By: David_Galland
David Galland, Casey Research writes:
Tune into CNBC or click onto any
of the dozens of mainstream financial news sites, and you’ll find an endless
array of opinions on the latest wiggle in equity, bond and commodities markets.
As often as not, you'll find those opinions nestled side by side with
authoritative analysis on the outlook for the economy, complete with the
author’s carefully studied judgment on the best way forward.
Lost in all the noise, however, is any recognition that the US monetary
system – and by extension, that of much of the developed world – may very well
be on the verge of collapse. Falling back on metaphor, while the world’s many
financial experts and economists sit around arguing about the direction of the
ship of state, most are missing the point that the ship has already hit an
iceberg and is taking on water fast.
Yet if you were to raise your hand to ask 99% of the financial intelligentsia
whether we might be on the verge of a failure of the dollar-based world monetary
system, the response would be thinly veiled derision. Because, as we all know,
such a thing is unimaginable!
Think again.
Monetary Madness
Honestly describing the current monetary system of the United States in just
a few words, you could do far worse than stating that it is “money from nothing,
cash ex nihilo.”
That’s because for the last 40 years – since Nixon canceled the dollar’s gold
convertibility in 1971 – the global monetary system has been based on nothing
more tangible than politicians' promises not to print too much.
Unconstrained, the politicians used the gift of being able to create money
out of nothing to launch a parade of politically popular programs, each
employing fresh brigades of bureaucrats, with no regard to affordability.
Such programs invariably surged during political campaigns and on downward
slopes in the business cycle when politicians hearing the cries of the
constituency to “do something” tossed any concern about balancing budgets out
the window of expediency. After all, the power to print up the funds for debt
service whenever needed makes moot any concern over deficit spending.
Former VP Cheney, who fashions himself a fiscal conservative, let the mask
drop when, in 2002, he stated that “Reagan proved deficits don’t matter.”
Those words were echoed just a few weeks ago, when both former Fed Chairman
Alan Greenspan and Obama economic advisor Larry Summers, in separate interviews,
said almost the same, paraphrased as, “There is no chance of the US defaulting
on its bonds, not when our government can borrow dollars and print new dollars
to meet any future obligations.”
Of course, Greenspan and Summers were referring to an overt default – of just
not paying – and not to a covert default engineered by inflation. Unfortunately,
like virtually all of the power elite, both miss the point that the mountain of
debt that has been heaped up since 1971 is fast reaching the point of collapsing
like a too-big tailings pile and taking the monetary system down with it.
Importantly, the debt shown in this chart whistles past the government's
unfunded liabilities, in particular for the Social Security and Medicare
systems. Adding those would more than triple the US government’s acknowledged
obligations – to over $60 trillion.
Given the role the US dollar plays as the world’s de facto reserve currency –
with all major commodities priced in dollars, and dollars forming the bulk of
reserves held by foreign central banks – the dismal shape of the US monetary
system spells trouble for the global monetary system.
Making matters worse, following the lead of the United States, governments
around the world long ago adopted similar fiat monetary systems. You can see the
deficit contagion in this next chart. It is worth noting that the dire condition
of the United States now leaves it in the same muddy wallow as Europe’s
desperate PIIGS.
In a recent article in The
Telegraph, Ambrose Evans-Pritchard referenced a paper out of the BIS that
paints the picture using appropriately stark terms.
Stephen Cecchetti and his team at the Bank for
International Settlements have written the definitive paper rebutting the
pied pipers of ever-escalating credit.
“The debt problems facing advanced economies are
even worse than we thought.”
The basic facts are that combined debt in the rich
club has risen from 165pc of GDP thirty years ago to 310pc today, led by Japan
at 456pc and Portugal at 363pc.
“Debt is rising to points that are above anything
we have seen, except during major wars. Public debt ratios are currently on an
explosive path in a number of countries. These countries will need to implement
drastic policy changes. Stabilization might not be enough.”
Viewing the situation from another perspective, we turn to the work of Carmen
Reinhart and Ken Rogoff, who studied the factors contributing to 29 past
sovereign defaults. They found that default or debt restructuring occurred, on
average, when external debt reached 73% of gross national product (GNP) and 239%
of exports. Using the Reinhart/Rogoff findings, Casey Research Chief Economist
Bud Conrad prepared the following chart showing that the US government is
already far along on the path to bankruptcy.
It’s hard to argue against the contention that the situation is, to be
polite, precarious. Given that the obligations of the US government, as well as
most of the world’s other large economies, are now impossible to repay and that
their reserves are just IOUs backed by nothing, the stage is set for a highly
disruptive but entirely necessary do-over of the fiat monetary system.
“Preposterous!” say the lords of finance and masters of all.
Is it?
