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Part 2 talks about the world
post the USD centric world economy. It looks out 1 to 3 years ahead. Part 1
talked about the immediate dangers to the world from a Middle East war, food
and energy shortages, and inflation. It looked into late 08 and 09.This part
talks about what would happen should the USD begin a final decent to far
lower values.
We are now a full year into the
credit implosion that started with the collapse of two Bear Stearns hedge
funds in Summer of 07. So many dimensions of the world economy have changed
dramatically for the worse since that pivotal event…
We can outline many aspects of a
disintegrating world economy since Summer 07. But one huge dimension seems to
stand out, the dim prospects for the USD going into 09. As we know, the USD
has become the key currency to the world economy since WW2. There are several
reasons, but one was that the USD was used to stabilize the European
currencies during WW2. Following that war, the US became the center of a
burgeoning world consumer economy. What happens when the USD is no longer the
center to the world economy? That means the end of roughly a century of US
economic and currency dominance. That is our discussion.
Since the end of WW2, what was
once a boon to the world economy, the USD, is now in a catch 22. The vast
interlinked world economy based on a consumer bubble that we are all used to,
that generated unprecedented wealth, is going through a radical
transformation as the USD falters. The demise of a consumer bubble based on
credit since WW2 is faltering, and the USD is suffering from abuses in the
credit system and in the US fiscal situation. The pillar of world commerce
since WW2 is faltering. All those James Bond movies you saw celebrated the
post WW2 world that grew out of the world USD prosperity bubble (the
lifestyle u saw in those movies).
In part one of Dangers, Danger
period 2008 and 2009, we discussed some ominous dangers that emerged in 2007
and 2008, and will continue to get worse in 2009. These included the
US/Israel- Iran nuclear showdown, the threat of a world financial sell off
initiated from a collapsing world credit system, rising world inflation, and
rising food and energy prices.
This second part of this
‘Danger’ piece discusses the other main danger, that the USD is
faltering, and into 09 has a risk of a major breakdown, if not outright
collapse. We have all heard this before, but the difference with now vs the
past years is that the US is faced with unprecedented financial disasters
that could be putting the final straws on the USD camel’s back.
The implications of a serious
USD breakdown to the world economy and financial system are staggering,
particularly if you consider that this entire world financial system we are
immersed in, from East to West, grew from/with the USD economy in a 50 year
world consumer and finance bubble that has built since WW2.
Deconstructing that 50 year
economic bubble/system will cause massive economic disruption in the world. The
problems the central banks and the world economies are facing, as we speak,
to deal with the problems the USD is having now are all related to the
shaking of what I call the ‘world USD economic system’. The onset
of the world credit crisis in Summer of 07 was the beginning of this latest
phase.
Shadow banking system down
The new credit securities
markets referred to as the shadow banking system have imploded. This was the
practice of creating credit of all types and then selling it as securities to
big investors. This new USD centered way of financing worldwide housing and
other credit grew to be 50% of all new credit from 2000 roughly. The collapse
of these diverse credit securities led to a severe tightening of credit
worldwide, as lenders had to pull back drastically to raise capital they lost
in the last year. This credit collapse is affecting all the Western nations,
from the US all the way to the emerging Eastern EU economies, and will also
affect all the major Asian economies by 09 as well.
At the same time, inflation has
exploded in only one year, not only in the Western economies but in Asia, and
the commodity economies such as the Mid East to Australia. Inflation is 10%
and higher in most of the big world economic zones. That level is not
tolerable without a severe reduction in living standards for everyone.
USD at risk this time
The last time the entire world
economy had this kind of economic paralysis was in the 1930s during the Great
Depression. At that time, the USD was not on the verge of a collapse. This
time the USD is on the verge of a collapse, or at least a major devaluation. That
means that the US has far less latitude to do fiscal stimulus and bailouts to
combat the present economic emergency spreading over the world. The US can only go so far this time with economic stimulus.
Rising inflation is putting
pressure on the US trade partner economies which forces them to raise
interest rates, and that causes competition to the USD, while the US has to keep rates low to fend off a total financial and economic meltdown. This is
boxing in not only the US economy, but our trade partner’s economies
and central banks as well. It is very clear that the gigantic financial
losses in the US since Summer 07 have spread all over the world as they have
become sort of tied at the hip with the US economy, the USD being the
world’s main trade currency for the last 50 years.
There are a lot of aspects to
presently emerging world stagflation. But, compared to previous Western
recessions, there is now a combined Western Bank crisis and, this time, the
prospect of a very shaky USD.
In the last great world
depression in the 1930s, the big difference from today was that the USD was
strong, and even gold backed…and destined to become the world trade
currency of the 20th century (20th century was the 1900s). The 21st century
is the century of – what, the first global government?
That is not the case today. The
USD is not strong. That is going to be a real problem for the world going
into 2009. Thus, we have a second major difficulty the world has to overcome,
what to do about the USD, to avoid a total financial disaster into 09. The
world’s economic weakness right now is only a foretaste of what is to
come from a weak USD. A weak and possible collapsing USD means a
weak/collapsing world economy.
