The Demise of the Dollar - An Impending Threat

by Adam Crum

“There can be no other criterion, no other standard than gold. Yes, gold which never changes, which can be shaped into ingots, bars, coins, which has no nationality and which is externally and universally accepted as the unalterable fiduciary value par excellence.”

–Charles de Gaulle

It was the beginning of the end for the gold standard as it confronted political and economic forces following the outbreak of World War I. The international monetary system that evolved at the end of World War II possessed a remnant of the gold standard, though it turned out to be a U.S. dollar standard expressed in terms of a fixed gold price, used to calculate the rates of other currencies.

As we progress further into the 21st century, the dominance of the U.S. dollar is shaky, to say the least. Inflation, interest rates, the trade deficit, personal debt, a possible VAR crash and war have come together to create a sobering scenario indeed. Add to that the dawning of the euro.

The Euro vs. the Dollar

While the dollar maintains its position in the Western Hemisphere, the euro poses a serious threat to the dollar in the former Soviet Union, Central Asia, Sub-Saharan Africa, and the Middle East.

• Iraq became the first OPEC nation to begin selling its oil for euros in November 2000. Since then, the value of the euro has increased 17%, and the dollar has begun to decline.
• From all indications (e.g. issuance of eurobonds, converting its foreign exchange reserves to euros, etc.), Iran is ready to switch to the euro. A recent report indicates that it has actually begun selling its oil to Europe for euros and is actively encouraging Asian customers to pay in euros as well.
• With both Indonesia and Malaysia’s oil industry being encouraged to make the switch to euros, the European Union’s Energy Commissioner has suggested that the euro could quite possibly replace the dollar as the currency of choice for oil pricing.
• The euro-zone avoids huge deficits, uses higher interest rates and is gaining an increasingly larger share of world trade. As the euro becomes more widely accepted, the dollar will no longer be the only option, and other nations could decide to exercise financial leverage against the United States.
• Estimates indicate the dollar is currently overvalued by at least 40% and has lost half its value against the euro in the past two years, burdening the United States with a huge trade deficit.

Robert Mundell, the Nobel-prize winning economist who might well be called the “father” of the euro, and who favors a global currency, has predicted that “the monetary collapse of the dollar is imminent within the next three to five years unless we get the Federal deficit under control because the numbers are now so staggering.” Before we look at the challenge that is the deficit, let’s examine inflation and interest rates. Keep in mind the words of Charles de Gaulle: “gold which never changes, which can be shaped into ingots, bars, coins, which has no nationality”

Inflation IS the Future

Over the past six months, the fastest consumer price increase in 13 years has hit us squarely in our collective bank accounts. Proof of this awaits us every time we visit the local supermarket or corner gas station.

• Butter, for example, has gone from $2.84 per pound to $3.46 according to the U.S. Department of Agriculture. This is linked to dairy farmers reducing their herds by 1.8 percent in 2002 when beef prices started rising, just as the U.S. cut off imports of dairy cows from Canada due to mad cow disease.
• With oil setting records at nearly $56 per barrel, gasoline is the highest price it has ever been in the United States. This doesn’t appear to be a short-term problem either. Consider the fact that Iran is and will continue to move forward with its nuclear program. Does anyone really believe Israel will stand by and say, “okay, whatever?” No way! In fact, Israeli leadership is already making subtle threats and charging that Iran is behind terrorism in the West Bank. What do you think the price of oil would do if Israel began bombing Iran?
• The widely watched Consumer Price Index shows inflation running at 5.1 percent annually, the highest since 1990.

As the federal debt increases, the FED is raising cash by printing money at an unprecedented rate. While the government’s public relations people admit to a $520 billion deficit just this year, the actual amount is undoubtedly higher. In fact, estimates indicate that more money was issued from 2000 to 2003 than had been printed from the time of George Washington through 1980. You do the math!

Since money is really no different than any other commodity, most savvy investors know that large increases in the monetary supply stimulate inflation. That’s why the truly savvy also know that such monetary expansion has also been a major cause of bull markets for precious metals and numismatic quality gold coins.

Interest Rates on the Rise

The Federal Reserve increased interest rates in 2004 for the first time since the historic lows of 1 percent. While the dollar has experienced rallies in response to rate hikes in the past, historically these rallies have proven to be short-lived.

In fact, rising interest rates can have many negative effects:

• Mortgage rates almost automatically increase right along with rising interest rates. This would certainly end the refinancing boom of the past several years and reduce the large amount of equity that many Americans have in their homes. A reduction in wealth usually means a reduction in spending.
• In the past, rising interest rates have gone hand-in-hand with stock market declines, some very brutal, as in the case of 1974 and 1987. Rising interest rates will only weaken an already shaky foundation upon which the stock markets presently rest.
• Foreigners buying U.S. treasuries have basically financed America’s massive debt. Rising interest rates decrease the value of their treasuries, making the dollar less attractive.

These are obviously very troubling signs and demand that wise investors seek protection. As interest rates increase, high quality rare gold coins can offer that protection.

The Trade Deficit and Consumer Debt

Inflation and interest rates are only two of the threatening economic storm clouds on the horizon. The immense U.S. debt and trade deficit are even more disconcerting.

• The U.S. trade deficit now represents more than 5% of our GDP, which is 2% higher than when the recent “recovery” began. Severe currency declines have been marked by a deficit of this size in the past.
• Some believe the dollar will eventually fall enough that the trade deficit will look more manageable. But as long as our important trading partners like China and Japan refuse to permit the dollar to fall sharply in relation to their own currencies, their goods will seem inexpensive in the U.S. and American-made products expensive in their countries.
• Reforms to stimulate declining European domestic demand for American goods will not come from the European Union or the European Central Bank to assist the U.S. in reducing its trade deficit and the downward pressure on the dollar.
• Massive, record-setting deficits are plaguing the state governments as well. In the meantime, American citizens have accumulated record personal debt while maintaining minimal savings.