Of course, these very same mavens completely missed the looming housing crash
and the depth and duration of the subsequent crisis – a crisis that is still far
from over. In other words, listen to them at your peril, because in our view
it’s essential in calibrating your financial affairs to understand that, if
history is any guide, we are now well down the road to a collapse in the
monetary system.
In fact, over its relatively short history, the US monetary system has come
unglued time and time again thanks to politically expedient attempts to
interfere with the workings of a free market in order to reward constituents or
kick the can on the economic problems of the day down the road.
Thus it is our contention that while the mainstream media focus on the daily
gyrations of equity markets or the futile political charade that is Washington,
they overlook powerful tectonic rumblings indicating the world’s prevailing
monetary system is about to fracture.
A Brief Timeline of US Monetary System Failures
Here’s a brief history of past disruptions here in the United States.
Importantly, with the US dollar now the de facto reserve currency of the world,
this time around it’s global.
1861 – When the Civil War begins, the dollar is convertible
into gold and silver.
1862 – Congress passes the Legal Tender Act and authorizes
the issuance of non-redeemable "Greenback" currency. Convertibility into gold
and silver is suspended for all US currency.
1863 – National Banking Act authorizes the chartering of
banks by the federal government.
1865 – A 10% tax is levied on the issuance of bank notes by
state-chartered banks, effectively ending that practice.
1879 – The US Treasury resumes redeeming dollars for gold
and silver.
1900 – Passage of the Gold Standard Act, adopting the gold
standard by the United States and demonetizing silver.
Specifically,
the act provided for "...the dollar consisting of twenty-five and eight-tenths
grains (1.67 g) of gold nine-tenths fine, as established by section thirty-five
hundred and eleven of the Revised Statutes of the United States, shall be the
standard unit of value, and all forms of money issued or coined by the United
States shall be maintained at a parity of value with this standard..."
But 33 years later, to gain the power to inflate the currency and collect the
profit from doing so…
1933 – By executive order, Franklin Roosevelt prohibits the
private ownership of gold. Congress passes the Gold Reserve Act, which enacts
Roosevelt's executive order, abrogates all gold clauses in all contracts public
or private, past or future (which cancels the convertibility of Federal Reserve
notes into gold), though it confirms the convertibility of US Treasury notes
held by foreigners into gold. Eleven years later, the US government takes its
show on the road…
1944 – Bretton Woods system adopted with signature countries
agreeing to tie the exchange rates of their currencies to the US dollar, which
itself is linked to a fixed price of gold. Foreign trading partners retained the
right to swap dollars for gold, imposing a de facto restraint on
printing more dollars. For all intents and purposes, the US dollar becomes the
world’s reserve currency. But 27 years later…
1971 – Nixon abruptly closes the “gold window,” unilaterally
reneging on the Treasury's promise to allow foreign governments to redeem
dollars for gold. Bretton Woods collapses. With no remaining tie to a tangible,
the dollar is reduced to a paper token. The transition to a global fiat monetary
system is complete.
Until 40 years go by and the inevitable consequences of giving politicians
free rein over money creation become untenable…
Present day – Sovereign debt crisis. Desperate, debt-laden
governments around the globe – the bulk of their reserves composed of fiat US
dollars and euros at risk of going up in smoke – turn to the only thing they
know, printing more money and issuing yet more debt. The global monetary system
cracks and heads toward failure with no workable alternative on the horizon.
Governments, corporations and investors alike are caught unprepared in the
downward spiral of failing fiat currencies and are wiped out by a combination of
frantic currency debasements, higher taxation, exchange controls and worse.
Social unrest spreads, with the public paradoxically demanding that governments
do more, not less.
That’s because all the world’s major currencies are at risk, simultaneously,
as the issuers engage in a dangerous race to the bottom. As the monetary system
moves inexorably toward terminal debasement and collapse, the results will be
catastrophic for the unprepared.
Importantly, while the list of historical attempts to re-jigger the US
monetary system have, to this point, more or less succeeded in kicking the can a
bit further down the road, the sheer scale of today’s government obligations has
driven us into a box canyon, with no way out. As the government’s debt and
spending obligations are mathematically impossible to resolve, it is now a
certainty that a lot of people are going to wake up one morning to the reality
that they are a lot poorer than they thought.
Fortunately for those now paying attention, the collapse of a monetary system
doesn't happen in a flash. It is a progression, like the spiral of water down a
drain. Thus, while no one can predict exactly when the downward spiral will
accelerate out of control, there is still time to prepare.
Dark though the lens may be, this is the lens through which we here at Casey
Research view all our investments. Simply, being right or wrong about your
investment decisions in the years just ahead will be insignificant if the
currencies underpinning those investments shrivel to just a fraction of their
current values.
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