Is A Currency Crisis Coming?

By John Schroder - May 14, 2015 

During the past few months we have had more than just a handful of clients asking us about this so-called currency reset that has been discussed in various forums recently.  And of course we have received a large number of phone calls from people asking about banking in other jurisdictions (away from their home country), how to secure their 401K or pension funds from possible government asset grabs, and related kinds of concerns.  But before anyone jumps to the conclusion that all this is simple conspiracy quackery,  former US Congressman Ron Paul recently participated in a few public interviews this year (2015) whereby he discussed his belief that a currency crisis is coming to the United States.  While there have been a large number of things posted on so-called conspiracy sites, we have to believe that when someone such as Dr. Ron Paul basically says that something wicked this way comes, you have to sit up and take notice.  After all, they said that Ross Perot was off his mind when he warned about what would happen to US manufacturing and the resultant loss of American jobs if NAFTA and other similar trade agreements were put into place, and to be honest, the man was eventually vindicated (although even he did not fathom the loss of manufacturing not to Mexico alone, but of course to China).  Now the new item on the agenda is the TPP or Trans Pacific Partnership Agreement that has not even been fully made public due to the so-called sensitive nature of it (interpret this as the general public is too dumb to know what is says, and it's none of their business anyway, or so would seem to be the US Government's attitude about it).  In fact, a few people that actually did read it claim if the American people knew what was in the document, there would be open revolt in the morning.  So, the point is, in a so-called free democratic open society, if the learned and esteemed politicians are willing to conduct themselves in such a manner regarding a free trade agreement – what else are they prepared and willing to do regarding other issues?  Never the less and getting back to the fate of the US Dollar, such a crisis would basically result in the rejection of the US Dollar both for trade internationally and a store of value for central bank reserves world-wide as well.  So, you can call it by whatever moniker or term you may wish, but the idea that there will be some kind of future crisis effecting or involving the US Dollar is not so far fetched.  Something has to give and changes are certainly in motion with respect to the pecking order of nations (in terms of economic power) and subsequent issues pertaining to trade settlement as well (and thus what currencies will become important, and what currencies will fall by the wayside).

What is the basis for this assumption and predictions about the long term future of the US Dollar (and other currencies as well)?  Some people will refer back to August 1971 as the starting point when then former US President Nixon took the US Dollar off the gold standard and closed off the gold convertibility of the US Dollar to foreign central banks.  And it certainly is true that date might be considered to be the start of the backing of the US Dollar by oil, or better said an agreement that was constructed so that ALL oil sales would be conducted in US Dollars, thus creating a demand for that currency for commodity trade settlement.  Such an agreement meant that all foreign governments (and any private businesses involved in oil or petroleum transactions) needed to keep a reserve of US Dollars to purchase oil.  This of course created a demand for US Dollars that very much so gave support and value for the USD use in global commerce (remember basic supply and demand economics, and currencies can be considered a commodity as well subject to supply and demand functions).  In essence the free floating currency (and variable exchange rate) system we have today was born out this, but it has left the door wide open to abuse by politicians and financial participants (Central Banks) that decided to print money with reckless abandon when they so desired to do so.

Conservative columnist David J. Frum summed up the inherent problems with a free floating (and untethered to gold or silver) currency unit this way:  The modern currency float has its problems. There is no magical monetary cure, monetary policy is a policy area almost uniquely crowded with trade-offs and lesser evils.  If you want a classical gold standard, you get chronic deflation punctuated by depressions, as the U.S. did between 1873 and 1934.  If you want a regime of managed currencies tethered to gold, you get regulations and controls, as the U.S. got from 1934 through 1971.  If you let the currency float, you get chronic inflation punctuated by bubbles, the American lot since 1971.  System 1 is incompatible with democracy, because voters won’t accept the pain inherent in a gold standard.  System 2 is incompatible with the free market economics I favor.

Gold, Silver, Paper: Which Is Better As Money?

In the past when gold and silver was used as a medium of exchange, and later on paper money backed by or attached to a metal standard (gold or silver) there existed some discipline placed upon government treasuries and central banks as to how much money they could actually create or inject into the financial system (or into the economy we can say).  Having a free floating fiat system, whereby paper money is backed by nothing more than consumer or user faith, is not in and of itself the problem entirely as a monetary system.  Rather it is human nature and the lack of discipline by those men and women responsible for the proper management of the money supply and financial system in general that is the problem.  And there have been numerous countries or political regimes throughout history has abused this trust and fiduciary responsibility.  There are almost no exceptions.  The Tang dynasty in China (618-907AD) was credited with creating the first paper money system with the invention of ink stamping.  But they too abandoned it in 1455 after experiencing a financial crisis, inflation and related mayhem.  Of course we cannot place blame on a paper monetary system alone for being vulnerable to political malfeasance (with the money supply) as the clipping of coins, or reduction of the gold or silver content minted coins by the Roman Emperors of ancient history proves that metal coinage can be debased as well.  In short, the history of mankind and use of various mediums of exchange only demonstrates that politicians will almost always resort to financial chicanery to try and solve their nation's respective economic problems regardless of what is being used as money.  In other words, they will cheat the citizenry, albeit through stealth, by debasing the national exchange medium individuals and businesses rely upon for their own personal wealth and financial well being.  Unfortunately it is the common citizen that suffers that most because they have no control over what is happening and they may not even be aware of it until it is too late.