What this USD situation means
today is that the US, with all of Bernanke’s willingness to use
inflationary methods to combat debt deflation, is constrained by the problems
that heavy inflationary methods will create for the USD going into 2009. Because
the US economy is so central to the rest of the world, what limits the US limits the rest of the central banks and their economies. If the USD were not the world
reserve currency, most of these problems would be confined to the US economy.
The USD is probably at a limit
of stress at this moment, with interest rates at 2% and the ever present need
for our trade partners to send about $700 billion a year to us to buy US
bonds of all sorts. Bernanke will cut the ground from the USD if he tries any
further rate cuts. Our trade partners who are basically subsidizing the USD
for their own reasons will balk. Not only that, but inflation in the US in some areas in already more than 10%, such as in food and energy. Any further rate
cuts to combat the present financial disaster in the US will only allow an inflation explosion.(Yes, the USD is indeed the world reserve
currency, but now that seems funny. It wasn’t funny during and in the
50 years after WW2.)
If the US persists in trying to ‘bail out’ ‘everything’ the USD will collapse. Our
treasury officials and the Fed are well aware of this fact. The USD is at an
extremity, right now. We are at the limits of unlimited USD expansion since
WW2. The US is at a crossroads with the USD system. If the US Treasury and
Fed try to bail everything out, the 50 year world prosperity Jig since WW2 is
up. I already heard talk by Bernanke that the Fannie Freddie mess might be
nationalized.
The bailouts are not just the US. Now, every major economy is talking about massive bailouts. Their currencies will all
suffer, and this post WW2 world prosperity boom is just about done for. They
are going to bail out their banks, stock markets, bond markets, and economies
by debasing all their currencies because they don’t have the political
guts to endure a serious world recession. China too….the final result
will be horrific.
What would be the outcomes if
the USD world financial / economic system fell apart?
Supposing the USD devalued by
over 50 to 70% in a year’s time, after endless attempts to save a
collapsing world consumer credit economy, we may see:
- First of all, the savings
of the US would drop drastically in value. That means everything from
savings accounts to pensions would lose much purchasing power, and
prices of every necessity would skyrocket.
- Second, our major trade
partner’s economies would have to do massive readjustments. They
are not in a good position to do that. We can take the present rapidly
spreading economic weakness of the EU zone as an example. Asia will not escape either. They will desperately try to keep their currencies from
strengthening too much at first as the USD falls. This is why the USD
seems to have 9 lives. These attempts to debase along with the USD allow
the USD to stay higher than it would.
- World inflation will spiral
out of control, lowering standards of living. Other major currencies
such as the Euro and Yen will be heavily pressured as well. Until the
world figures out how to actually delink from an imploding US economy, they will suffer along with the US’s fate. So far, the delink theory has been
shown to be completely wrong. Why? Because the world economy is tied at
the hip to the USD (The delink theory is that other strong economies of
Asia or the EU will be able to carry the world economy even if the US economy falls apart. So far, that has been completely discredited in this latest world
economic slowdown).
- Big geopolitical turmoil as
regimes combat out of control food and fuel prices.
- A war in the Middle East over oil. The Iran / Israel situation might also be called a proxy war/struggle
over Mid East influence for China, the US, Russia, the EU, and Asia because energy is so expensive.
- A very possible period of
insurrection, riots, hortages, and chaos in large US cities. I also believe that the EU and China and India are at risk for this too.
- A 10 year world economic
depression, that China in particular cannot tolerate, as the world
economy readjusts out of necessity into a totally new form, one that is
less global and probably more warlike.
- Debt deflation where a
rapidly dropping USD effectively wipes out outstanding debts, while the
population struggles merely to exist.
- Vast bank failures in the US and major Western economies, and likely China as well.
- Efforts of world central
banks to ‘bail out’ ‘everything’ resulting in
their currencies falling drastically in value while inflation
skyrockets, until either they learn better, or have hyperinflation and
their own currency collapses after the USD falls apart. In effect they
will have to either ‘let go’ of the USD or suffer the same
fate.
- Stock markets at 10% of
where they are now in 3 or 4 years if the USD actually lets go by 50% or
more in 09 (nominal stock prices might actually stay higher but the
devaluation of the currencies would effectively cut the purchasing power
in half anyway.)
- Prices of most essentials
effectively 4 times higher, worldwide.
- Big increases in energy and
food prices causes many other sectors of world economies to fall apart,
as all ‘money’ is used merely to survive.
- Gold at $3000to $5000 plus
and oil at $300 plus putting a further huge crimp on world economic
growth. Obviously if the USD did a real collapse, say to 10% of its
purchasing power now over several years, gold is over $10,000 and in
some areas you will buy a decent house for one ounce of gold. Oil will
be traded/priced in other currencies, and probably rationed in the US at a cost of $20 or more a gallon. In this case, the present world economy that depends
on cheap transportation totally devolves. Globalization becomes
de-Globalization, and China either figures out how to migrate to its own
domestic demand or faces a huge collapse of their export economy.
