THE DOLLAR'S TERRIBLE FATE
My
readers are familiar with my forecast that the US dollar is in terminal decline.
America is tragically bankrupt, unable to pay its lenders without printing
the dollars to do so, and enmeshed in an economic depression. The clock is
ticking until the dollar faces a crisis of confidence like every other bubble
before it. The key difference between this collapse and, say, the bursting of
the housing bubble is that the US dollar is the backbone of the global
economy. Its conflagration will leave a vacuum that needs to be filled.
Mainstream
commentators often discuss three main contenders for the role: the euro, the
yen, or China's RMB (known colloquially as the "yuan").
These other currencies, however, each suffer from a critical flaw that makes
them unready to carry the reserve currency role in time for the dollar's
collapse. When it comes to fiat alternatives, it appears the world would be
going out of the frying pan and into the fire.
EURO: FRAYING AT THE EDGES
The
euro is a ten-year-old experiment in uniting divergent political, economic, and
cultural interests under one monolithic fiat currency held in the hands of
one very powerful central bank.
If
managed correctly, such a currency could serve to keep its member-governments
honest - but that is not the world in which we live. Instead, the fiscally
irresponsible members are discussing ditching the currency at the first sign
of trouble. That is, they'd rather have their own national currencies to
inflate in order to cover over their burdensome public debts. So, in order to
keep the euro together, creditor states have been strong-armed into bailouts
of the debtors - even though such measures violate the compact that created
the common currency.
The
question becomes: how long do Germans - still wrought with the memory of
Weimar hyperinflation and the rise of the Third Reich - want to keep printing
euros to pay the debts of the spendthrift Greeks? How many German politicians
will ride to electoral victory on promises of unending bailouts and higher
prices across Europe? This is the fundamental flaw of the euro.
And,
of course, Greece isn't the only problem. Ireland and Portugal are vying for
second-worst debt crisis in Europe. Spain, representing over 12% of eurozone GDP, saw sovereign yields jump from 4.1% at the
beginning of 2010 to 6.6% by the end of the year. Yields on most other eurozone countries have been rising
as well - a clear indication that the eurozone is
an increasingly risky bet.
While
a euro secession by the PIGS could actually leave a
stronger currency region at the end, it would be a traumatic event. That
prospect is undermining confidence in the euro at just the time when the
world is considering where to go next.
Perhaps
a mature currency that didn't falter so easily amidst the recent global
financial crisis would be a good contender for the world's reserve. The euro,
by contrast, is both young and in serious trouble. If less than two-dozen
nations are too immense a burden for the euro to shoulder, should we expect
better results when it's stretched across two hundred?
YUAN: CAPITALIST COUNTRY, COMMUNIST CURRENCY
The
investment community is slowly coming around to my long-held excitement about
the miraculous growth of China. This is no frenzy. In fact, if anything, I
think many are still too skittish when it comes to this market. Yet, those
that are jumping on the bandwagon are now proclaiming the Chinese yuan as the logical successor to the dying dollar. But
while China is becoming an immense economic force, the yuan
itself is hobbled by the country's communist past.
Foremost,
China enforces stern capital controls on the yuan.
A reserve currency must be freely and easily exchangeable with other
currencies. Even within China's borders, one cannot exchange large amounts of
yuan for dollars or any other currency.
China
is slowly undertaking reforms to relieve these controls, but remember they
were not put there arbitrarily. The controls allow China to suppress the
value of the yuan, thereby maintaining artificially
high exports, among other consequences. If China allowed the yuan to trade freely, it would lose the power it
maintains over its money - and by extension, its people.
Let's
remember that all fiat currencies are routinely manipulated and
inflated. The People's Bank of China has reported M2 growth of over 140% in
the past five years - almost entirely to maintain a stable exchange rate with
a depreciating dollar. Given rampant inflation, combined with exchange
restrictions and a serious lack of transparency, the yuan
is simply not ready for primetime.
YEN: BLACK HOLE OF DEBT
The
Japanese yen is the third amigo at the international fiat fiesta. While it
doesn't suffer the structural risks of the euro, the yen is subsisting in an
environment of massive sovereign debt. Japan's debt-to-GDP ratio is the
highest of any developed country at 225%, meaning there is a perpetual
impetus to print more yen to pay it back. The yen must endure this
debt-noose, making it a poor alternative to the USD, which suffers the very
same problem.
While
I believe Japan is in a much better position because it generally maintains a
net trade surplus and because most of their debt is held domestically, it's
still not a stable unit with which to conduct world trade.
Perhaps
more importantly, with a world seeking yen reserves, the price of yen would
increase drastically. This is politically unpalatable in Japan, where the
export lobby is constantly trying to push the yen down to boost their sales
overseas.
These
two factors combine in such a way as to make the yen a plainly infeasible
reserve currency. The appreciation in yen value would simultaneously make
Japan's debt problems worse and cause its export industry to suffer greatly,
meaning that Japan probably doesn't want this role any more than we want her
to have it.
As
an aside, if you type "yen as reserve currency" into Google, it
will ask, "Did you mean: yuan as
reserve currency?" I guess even the world's smartest search engine
doubts the yen could fill that role.
THE SIMPLEST ANSWER IS OFTEN THE BEST
As
J.P. Morgan famously said to Congress in 1913, "gold is money and
nothing else." Morgan meant that gold was unmatched in its effectiveness
as a store of value and medium of exchange.
Given
that his namesake bank started accepting physical gold bullion this past
February as counterparty collateral, why should the trend of a widespread
return to gold be considered only a remote possibility? On the contrary, it
should be expected - if for no other reason than every other currency is
fundamentally dismal.
Markets
are powerful things, and require a reliable medium of exchange. The call for
sound money is not just philosophical; it is derived from the market itself.
Throughout human history, merchants have always turned to pure gold and
silver over every pretender. This is not the first experiment in a paper
money system, nor is it the first widespread debasement of money. In fact,
the lessons of history were impressed upon our well-read Founding Fathers to
the point that they included the following clear language in the
Constitution: "No state shall... make any Thing but gold and silver Coin
a Tender in Payment of Debts."
While
it has always been possible that another fiat currency would rise up to take
the dollar's place, and thereby keep this irrational experiment in valueless
money going awhile longer, the particular circumstances that abound today
make it seem less and less likely to me. Instead, I'm seeing signs that the
world is moving back to gold at a breakneck speed.
This
is a return to normal and has many positive implications for the global
economy. It's certainly a trend we can all welcome, and profit from.
Peter Schiff
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Peter
Schiff is
CEO of Euro Pacific Precious Metals, a gold and silver dealer selling
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(888) GOLD-160.
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