Leviathan Loves Debt (And So Does The Citizenry It Would Seem)

Many people have already highlighted the issue of the US national debt, and Dr. Ron Paul has made the quite correct observation that it took the United States Government over 200 years to rack up US$8 Trillion in Federal Government Debt, and then just about one decade more to double it.  And do not think this is a US problem alone as governments from the collective so-called modern wealthy developed nations went from about US$11 Trillion in sovereign debt issuance up to US$41 Trillion in about the same time frame as well (meaning within the last decade).  But that is not the entire story, as unfunded liabilities for government pension and other social welfare programs are postulated to add up to 4 times these national sovereign debt levels (or even more, all depending whose statistics or estimates you wish to use).  So, while the current US national debt is already past 100 percent of GDP (and ironically the IMF claims anything over 60 percent is an indicator of fiscal problems, with ratios closer to 100 percent or more absolute doom), these unfunded social welfare programs make the scenario even more dire.

While one can easily chastise politicians for doing what they often do best: spend other people's money with reckless abandon, the levels of personal or private debt had skyrocketed as well.  We all are quite aware of the 2008 housing crisis and subsequent problems with mortgage debt, but we also now have a very serious problem with other areas such as college student loan debt as well.  America it would seem has been running on, and has been addicted to debt on almost all levels and in all areas of the economy.  This cannot continue and it will not.  If individual citizens and governments are not willing to reassess their own finances and make adjustments accordingly, the market will do it for them – and there in lies just one possible catalyst for this so-called coming currency crisis or reset.  Why is this an important point in the discussion of money?  Well, if one is using a fiat currency (something created and used by edict, and backed by nothing more than the supposed faith and credit of the government issuing it) then in theory the value of that monetary unit depends very heavily upon the local economy and the credit worthiness of the government issuing it.  If the local economy of that particular currency issuing country is in dire straights and if the said government is reaching unsustainable debt levels, then that circumstance alone would cause the currency markets to downgrade the currency.  The only reason this has not happened before, general economic or debt issues aside, was because the United States did indeed have what was called an extraordinary privilege of being the issuer of a currency used for almost all commodity and trade settlements plus global central bank reserves as well.  In fact, that is one reason why they have been able to get to the point they are at now without too much negative consequences of running up debt and running the proverbial printing presses also.  But expressly because this is what they have been doing, the rest of the world is getting nervous and why they are now looking for other world trade settlement arrangements (be it another currency other than the US Dollar, be it a basket of currencies, be it gold or silver itself).   

World Trade Supranational Alternatives

There are of course a number of initiatives taking place right now to replace both the US Dollar and many of it's supporting institutions.  In terms of such institutions, we are of course speaking about the International Monetary Fund and World Bank as supranational institutions created out of the Bretton Woods monetary agreement fashioned after the second world war.  As a replacement for such institutions we now have the Asian Infrastructure Investment Bank (AIIB) which has China as it's founding sponsor and a surprising number of European nations that have signed up along with a long list of emerging market countries as well.  In addition we also now have the New Development Bank, or what was previously referred to as the BRICS bank because it's founding members are China, Russia, India, Brazil and South Africa.  Interesting enough, as competition for some of these other previous entities, the New Development Bank represents a group of nations that accounts for about 25 percent of world GDP and 40 percent of the world's population.  If we talk about the Asian Infrastructure Investment Bank in the same terms, then of course we are speaking of a supranational financial institution covering even that much more of the world's GDP and population (and the membership of Germany, Switzerland, The United Kingdom, France, Italy, Australia along with a number of other countries makes it quite meaningful).  The United States of course is notably absent and one might surmise that the rest of the world is seemingly tethering their lifeboats to China and the emerging markets while attempting to distance themselves what could be perceived as a sinking ship in terms of the United States.  Of course it is in no one's interest to see that ship go down until such time an alternative is gradually put into place, but we do believe an alternative is coming (and we do believe the rest of the world is trying to prepare the lifeboat, at least for themselves).

Can You Believe The Statistics & Rhetoric?