To say this is extremely bearish for stocks and the economy in general is an understatement. But, rare U.S. gold coins have traditionally had an inverse relationship to the dollar. This characteristic makes them an ideal hedge to protect and increase investor and collector wealth in the years ahead. As the government and individuals continue to watch their debt increase and the economy weaken, sophisticated investors and collectors are diversifying their portfolios appropriately in order to protect themselves AND benefit from an economic downturn.

Value-At-Risk (VAR) crash

Value-at-risk (VAR) models determine the amount of capital that banks must set aside against their trading positions. This supposedly shows how many millions of dollars a bank might lose should their investments sour.

• VARs have increased for just about all of the banks that participate seriously in financial markets. The VAR at Goldman Sachs, for example, has more than doubled. One of the bank’s senior traders was recently instructed to take still more risk.
• Banks have admitted to risking more and more of their own money to generate huge profits. This can be substantiated by reviewing the risk-management models used by the big banks and released in their financial statements. Some banks positions are as much as three times those in the Fall of 2002. Banks as a whole have invested many billions of dollars in these funds.

According to Michael Thompson, a strategist at RiskMetrics (a firm that specializes in the risk-management models that banks use) reports that the present situation is reminiscent to that which preceded the collapse of Long-Term Capital Management (LTCM), a large hedge fund. After Russia defaulted on its loans, LTCM had to be rescued by its bankers, at the request of the Federal Reserve, to the tune of at least $1.3 billion.
Like LTCM, banks are increasing their positions of risk with the dubious expectation that markets will remain stable. They are “walking themselves to the edge of the cliff,” says Thompson. Past financial crises have shown the risk-management models utilized by these financial institutions dramatically underestimate the destructive results of markets gone awry.

We are at war

The sobering reality is that we are at war, and it is a war that will not end quickly. Some experts are estimating that this is a war that could easily extend into the next decade or longer. Others say it is now a permanent fact of life. No matter who is correct, the bottom line is that there are enormous financial implications connected with an ongoing war and struggle against terrorism.

• The war in Iraq, the enormous expense for Homeland Security and continued operations in Afghanistan represent an almost inconceivable financial load on the federal government and its citizenry.
• Reports of terrorist attacks to come and the constant nagging of “when will it happen again” overshadows each of us since September 11, 2001 (whether we are consciously aware of it or not). It generates fear for financial well-being. The economic toll that worldwide insecurity caused by terrorist threats will take cannot be measured, but it will be significant in the long run.
• Depending upon the type and location of the next attacks, any form of electronic wealth could be threatened. This will ripple throughout the U.S. stock market and the entire economy.

Investors willing to grasp the painful realization that the terrorists are very likely to attack again are taking steps to prepare themselves now. They know that even the smallest of successful attacks could generate catastrophic financial repercussions.

The flight to hard assets such as gold and rare coins

In the 19th Century, the gold standard was the monetary system that dominated the developed world. To quote Joseph Schumpeter regarding Austria’s decision to link her currency to gold, “it was a badge of honor and decency.”

In 1971, with the final breakdown of the Bretton Woods system and exchange rates “floating,” investors searched for currencies that provided “safe haven.” Yet, even the so-called “safest” of currencies is subject to the vagaries of economic and political risk and manipulation. So, in a way, it is ironic that among the ways investors found to hedge this risk and manipulation was investment in gold and the many forms it takes, such as rare gold coins.

• Numismatic quality rare gold coins have proven time and time again to be an excellent hedge because they have become a standardized asset, easily traded in a market that is always open.
• Rare gold coins have become a solid asset because governmental authorities cannot produce and, thus, debase them. Because of this, rare gold coins have acquired long-term wealth preserving properties.
• Compared to levels of late last summer, gold has posted a solid 15% gain, the NASDAQ has rallied a mere 5%, and the DOW a little over 8%. During the same timeframe, my Top Picks, rare Type I $20 Gold pieces, have increased 30%, 40%, and some more than 100% in value.
• Gold coins are a great value now (although quality coins will get more difficult to find). Now is an opportune time to trade up and add to a collection.
• There are tens of thousands of new collectors and investors who have emerged over the past seven years. Many coins have been added to collections, which is good for the market since those coins will be off the market for years to come. Remember, they are not making any more 100+ year old $20 gold coins. I believe this could be the greatest rare coin buying opportunity…EVER!
• Rare gold coins have intrinsic, aesthetic and historic value as well. They are, quite honestly, works of art and pieces of history.
• Inflation traditionally affects the dollar and the stock market negatively. Rare coins have provided an ideal hedge against inflation, thrived in times of insecurity and rising interest rates and provided a long-term storage of wealth that has consistently outperformed other assets in times of turmoil against the dollar.

It’s conceivable that the total deficit of the United States will continue to grow from its current $7 trillion. Any way you look at it, it is an outrageous sum of money that can only be repaid with the use of a printing press. Politicians will never allow a monetary collapse or depression, so inflation IS the future.

In a hectic world where the boom of the 1990s reinforced the expectation of instant gratification, investors must now be patient and look at the larger picture, watching short term moves while placing more emphasis on the long term. The dollar and the U.S. economy in general struggle to find solid ground, and further losses appear imminent.

Conventional wisdom says that to be truly diversified and safe, you must own gold in one of its various forms. Without nationality and freedom from any government’s meddling, gold has proven itself to be the ultimate standard of value. This characteristic has affixed itself to the many shapes of which de Gaulle eloquently spoke including rare numismatic quality rare gold coins.