Tune into CNBC or click onto any of the dozens
of mainstream financial news sites, and you’ll find an endless array of
opinions on the latest wiggle in equity, bond and commodities markets. As
often as not, you'll find those opinions nestled side by side with
authoritative analysis on the outlook for the economy, complete with the
author’s carefully studied judgment on the best way forward.
Lost in all the noise,
however, is any recognition that the US monetary system – and by
extension, that of much of the developed world – may very well be on
the verge of collapse. Falling back on metaphor, while the world’s many
financial experts and economists sit around arguing about the direction of
the ship of state, most are missing the point that the ship has already hit
an iceberg and is taking on water fast.
Yet if you were to raise your hand to ask 99%
of the financial intelligentsia whether we might be on the verge of a failure
of the dollar-based world monetary system, the response would be thinly
veiled derision. Because, as we all know, such a thing is unimaginable!
Think again.
Monetary Madness
Honestly describing the current monetary
system of the United States in just a few words, you could do far worse than
stating that it is “money from nothing, cash ex nihilo.”
That’s because for the last 40 years
– since Nixon canceled the dollar’s gold convertibility in 1971
– the global monetary system has been based on nothing more tangible
than politicians' promises not to print too much.
Unconstrained, the politicians used the gift
of being able to create money out of nothing to launch a parade of politically
popular programs, each employing fresh brigades of bureaucrats, with no
regard to affordability.
Such programs invariably surged during
political campaigns and on downward slopes in the business cycle when
politicians hearing the cries of the constituency to “do
something” tossed any concern about balancing budgets out the window of
expediency. After all, the power to print up the funds for debt service
whenever needed makes moot any concern over deficit spending.
Former VP Cheney, who fashions himself a
fiscal conservative, let the mask drop when, in 2002, he stated that
“Reagan proved deficits don’t matter.”
Those words were echoed just a few weeks ago,
when both former Fed Chairman Alan Greenspan and Obama economic advisor Larry
Summers, in separate interviews, said almost the same, paraphrased as,
“There is no chance of the US defaulting on its bonds, not when our
government can borrow dollars and print new dollars to meet any future
obligations.”
Of course, Greenspan and Summers were
referring to an overt default – of just not paying – and not to a
covert default engineered by inflation. Unfortunately, like virtually all of
the power elite, both miss the point that the mountain of debt that has been
heaped up since 1971 is fast reaching the point of collapsing like a too-big
tailings pile and taking the monetary system down with it.
Importantly, the debt shown in this chart
whistles past the government's unfunded liabilities, in particular for the
Social Security and Medicare systems. Adding those would more than triple the
US government’s acknowledged obligations – to over $60 trillion.
Given the role the US dollar plays as the
world’s de facto reserve currency – with all major commodities
priced in dollars, and dollars forming the bulk of reserves held by foreign
central banks – the dismal shape of the US monetary system spells
trouble for the global monetary system.
Making matters worse, following the lead of
the United States, governments around the world long ago adopted similar fiat
monetary systems. You can see the deficit contagion in this next chart. It is
worth noting that the dire condition of the United States now leaves it in
the same muddy wallow as Europe’s desperate PIIGS.
In a recent article in The
Telegraph, Ambrose Evans-Pritchard referenced a paper out of the
BIS that paints the picture using appropriately stark terms.
Stephen Cecchetti and his team at the Bank for International
Settlements have written the definitive paper rebutting the pied pipers of ever-escalating
credit.
“The debt problems
facing advanced economies are even worse than we thought.”
The basic facts are that
combined debt in the rich club has risen from 165pc of GDP thirty years ago
to 310pc today, led by Japan at 456pc and Portugal at 363pc.
“Debt is rising to
points that are above anything we have seen, except during major wars. Public
debt ratios are currently on an explosive path in a number of countries.
These countries will need to implement drastic policy changes. Stabilization
might not be enough.”
Viewing the situation from another
perspective, we turn to the work of Carmen Reinhart and Ken Rogoff, who studied the factors contributing to 29 past sovereign
defaults. They found that default or debt restructuring occurred, on average,
when external debt reached 73% of gross national product (GNP) and 239% of
exports. Using the Reinhart/Rogoff findings, Casey
Research Chief Economist Bud Conrad prepared the following chart showing that
the US government is already far along on the path to bankruptcy.
It’s hard to argue against the
contention that the situation is, to be polite, precarious. Given that the
obligations of the US government, as well as most of the world’s other
large economies, are now impossible to repay and that their reserves are just
IOUs backed by nothing, the stage is set for a highly disruptive but entirely
necessary do-over of the fiat monetary system.
“Preposterous!” say the lords of
finance and masters of all.
Is it?
Of course, these very same mavens completely
missed the looming housing crash and the depth and duration of the subsequent
crisis – a crisis that is still far from over. In other words, listen
to them at your peril, because in our view it’s essential in
calibrating your financial affairs to understand that, if history is any
guide, we are now well down the road to a collapse in the monetary system.