For as long as most of you can remember the US Dollar and US Treasury securities have reigned supreme in terms of foreign reserves and investment holdings.  However, while China and Russia have been reducing their US Treasury holdings recently, on the surface it would seem that there is still foreign demand for US Dollars and US Treasury Securities – or is there?  According to statistics reported on April 16, 2015 by the US Treasury, the top four foreign holders of US Treasuries are 1. Japan, 2. China, 3. Caribbean Banks and 4. Belgium.  What attracts immediate attention are these figures for the Caribbean Banks and Belgium.  Where do or did they get the money to make such purchases?  Belgium held $188 Billion of US Treasury Bonds in March 2013, and in January of 2015 they held US$354 Billion.  This from a country that has a national GDP of about US$400 Billion.  Dr. Paul Craig Roberts speculates that Belgium was being used as a straw man for the US Federal Reserve to buy up about US$100 Billion in Treasuries dumped back in 2014 (we can speculate the dumping was being done by Russia).  In fact, Dr, Roberts goes on to coin it a money laundering operation by the US Fed, which may be a fairly accurate description.  In terms of both Belgium and the Caribbean Banks, each holds roughly US$350 Billion in US Treasuries, which is about one third what China and Japan still hold individually.  Make from that what you will, but if you think tiny Belgium and a few Caribbean nations have US$700 Billion collectively in extra cash on their own to buy up US Treasury securities, then you may have an inclination to believe fairy tales as well.

Recent figures for 2015 put foreign holdings of US Treasuries at about US$6 Trillion (out of US$18 Trillion) which translates into roughly one third of US Treasuries supposedly in foreign hands (Belgium??).  However, February 2015 statistics indicate that holdings of US Treasuries by foreigners has actually declined.  China got rid of US$15 Billion, Japan US$14 Billion, Russia US$12 Billion and reductions in holdings by a few European nations as well.  In any event, while it is not in the interest of China to do something that would dramatically reduce the value of it's US Treasury holdings, the long term trend seems to be a net reduction in such holdings and an increase in gold and or other kinds of assets.

The Currency Crisis Plan

Obviously we have glossed over a number of different issues and a short article does not do justice either in depth or scope to the entire problem.  However, for most investors the questions are going to be: How do I protect my savings from a currency devaluation?  How can I protect myself from possible currency controls and or government asset grabs?   The problem of course is you do not know nor cannot know exactly what you might be protecting yourself from.  In other words, no one really knows what might trigger a US Dollar currency crisis, or even if it will be sudden as opposed to something gradual.  And with that said, you really do not know what any government might do (although history offers some clues).  However, we have a tendency to believe that having assets out of reach is better than not.  As just one example, if you were alive back in the early 1930's and had the good sense to get your gold out of the US before the US Government decided to confiscate all private gold (and into another jurisdictions that did not prohibit individual gold ownership) then you might have had a fighting chance.

While we cannot say if that kind of action would be repeated today, it certainly is not out of the question to be concerned about a possible nationalization of private pension funds.  Considering that most Americans historically had the bulk of their personal wealth or net worth tied up in their home and pension savings, and with the real estate market still on tenuous ground in some areas, the estimated US$24 Trillion Dollars in US retirement assets is a tempting target (which represents an estimated 35 percent of the private wealth held by individual US citizens).  Of course there does not have to be outright nationalization of private pensions as has happened in Argentina in recent years.  Instead, the US government could simply mandate that private pension funds (IRA accounts, 401K accounts, defined benefit and defined contribution plans, private insurance annuities) must invest in or hold say 50 percent of the investment funds in US Treasuries.  In other words, IF there is a point whereby there are no buyers for US Treasuries, they could conceivably force a number of domestic institutions to hold or invest in such securities by law.  It all sounds somewhat unbelievable, but consider who would be the buyer of US$6 Trillion worth of US Treasuries if those current foreign holders decided to get rid of them?  The analysis of tiny Belgium's 2014 purchase of roughly US$100 Billion worth of US Government securities is that it was a back door purchase by the US Fed.  But that is a relatively meager amount.  Who would be a buyer of US$6 Trillion worth if these foreign nations or foreign individuals decided to get rid of it?  Mozambique?  Andorra? The Cat in The Hat?

Perhaps we already have evidence of some things being currently planned.  The recent push for a cashless society is just one change on the agenda, but who will really benefit?  Of course governments and banks are on board (we refer to the fairly recent comments by a Citibank economist regarding going cashless, and all of the recent articles appearing by academics on the subject) and naturally they want to tout the operational cost savings and supposed general convenience for the public.  But there remains a number of possible uses, reasons and dangers inherent in a cashless system.  For one thing we have the blaring issue of privacy or better said, complete lack thereof.  Conducting your personal business with cash is the only truly private way of handling your transactions.  That goes completely away with an electronic, tracked, cashless system.  And of course hacking and similar electronic mayhem is a real possibility.  Granted, you can be physically robbed of your cash too, but imagine someone thousands of miles away somehow hacking into your account, cloning your debit card and who knows what else.  Electronic long distance theft, all done without a weapon or even being near the intended victim.  To be sure that can also happen right now if you have a debit card or credit card, but in the least one can keep cash on hand for any emergency.  If they do away with or outlaw cash, then you are really in a problem.

