Weakening Dollar In a Civilization Shift by Navin Doshi


(By Navin Doshi)

In ancient times, gold coins circulated far and wide across the globe just as paper currency does today.  Even after the birth of paper currency, the gold standard for paper money ensured its stability.  Between the Waterloo battle in 1815 and the Great Depression of the 1930s, the pound sterling ruled, but it was still convertible into gold.  Even in the 20th Century from the Depression years to the late 1960s, the dollar could be converted into gold.  In fact, section 19 of this country’s founding monetary legislation, the Coinage Act of 1792, prescribed the death penalty for any official who fraudulently debased the people’s money. The act was later repealed because Keynesians opposed it. Today, however, there is no backing for the U.S. dollar except the hollow faith of the U.S. government.  The world is rapidly losing respect for the dollar, and our currency now resembles General Motors in that our best days are behind us.

Let us turn our attention to the economic views of Keynes and Mises discussed in my earlier article on the dollar to get a deeper understanding of our current economic problems. The two men represent a pair of opposites in the realm of economics.  In a recession, Keynes encouraged government spending to stimulate the economy, while Mises opposed government intervention. Would Keynes be wrong today?  In short, yes. Keynes’ support of uncontrolled government expenditures would worsen the current situation, although it is occasionally good to have a controlled elastic currency at the government’s disposal. The pure paper currency monetary system of Keynes creates “black holes” of secrecy and violent volatility that results in unjust imbalances.  As we have shifted drastically in the direction of fiscal recklessness bringing us closer to potential hyperinflation, we need to restore a balance and harmony with a return to sound principles of saving and investment in productive assets. America has consumed more than it has produced since 1976, as measured by the trade balance, which amounts to a deficit of 32 years and counting.

If the rulers of the country keep printing money for their advantage, purchasing power is sure to fall in proportion to the increase in paper currency. If the inflation rate is much higher than the interest rate, purchasing power will keep dwindling.  However, if the interest rate is much higher than the inflation rate, the currency is bound to become stronger reminiscent of the 1980s.  Money flows to where it is treated the best, where returns are high. Holders of American bonds are being penalized with a negative real return, causing significant capital flowing away from America.

If we look back to the 1980s, Fed chairman Volker squeezed liquidity out of the system by increasing the interest rate. The dollar became one of the strongest currencies with an inflation-adjusted interest rate topping over 10 %, and it remained strong through 2000 with the real interest rate declining gradually to 3.5%.  After 9/11, pessimism and fear dominated, creating an economic slowdown.  The interest rate dropped close to 0%.  With the promise of easy credit, the markets took off in 2003.  However, the dollar was becoming ever weaker.  In a healthy economy, the deficit as a percentage of GDP should be less than 3%.  If it is over 5% of the GDP, the currency is bound to get weaker.  Currently the deficit has soared to over 10 % of GDP and climbing. The dollar, in terms of gold, has gone down below 30%. America had gone through a situation similar to the 2008 financial tsunami when the stock market crashed in 1929, resulting in depression. Newly-elected president Franklin Delano Roosevelt was wise when he didn’t remove the dollar pegged to gold.  All he did was to inflate the economy only once by lowering the peg to gold from $20/oz to $35/oz.  He maintained sufficient discipline to keep a constant purchasing power at $35/oz of gold by maintaining gold as an anchor.

In our time of astronomical deficits, the government issues debt paper to finance the deficits.  The first stage of the money-printing cycle is that investors keep buying.  When the buyers realize the risk associated with the excessive borrowing, they curtail their purchase of the government paper.  The next stage is that the government buys their own paper, also known as “quantitative easing”, or I would call “legalized counterfeiting”.  As the deficit keeps increasing with more and more paper currency printed, the rest of the world realizes the problem, and that is the start of runaway inflation.  During the hyperinflation of the 1980s in Brazil, people would keep the currency in hand for the shortest possible period, spending it in the same hour they received it.  They knew that the next hour the price of essential goods would be higher.

The U.S. is in the middle of a perfect storm that will have significant ripple effects throughout the world.  Currently the unemployment in U.S. is in the double digits, and some estimate true unemployment, including underemployment, at close to 20%.  Bank problems are still not resolved, and those issues will also cause more printing of money.  The toxic debt issue still looms large.  A huge portion of the derivative market, about $500 trillion, is worthless.  So far over 100 U.S. banks have failed.  The FDIC has run out of money. There is a good chance that more than one major bank will fail.  For example, J.P. Morgan holds over $100 billions in derivatives, and if and when those collapse, JPM could face a philosophical death. All of these issues will continue to weaken the dollar over time.  These problems are bound to proliferate worldwide.

There is a significant probability that the world financial system as we know it may not survive, and it will have to be revived in a different form.  Money printing keeps rulers in power for a while, but ultimately they are thrown out because they destroy the economy. Voltaire had said in 1729 that paper money will eventually return to its intrinsic value – zero.  The people have been put in these dire straits by their politicians, and it could take many years to come out of it. As Einstein wisely commented, “don’t expect the people who caused a problem to solve it.”  Matt Taibbi, in the December issue of Rolling Stone magazine, narrates the story of how President elect Obama brought in the same gang of Wall Street who created the financial tsunami of 2008.

Is the world following India in matters of savings and social security?  China is certainly doing it, encouraging their citizens to put their savings in gold and silver. People in the Western countries are doing the same by buying the gold and silver coins. Gold and silver in India represents their IRA and Keogh, the savings for a rainy day, the dowry for a daughter’s wedding, and more. We are shifting from a dollar hegemony to the age-old 5000 year-old system of saving in the form of gold, silver and other tangible assets.  We know that John Paulson, Jim Rogers and many more all over the world, the billionaire fund managers, are making a big bet on gold, silver, and other resources.  Petroleum exporting Arab countries plan to float their own currency calling it “Gulfo” and modeled after the Euro, some time next year, probably backed by the gold reserve.

Ambrose Evans-Pritchard of The London Telegraph narrates the story about the rising economic powers of Asia and the Middle East. They have lost confidence in Western currencies and are replacing them gradually with gold.  Currently, on average, these countries have only about 2.2% of their foreign reserve compared to over 35% for the G-7.  They would have to buy about $700 billion worth of gold to have half (18%) of their foreign reserve at the current price.  The top Chinese banker Zhu Min indicated that they buy gold when the price goes to some support level.  The implication here is that the gold price may drop some but cannot crash.  The rise of the gold price does not seem to be due to the momentum players.  Perhaps it is a civilization shift.  I would call this reversing the direction of the pendulum, the “laws of karma” at work – transfer of wealth from West to East!  Please note that India was one of the richest countries at the end of the 17th century before Robert Clive from England arrived in India. I would urge you, dear friend, to review the first article on the dollar (Nov 21, 2009), posted on www.nalandainternational.org to get a deeper understanding of current economic matters.

(Navin Doshi, January 10th, 2010)
(Mr. Doshi is a trader, writer, and philanthropist)


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