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Wednesday, March 13, 2013
It's a simple question...
Do new all-time highs on the Dow Jones Industrial Average indicate that our country is no longer in danger of the End of America scenario I've outlined over the past several years?
For those of you unfamiliar with my End of America hypothesis... the idea is as simple as it was controversial. To summarize, I believe that America's mounting debts (particularly our runaway federal government's debts) will cause our creditors to abandon the U.S. dollar.
They will do so not in a deliberate effort to sink our economy, but in an effort to hedge their exposure to the inevitable inflation that must result as America prints trillions of dollars to repay its debts.
In this scenario, the U.S. dollar would lose its standing as the world's reserve currency, causing a cascade of further financial, political, and social problems, including a massive devaluation of the dollar. It is a serious question to ask what the 46 million people who depend on food stamps would do if, suddenly, a crisis left the government unable to feed them.
To many people, such questions seem radical or only meant to inspire fear. That's not why I wrote them. Nor is this scenario what I hope will occur.
Instead, as when I wrote about the inevitable bankruptcy of General Motors and the inevitable failure of Fannie Mae and Freddie Mac, I believe I am merely pointing out the obvious. What I hope is that by drawing attention to these very serious financial problems, we can avoid the worst outcomes.
Today, for the first time in human history, the entire global economy relies on a paper currency – the U.S. dollar – which is not linked or backed up by any reserve commodity (such as gold). Around the world, roughly 60% of all bank reserves are U.S. dollars. Our leaders and our bankers greatly admire the dollar's remarkable financial flexibility. Its standing as the world's reserve currency permits America's leaders to do what no other country in the world can do: legally print money to repay debts.
As long as this system remains in place, there is no limit – none whatsoever – to America's credit.
When this system was created following World War II, America's reputation was such that no one believed that we would ever become a net debtor to the world. At the time, we were the world's largest creditor (by far). It was greatly in our best interest to maintain a firm and stable value of the dollar, so that our loans would be repaid in sound money.
However... the power to rack up unlimited debts quickly corrupted our political system. In less than 50 years, we went from being the world's largest creditor... to being a net debtor... to being the world's largest debtor... to being the largest debtor in history. With access to this kind of unlimited credit, our federal government – whose total budget during peacetime had historically been well below 5% of GDP – grew like the magic beanstalk to nearly 25% of GDP.
As a result, today, the U.S. dollar – which remains the foundation of the world's financial system – is little more than an "I.O.U. nothing." The U.S. Treasury has no realistic ability to ever repay the holders of its notes in sound money, not with total current debts that exceed the United States' GDP. And that's not including our government's unfunded liabilities, which exceed the value of every liquid asset of every country in the world.
So... what will happen next? As long as we retain our status as the world's reserve currency, we will continue to have every incentive to go further and further into debt and to finance these massive obligations with our unique printing press. I believe we will continue to exploit this system until it collapses.
Remember, the dollar is purely a paper (or a digital) abstraction. It is not tied to any firm or fixed value. There's literally nothing to prevent us from continuing to borrow trillions every year.
This unbelievable power seems like a miracle to our leaders, who undoubtedly believe that by cutting more slices into the pie, they're creating a bigger pizza. I suppose they haven't fully considered the downside to such a system, however. If confidence in the dollar were to fail, what on Earth could be used to stop the panic? There are no reserves. There is only more paper. Perhaps that's why the Department of Homeland Security is buying millions of rounds of ammo and thousands of tanks.
Since I began writing about the End of America scenario, there have been plenty of signs that I'm right and that the world is turning away from the dollar. Our two biggest economic rivals, China and Russia, have begun buying enormous amounts of gold and other strategic commodities and assets all around the world. They're using their dollars as quickly as they can to hedge their enormous exposure to the U.S. dollar.
They've also negotiated trade agreements that allow them to exchange goods without using dollars. Dozens of other countries have done the same, reducing the use of dollars around the world.
For the first time since 1971, central banks are again net buyers of gold. This is a run on the dollar. It has already started. Credit-ratings agency Standard & Poor's downgraded U.S. debt in response to these moves and the federal government's continued runaway spending. Many major corporations have begun to use China's capital markets to sell bonds denominated in China's renminbi, rather than sell dollar-denominated bonds in New York. This reflects a growing investor interest in other, safer currencies.
Finally... there have been large (and sometimes violent) public demonstrations protesting any effort to reduce the government's spending or to cut entitlements.
In many ways, I would argue that my End of America warnings were right... and that this process is currently underway. But... in the most important way of all... my prediction has been totally wrong.
I believed that as America continued to rack up trillions in new debt – and as it continued to finance these debts by using the Central Bank to buy its notes and bonds (aka quantitative easing) – our creditors would flee the U.S. bond market, causing interest rates to soar.
That hasn't happened. Instead, the U.S. Treasury bond market has rallied, almost continuously. Whether that's because the Fed continues to buy all the excess paper or not, I've been wrong about my predictions of a bond-market collapse... at least, so far.
The real test of my hypothesis will come when the Fed stops intervening in the market and when, eventually, it must begin to sell some of the bonds it holds to reduce the inevitable inflation its vast expansion of the money supply will cause.
Today, speculators from around the globe have a nearly foolproof way to make money: They merely front-run the Fed's bond-buying operations. The same thing will be true in reverse, too. When the Fed begins to sell the trillions it holds in U.S. Treasury bonds, the world will try to sell first.
When that happens, you could see a global run on the dollar.
But if that were likely, would stocks really be trading at new highs? I would argue that the new highs in the stock market are actually part of the problem I'm describing.
You see, as the dollar loses value, it causes the nominal price of stocks and the nominal amount of earnings to go up. In short, a weaker dollar is one path to a higher stock market. But it's not the path to prosperity or wealth.
It's just a sign of more dollars in the system.
If you're not convinced, be sure to read tomorrow's essay. I'll show you real-world data that proves the dollar has lost between 20% and 40% of its purchasing power... in less than six years.
"I believe the sovereign-debt bubble in the U.S. will end badly," Porter says. "But I also believe life will get tremendously better... and huge fortunes will be made... It's inevitable."
See how he reconciles these apparently "contradictory" views here: The Next 25 Years Will Bring an Epic Crisis... and Vast Prosperity.
THIS "RISK FREE" INVESTMENT JUST FELL TO A NEW LOW
As most news outlets cheer the latest stock-market highs, one major asset class continues to move lower: U.S. Treasury bonds.
As regular readers know, falling interest rates since 2008 – plus no sign of inflation – created the perfect environment for bonds. Many investors believed that Treasurys offered a "risk free" place to stash their money. This fueled a huge rally in the big long-term Treasury fund (NYSE: TLT).
But as we noted in November... after soaring 50% in 18 months, the two-year uptrend in Treasurys started to break down.
As you can see in today's chart, TLT just broke out to a 10-month low. The fund is down about 12% since July. More important, it's forming a bearish trend of "lower highs and lower lows." The downtrend in Treasury bonds continues.
– Larsen Kusick
In The Daily Crux