The third issue with electronic or cashless systems is the good old negative interest rate.  Banks of course right now can impose a fee for you to have a bank account open and in the process not pay you any interest, ergo a negative interest rate in effect.  But you cannot impose that on cash held in the personal possession of individual citizens.  However, negative interest rates or charging people for not spending their money is very doable with a cashless electronic system.  The electronic balance simply goes down every day the funds are not spent.  Why would a government do that you might ask?  Well, let us say the average consumer is not responding to whatever other economic policies are put in place, and are not spending and thus not stimulating the economy.  Negative interest rates on electronic balances could be the equivalent of a high voltage cattle prod to the nether regions of the citizenry, forcing them to use it or lose it, spend it or see it disappear. How's that for effective government economic coercion?

But the above mentioned items are not the only issues, as one economist opines using the case of Ecuador as an example.  Ecuador, which adopted the US Dollar as a legal tender medium in the year 2000 in order to address inflation and other problems with the previously used Sucre monetary unit in that country has now implemented a new electronic or cashless monetary system.  Ecuadoran economist Diego Martinez claims that the government in Ecuador spends US$3 Million each year collecting and replacing worn out paper money in circulation (US Dollars) and thus by going to a cashless system using the US Dollar that the government will see a cost and manpower savings.  However, according to Mr. Lawrence White, who is an economics professor at George Mason University, Ecuador's move to a cashless system is a precursor to eliminating the US Dollar as the currency used in Ecuador.  So, is going completely electronic or cashless a way to easily and cost effectively put in place another new monetary unit? We do not know but Professor White from George Mason University seems to think so.  And that makes us wonder what the future is or what someone may have in mind regarding the US Dollar.  Sounds like crazy conspiracy stuff, but is it so far fetched?

The interesting thing about going cashless is that is extremely difficult to do in an emerging market country with large percentages of the population still considered poor, and for this reason we can envision them getting away with it in Europe or the US maybe, but not in developing countries.  Why?  Simply because poor people rely upon and use cash almost exclusively.  And in terms of even having a bank account, many people in these countries do not have one because even though you might consider a US$500 minimum (or equivalent in another currency) required to open a bank account no big deal, for some people that could represent 4 or 5 months worth of wages.  And in general poorer people in many developing nations look upon banks with suspicion regardless.  The logic of my 7 year old Dominican niece, whom my wife opened a children's savings account for at the bank, succinctly explains it.  Her question: Why should I give my piggy bank money to that woman behind the counter at the bank?  My Answer: Because she will deposit it to your savings account and you can earn interest or more money on the money.  Her question:  What will they do with my money?  My answer: Well, they loan it out to other people that want to borrow and thus earn interest on it, and they pay you a portion of that.  Her question:  But what if that other person does not pay, or what if the bank loses my money?  My answer: Well, the bank has people that make decisions about whom they loan money to, and they try to be careful to only loan money to credit worthy people.  Her comment: Sounds too fishy uncle, I want to see my money.  My comment:  Well, you cannot really see your money because it goes into a pool with the money of all the other bank account holders.  Her comment:  I do not like this banking thing uncle, I want to have my own money in my own piggy bank in my room where I know where it is.  Ah, the simple logic (and sensibility) of children.

In conclusion we have a tendency to believe that something will be done to address the profligate spending and debt accumulated by western governments in general and by the United States in particular.  In fact, it is already under way in terms of initiatives taken by China, Russia and a list of other nations as well.  That is not in and of itself a problem.  Rather, our concern is how will these governments react and how will individual citizens be effected.  A recent news article from the International Business Times claims that about half of all US university or college graduates from the 2013 and 2014 graduating classes still do not have jobs in 2015.  Such graduating students also have anywhere from an average of US$50,000 worth of student loan debt over their heads, and in some cases up to US$200,000.  That does not sound like an economic recovery to me.  So, what is a nation such as the United States going to do when they loose that extraordinary privilege (of having the world's reserve currency)?  With unprecedented levels of government and consumer debt, and after running the proverbial printing presses with wild abandon (or the electronic equivalent), and with an economy that has not really responded in a very positive way – what are they going to do?  Raise taxes on all the unemployed college graduates?  As a kid I remember having a class trip to visit and learn about the tomb of the unknown soldier, but as an adult I am more worried about the office of the unknown politician.  My grandfather once told me you need not worry about the dead (they can do you no harm), but rather it is the living you need to worry about.  Grandpa was right.