The Violent Demise of the U.S. Dollar

11.21.08 | Money | 1 Comment | by Andrew

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"Your premium brand had better be delivering something special, or it's not going to get the business." — Warren Buffett

The U.S. Dollar is the premium brand of currency in the world. It's the standard against which all other currencies are measured and it's where the money goes when people want rock-solid security.

This has been true for decades, but in the last 35 years, the U.S. has gone from the largest creditor nation to the largest debtor. Our twin deficits combined with artificially low interest rates have left us with a $10 trillion national debt — $50 trillion if entitlement programs are included, as they should be.

We haven't been spending the money on factories or production. Instead we've been buying houses, cars, HDTV's, playing world cop, and dramatically overpaying for health care.

To put it bluntly, we are broke, both as a nation and as a set of individuals. The dirty secret is that our lifestyle of the last 20 years is unsustainable.

Why Saving, Not Spending is the Key

To fix this mess we've made, we need to tighten our belts and start saving money rather than borrowing to spend. That goes both for individuals and the government. In addition, we need to focus on producing goods that can be exported to other nations so that we can get money flowing back into this country rather than out of it.

Unfortunately, the government is determined to sustain consumption epidemic. Certainly consumption brings short-term pain relief, but it just makes the long-term imbalance worse, similar to giving a crack addict more crack to avoid withdrawal.

People keep saying the the bailouts will be paid for by our children, but the truth is that we'll have to pay the price ourselves. If the government continues its spending spree, which is even more likely now that we'll have a unified government of Democrats, inflation risk is very real.

Standard & Poor has already stated that the U.S. is at risk of losing its AAA bond rating.

If the dollar devaluation prediction comes true, the new financial capital of the world will be Asia. Asian countries have been effectively taxing themselves to subsidize U.S. consumption by buying and holding our bonds and thereby keeping our currency valuable.

If the U.S. economy collapses, Asia will decouple and begin to flourish on its own. They will be in excellent position with industrialized production, steady growth, and plenty of reserve savings.

What Happens if the Dollar Falls Apart?

If the U.S. dollar declined to 1/2, 1/4 or even 1/10th of its current value, chaos would ensue and a great number of people would be in deep trouble, especially retirees.

Are you prepared for such a contingency? Any bonds you hold would decline in value significantly, as would any cash.

According to the government numbers, inflation was around 4% this year, which means that any cash you had in a high-interest savings account has actually been declining in value at 1% rather than increasing by 3%.

If we're headed for dollar deflation, as some say, then it's a good idea to keep your cash. If you believe the inflation scenario, then you should buy some commodities such as gold. Or of course you could hedge your position and buy some gold while also keeping some cash on hand.

If you do decide to buy gold, it's a good idea to avoid futures and stick with real, physical gold or a fund that holds physical gold to avoid counterparty risk of the futures not being delivered.

If you want to take more risk and attempt to profit off the possibility of a falling dollar rather than simply maintaining your wealth, buy mining companies rather than physical gold, but still don't buy futures.

As for equities, Asia is a solid long-term investment but it will suffer in the short term along with the rest of the world.

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