In fact, over its relatively short history,
the US monetary system has come unglued time and time again thanks to
politically expedient attempts to interfere with the workings of a free
market in order to reward constituents or kick the can on the economic
problems of the day down the road.
Thus it is our contention that while the
mainstream media focus on the daily gyrations of equity markets or the futile
political charade that is Washington, they overlook powerful tectonic
rumblings indicating the world’s prevailing monetary system is about to
fracture.
A Brief Timeline of US
Monetary System Failures
Here’s a brief history of past
disruptions here in the United States. Importantly, with the US dollar now
the de facto reserve currency of the world, this time around it’s
global.
1861 – When the Civil War begins, the dollar is convertible into
gold and silver.
1862 – Congress passes the Legal Tender Act and authorizes the issuance
of non-redeemable "Greenback" currency. Convertibility into gold
and silver is suspended for all US currency.
1863 – National Banking Act authorizes the chartering of banks by
the federal government.
1865 – A 10% tax is levied on the issuance of bank notes by
state-chartered banks, effectively ending that practice.
1879 – The US Treasury resumes redeeming dollars for gold and
silver.
1900 – Passage of the Gold Standard Act, adopting the gold standard
by the United States and demonetizing silver.
Specifically, the act provided for
"...the dollar consisting of twenty-five and eight-tenths grains (1.67
g) of gold nine-tenths fine, as established by section thirty-five hundred
and eleven of the Revised Statutes of the United States, shall be the
standard unit of value, and all forms of money issued or coined by the United
States shall be maintained at a parity of value with this standard..."
But 33 years later, to gain the power to
inflate the currency and collect the profit from doing so…
1933 – By executive order, Franklin Roosevelt prohibits the private
ownership of gold. Congress passes the Gold Reserve Act, which enacts
Roosevelt's executive order, abrogates all gold clauses in all contracts
public or private, past or future (which cancels the convertibility of
Federal Reserve notes into gold), though it confirms the convertibility of US
Treasury notes held by foreigners into gold. Eleven years later, the US
government takes its show on the road…
1944 – Bretton Woods system adopted with signature countries agreeing
to tie the exchange rates of their currencies to the US dollar, which itself
is linked to a fixed price of gold. Foreign trading partners retained the
right to swap dollars for gold, imposing a de facto restraint on printing more
dollars. For all intents and purposes, the US dollar becomes the
world’s reserve currency. But 27 years later…
1971 – Nixon abruptly closes the “gold window,”
unilaterally reneging on the Treasury's promise to allow foreign governments
to redeem dollars for gold. Bretton Woods collapses. With no remaining tie to
a tangible, the dollar is reduced to a paper token. The transition to a
global fiat monetary system is complete.
Until 40 years go by and the inevitable
consequences of giving politicians free rein over money creation become
untenable…
Present day – Sovereign debt crisis. Desperate, debt-laden governments around the globe
– the bulk of their reserves composed of fiat US dollars and euros at
risk of going up in smoke – turn to the only thing they know, printing
more money and issuing yet more debt. The global monetary system cracks and
heads toward failure with no workable alternative on the horizon.
Governments, corporations and investors alike
are caught unprepared in the downward spiral of failing fiat currencies and
are wiped out by a combination of frantic currency debasements, higher
taxation, exchange controls and worse. Social unrest spreads, with the public
paradoxically demanding that governments do more, not less.
That’s because all the world’s
major currencies are at risk, simultaneously, as the issuers engage in a
dangerous race to the bottom. As the monetary system moves inexorably toward
terminal debasement and collapse, the results will be catastrophic for the
unprepared.
Importantly, while the list of historical
attempts to re-jigger the US monetary system have, to this point, more or
less succeeded in kicking the can a bit further down the road, the sheer
scale of today’s government obligations has driven us into a box
canyon, with no way out. As the government’s debt and spending
obligations are mathematically impossible to resolve, it is now a certainty that
a lot of people are going to wake up one morning to the reality that they are
a lot poorer than they thought.
Fortunately for those now paying attention,
the collapse of a monetary system doesn't happen in a flash. It is a
progression, like the spiral of water down a drain. Thus, while no one can
predict exactly when the downward spiral will accelerate out of control,
there is still time to prepare.
Dark though the lens may be, this is the lens
through which we here at Casey Research view all our investments. Simply,
being right or wrong about your investment decisions in the years just ahead
will be insignificant if the currencies underpinning those investments
shrivel to just a fraction of their current values.
The
dismal state of the US economy and out-of-control government spending affects
every American’s life and wealth. In our free online event, The American Debt Crisis – How Big? How Bad? How to
Protect Yourself, five Casey Research experts were joined by
guests John Mauldin, Mike Maloney and Lew Rockwell to discuss the potential
for a breakdown in the monetary system, and specific ways to protect and
build your assets. Watch the video now.
David Galland
Managing
Editor, Casey Research
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