The Dollar's Days are Numbered

Those who don’t take action will be missing out

The dollar’s days are numbered. We are beginning to feel sorry for it…as we do all lost causes.

Trouble is, we don’t know whether it’s a big number or a little number that marks the dollar’s last days.

Last week, a decimal point seemed to move to the left. A UN advisory panel had suggested that maybe it was time to figure it out a better way to run the world’s monetary system. Better, that is, than using the U.S. dollar as the reference currency for the whole world.

As you’ll recall, almost every price on the planet ultimately relates to dollars. You can buy an orange here in Granada for euros. But the global market in oranges is priced in dollars. So when people figure out how much something is worth – in global terms – they typically refer to dollars. And when countries want to make sure they have enough money on hand to settle up their debts with other countries…or enough money to buy Florida oranges…or enough to purchase oil to run their factories – they lay in a supply of dollars.

But while the value of everything is referenced to dollars, what’s the dollar’s value referenced to? At the end of the day, upon what rock does the world financial system rest? Ah…that’s the weakness of it…there ain’t no rock. Look at the foundation of the world’s money system and all you find is mush…

And last week, the Chinese poked around with a stick to see how soft it was…

They, too, said it was time for a change – a new money system with the IMF operating as a sort of Super Central Bank – giving nations ‘special drawing rights on gold’.

And this week, the G20 will meet in London.

They are to have a ‘rendezvous with destiny,’ say the papers. The world is faced with a huge challenge. People turn their weary eyes to the politicians, hoping they will meet the challenge. Historians will record the event like they did the Council of Trent or the Treaty of Westphalia.

Blah…blah…blah…as near as we can tell.

The fact is there isn’t anything our leaders can do about the situation except make it worse.

The markets need to clear…and adjust to the new post-bubble reality. The more effective governments are at preventing this from happening – that is, the more successful their bailouts are – the longer and deeper the correction will be.

At least on the subject of the dollar, the G20 group could do something worthwhile. They could renounce Nixon’s faith-based currency system…and return to a gold-backed system. But they’re not going to do that. Not yet. Not until the dollar-based system has blown itself up.

When will that happen?

We wish we knew. But, one way or another…sooner or later, a new money system is bound to emerge. Most likely, it will have gold at its base.

Why? Because in thousands of years of human experience, nothing better has ever been found.

Not that we completely discount the possibility of a better system; humans can be clever. But money is the sort of activity where you don’t want cleverness.

You want dumb, honest solidity…you want something that cleverness can’t undermine or circumvent. You want money that smart people can’t fiddle…and that is gold.

This is why we believe that the gold price has much, much higher to go…and investors who buy now, when the price is low, will be rewarded in spades.

Right now, central banks are fiddling faster than Nero.

The total cost alone for all this fiddling in the United States is something on the order of $14 trillion. Under these circumstances, you’d think inflation was a sure thing…and that the dollar was a goner.

Not so fast. Inflation is not that easy to create or control. It could be months – or years –before consumer prices rise. As we explained last week, people who expect consumer prices to rise immediately could be deeply disappointed.

For one thing, the depression is sucking money out of the system even faster than the feds are putting it back in.

It’s that old ‘paradox of savings’ issue. When an economy goes into a downswing, people save money.

This causes prices to fall…making saving more valuable.

Then, people save even more. Instead of circulating, money goes into pockets, vaults, and mattresses; saved for a rainier day…and lower prices.

For another thing, “the money multiplier… has collapsed,” as one economist put it in the Financial Times.

Normally, when banks get more money they ‘multiply’ it by lending out even more. That’s how fractional reserve banking is supposed to work.

But now, the banks aren’t lending.

They’re rebuilding their own coffers…just like ordinary citizens.

Besides, they’re afraid to lend – who knows what the collateral will be worth when this depression gets finished with it!

The multiplier has forgotten how to do arithmetic.

And for still another thing, there’s what Keynesian economists call an “output gap.

” What this means is that the economy is functioning at less than full capacity. In fact, Goldman Sachs estimates this “output gap” at 8% of global GDP.

As long as industry can provide more things – using its surplus capacity – without the need for major additional inputs, it has no pricing power. People can buy…but it won’t cause prices to rise.

We also have the Japanese experience.

True, the United States is not Japan. Things are different. And we have a strong hunch that they will turn out differently too. But the Japanese experience is worth keeping in mind. The Bank of Japan tried to get prices rising for more than 10 years – putting huge amounts of cash into the system. But instead of causing consumer prices to rise in Japan, the money was borrowed and re-invested in the United States and emerging markets. It did nothing to increase consumer prices in Japan.

You are probably wondering what the bottom line is…

We’re wondering too. What we take from this soliloquy is that inflation is tougher to conjure up than it generally recognized. Putting an extra dollar of cash into the system doesn’t necessarily make prices rise.

On the other hand, this mush under the world financial system makes the structure inherently unstable.

And as more and more brine is pumped in, it becomes even more unstable.

It’s not that the additional liquidity raises the consumer price level directly…dollar for dollar. Instead, it is like floodwaters backing up behind an earthen dam.

The risk of a sudden flood increases…one that will swamp the dollar and send investors and savers running for the high ground.

Yes, dear reader…there’s the surprise we were looking for. The Fed’s “quantitative easing” won’t cause inflation. At least, not serious consumer price inflation directly linked to the money supply increases.

The Fed will inflate the money supply. But consumer price inflation will remain relatively low – as it did in Japan. This will lead investors to believe that they can sit tight…believing that they will be able to move to a higher elevation when consumer prices finally begin to rise.

They will think about buying gold, but they will put it off – waiting for the CPI to rise.

Then, very suddenly, investors will see the threat. Maybe the Chinese will be the first to rush. Maybe private investors will make the first move. Maybe it will be a sudden spike in the CPI that sets them off. Maybe it will be an unexpected spike in the price of gold…or oil. Or maybe even a bold move from the Fed that leaves no doubt as to its intentions. Then, all of a sudden people will realize that what they are holding is just paper – nothing more – and they will try to get out of it as fast as possible.

But it will be too late. Once the dike breaks, in a matter of hours, the dollar will sink like Lehman shares.

That’s why we will keep our Dollar Crash Alert flag flying... while recognizing that it may not happen soon.

Bill Bonner