- Severe world currency
restrictions and foreign exchange controls. You won’t be able to
move your money out of your country. Likely restrictions of withdrawals
to monthly limits from bank accounts as governments attempt to deal with
currency chaos.
- Rationing of necessities as
the world economy enters paralysis and governments have no choice.
- One bright spot for all,
the return of employment to local instead of outsourcing. Production and
consumption returns to local economies, as it should have been all
along. That is a long 20 year process and involves a severe deep
economic depression until the world economies/economy is rebuilt from
scratch compared to what it is now. Debt repudiation on a massive scale
as the world emerges from the ashes (hopefully not real ashes…)
- Many new governments
worldwide after revolutions during economic collapses and or wars. Democracies
falter worldwide, and more authoritarian governments appear to deal with
the chaos as the democracies enter paralysis.
In case you think these outcomes
are exaggerated, these are the things that happened after the French
Revolution, the fall of the Roman Empire, The fall of the Spanish Empire, the
Fall of Byzantium, the fall of the British Empire… etc. The fall of the
US economic system, the world USD system, and the US as a superpower
won’t be any different. Also, a lot of these outcomes happened during
and after the Great Depression of the 1930’s. That all happened
commensurate with the decline and fall of the British Empire and Pound that
dominated world economies for 200 years, and eventually led to the USD system
taking prominence after WW2 and the USD was used to stabilize the European
currencies during the war.
How we reached a USD tipping
point
After WW2, the US emerged as the dominant world economy and manufacturing power. Because the USD ended up being
used to stabilize European currencies during the war, after the war was won
the US had a lot of economic clout. Eventually, after running a bunch of
fiscal deficits with the Vietnam and Korean and cold wars, the USD started to
have pressure to let go of its gold standard. Once the gold standard was
abandoned, the recipe was created for the US to use and inflate the USD for
any and everything. The US congress happily obliged. This resulted in a world
consumer and economic bubble that leads us to our present times. This lead to
a simulative USD world economic bubble. The result is our present indebted
world economy and its imminent bankruptcy.
The rest of the world economies
will try to devalue along with the USD. At some point they will be forced to
let go, or they face the fate of the USD losing 50% to 90% of its value.
What will any saver in the world
do?
- First of all, your
currencies, retirements, bonds and annuities will be severely devalued. Your
savings will be severely downgraded in purchasing power. The world
governments clearly will not act until they are forced to, as they are
weakened. They are going to debase your money to try to delay the
inevitable economic retrenchment in a post USD centered world.
- Your primary objective
might be to save any wealth you have. You will have to try to keep
enough liquid wealth, cash, various currencies to be able to pay bills. You will have to reduce
your financial expenses.
- You will have to try to
keep wealth in paid off assets, such as non bubble real estate (yes that
still exists in most parts of the world) and also maybe in gold or other
precious metals. You will have to plan on currency restrictions if
things get bad, and limited monthly withdrawals on your accounts,
regardless of how much they have in them. You are going to experience
your financial accounts being restricted and or frozen in some
institutions.
- You are going to have to
plan on some place you can live in if you lose your income, or that
income is drastically reduced in purchasing power… preferably some
modest property that is paid off.
- People will have to deal
with fuel and food shortages and high costs.
- People are going to have to
give up the idea of getting investment returns since risk is out of
sight, and merely keeping what money/wealth they have is most important.
- You must toughen
yourselves, regardless of your age or position in life.
If you do these things, you may
survive without terrible hardship. But you will find some kind of hardship
regardless, because that is what these kinds of times cause for anyone on the
planet. You are going to have to tell your loved ones to do the same too. Families
will most likely have to live together to survive. You are going to have to
tell loved ones ‘no’ at some point if they insist on remaining in
the same level that USED to be. This is all happening as we speak.
Then, hopefully, the world
regains its economic footing. This all happened worldwide in the 1930’s
depression, and it lasted 10 long years.
The PrudentSquirrel Newsletter
is our financial and gold commentary. We have been tracking these issues for
all of 2008 for subscribers. We will continue closely monitoring these issues
this Summer, and rest of the year, in the weekly subscriber newsletter and
with subscriber alerts.
I had one potential subscriber
ask me if the newsletter has much more content than these public articles,
ie, if it was worth subscribing. The answer is that the public articles have
less than 10% of our research and conclusions that subscribers see, not to
mention the subscriber email alerts of important breaking financial news. We
have anticipated many significant market moves in the last year, such as
imminent drops in world stock markets within days of them happening, and big
swings in the gold markets within days of them occurring. We have also made a
number of good calls on big currency swings, such as with the USD, the Euro
and the Yen.
Chris
Laird
Prudent
Squirrel
Chris Laird has been an Oracle
systems engineer, database administrator, and math teacher. He has a BS in
mathematics from UCLA and is a certified Oracle database administrator. He
has been an avid follower of financial news since childhood. His father is
Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He
has grown up immersed in financial news. His Grandmother was Alice Widener,
publisher of USA magazine in the 60?s to 80?s, a newsletter that covered many
of the topics you find today at the preeminent gold sites. Chris is the
publisher of the Prudent
Squirrel
newsletter, an economic and
gold commentary.
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