of a genuine financial pandemic. And this latest strain of affluenza saddles up private and public balance sheets with huge liabilities to go along with declining asset values.
“It’s the kind of trade only a very stupid or very immoral man could make. Unfortunately, there are a lot of both in the world right now. And most of them are living in the best apartments in Mayfair, Manhattan, and Manley Beach…for now.
“It wasn’t really until today that I ever thought I’d actually live through something as audacious and destructive as John Law’s Banque Royale and the Mississippi or South Sea Bubbles. But I think we’re watching it happen right before our eyes.
*** Jet lag, late nights, and hard traveling are catching up with us. Normally, we are agreeable and easy going, but when we are moving fast, there are bound to be disagreements and problems. On Wednesday we rose at 5AM and rushed to the airport only to discover that Argentina’s domestic airlines are not quite as on-the-ball as those of the rest of the world. Our plane to Salta was delayed seven hours. Coming back, the plane was five hours late.
Still, the biggest hassle we had was actually at Baltimore-Washington International Airport on our way out of town:
“Don’t you know our policy regarding liquids and gels,” asked the oaf in the uniform after he discovered a tiny tube of toothpaste in our bag. “It’s posted in front of you.”
“Well, I thought these small samples were permitted.”
“Sir…that’s an exception to our general policy, but it only applies if they are in a clear, zip lock bag. We are just doing what we have to do to protect our country from terrorists…”
“Do I look like a terrorist? I’m not going to blow up the plane. Sure I’ve thought about it; who hasn’t? But I’m going to do it. You don’t have to worry about me…”
“Sir, it’s for your own protection…”
“Well, do you get a lot of people blowing up planes with sample-size tubes of Colgate… or maybe they strangle the pilot with dental floss?”
“Sir, we are protecting you from others…”
“Then go take other peoples’ toothpaste; I want to brush my teeth…”
“Sir, are you getting hostile? I’m sorry, but I have to confiscate these things. They are suspect.”
“I thought you said that small amounts were permitted.”
“Only in zip-lock plastic bags.”
“Why do they have to be in zip-lock plastic bags?’
“So we can inspect them.”
“Well, now you’ve inspected my toothpaste. You’ve got it right out in front of you. You know what it is and where it is. And you know it’s not going to bring down a 747.”
“Sir, it’s the policy…”