Decline of the Dollar; In the Works but Not Coming Quite Yet

"By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens."  -John Maynard Keynes

By now most Americans have been exposed to the idea of the “death of the dollar” in the media, whether through tacky “buy gold” commercials, occasional mention in mainstream media (usually in the form of mocking dismissals of the issue), or through alternative media and blogs such as this. Unfortunately such information is often presented as either black or white with little in-between; more often than not it tends to be either “The dollar as the reserve currency will never die… USA! USA!” on one end, and “The dollar will crash any minute! Buy your gold, silver, guns & ammo right now!” on the other end.

Now realistically speaking, the dollar’s days as the reserve currency are truly numbered. It’s not so much due to the money the Federal Reserve has to date “printed” (which is still a pretty insane amount) as much as it is the US government’s future and increasing reliance on printed money and their total inability to cut their budget in any meaningful way. It cannot change on its own, therefore change will at some point be forced upon it in the form of a loss of confidence in the government and the currency. But is this going to happen this year or next? Probably not. Like it or not, the US is still seen as the safe haven (or as I’d put it, the least crappy haven) for large amounts of tertiary or paper wealth. In my mind, we will need to see a collapse in confidence with one or more of the other economic powers first before it reaches America’s shores. My best guess is we will see Japan as the first economic power to suffer this fate. Japan on a percentage basis is printing more than the US, it has a much higher absurdly high debt to GDP ratio at 227% as of 2013, and is much more reliant on imported energy for both transportation and electricity. Once Japan or some other major economic power suffers a currency crisis, THAT will be the time I’ll start worrying about the US dollar. While I do expect some other “advanced” economies will suffer the same crisis before the US, my sense of it is that when Japan falls the spread of this loss in confidence will pick up speed and “go global” rather quickly. I may be wrong on that assumption (and I certainly hope I am), but with how interconnected the financial world is nowadays I think the period of time between a crisis in Japan and a crisis most everywhere else will be pretty short (maybe a year, or maybe just a matter of months).

Now how will "The Powers That Be" respond to said crisis? Well here I’m going to take a page from Jim Rickards (of “Currency Wars” and “The Death of Money” fame) and assign the highest probability outcome to the IMF and the larger economies calling for an "emergency restructuring" of the international monetary system, where they’ll tap the IMF’s SDR’s (special drawing rights) to assume the role as the dominant reserve currency. Though I do think there’s a distinct possibility that we may see other regional reserve currencies pop up alongside the IMF’s SDR, depending primarily on whether China and Russia feel their interests are best served by breaking with the IMF and the West.

Either way, when the dust clears it will mean a different standing for the US dollar and new limitations on the US government's ability to borrow. So THEN will the dollar crash to near worthlessness? Not bloody likely. What I'm expecting is a substantial devaluation in the dollar along with the imposition of capital controls preventing money and wealth from easily fleeing the country. But while the dollar may at that point only buy 50-70% of what it used to mere months before, most Americans will still get paid in dollars and use dollars for everyday transactions. The key change will be in the higher velocity of the currency, which essentially means that people won't hang on to their dollars very long before spending them. The dollar will still be a valid and accepted means of exchange, but it's image as a store of value will be damaged for a generation or more.

So while it will definitely be to one's advantage to diversify out of the dollar before that time, it won't turn America into a nation of absolute paupers overnight. It will be a world of suckage and most of us will be poorer on the other side of it, but we won't turn into Zimbabwe or Weimar Germany overnight. If one wants to avoid the worst of it, one would ideally convert one's financial (i.e. paper) assets into a combination of precious metals, select real estate, and other useful tangible assets. If one has to keep substantial wealth in the financial system, my guess is that the stock market (or at least select stocks) might be the best place. Even the best stocks will probably still lose some value in real terms, just not nearly as much as the other classes of financial assets. Many businesses will find some ways to adjust to the new world. And while they may suffer, as long as they make useful products or provide needed services they will survive and be worth something. My take is the ones that come out on top in the new world will be those who turn their paper wealth towards ownership of or large stakes in essential businesses. In the meantime, I have few reservations about pooling my savings in dollars, at least in the short term.