Another Crisis of Confidence in the US Dollar is Coming

On 15 August 1971 — a quiet Sunday evening — US President Richard Nixon took to the airwaves. He cut in on America’s most popular TV show to announce his ‘New Economic Policy’.

Nixon’s government imposed national price controls…a steep surtax on foreign imports…and banned the exchange of US dollars for gold.

America was in the midst of a crisis. It was the result of an ongoing currency war that had destroyed faith in the US dollar. The president saw the need for extreme measures.

Today, we are engaged in a new currency war. Another crisis of confidence in the dollar is on its way. This time the consequences will be far worse than those that confronted Nixon…

A radical plan

The growth in globalisation, derivatives and leverage over the past 40 years have made financial panic and contagion all but impossible to contain.

The new crisis will likely begin in the currency markets. It will spread quickly to stocks, bonds and commodities.

When the dollar collapses, the dollar-denominated markets will collapse too. Panic will quickly spread throughout the world.

As a result, another US president — possibly President Obama — will take to the airwaves and cyberspace. The president will announce a radical plan of intervention to save the dollar from complete collapse — invoking legal authority that is already in place today.

This new plan may even involve a return to the gold standard. If gold is used, it will be at a much higher price to support the bloated money supply with the fixed quantity of gold available.

Americans who had invested in gold earlier will face a 90% ‘windfall profits’ tax on their newfound wealth…imposed in the name of ‘fairness’. The government will confiscate foreign-owned gold presently stored in New York…and convert it in the service of the New Dollar Policy.

No doubt the Australians, Europeans, Japanese and other global investors will receive receipts for their former gold…convertible into ‘New Dollars’ at a new, higher price.

Alternatively, the president may eschew a return to gold. He or she could implement an array of capital controls — using the IMF to create money — to stabilise the situation.

This IMF global bailout would not be in old, nonconvertible dollars, but in a newly printed global currency called the SDR (special drawing right). Life will go on, but the international monetary system will never be the same.

The greatest gamble in history

This isn’t far-fetched speculation. It has all happened before.

Time and again, paper currencies have collapsed…and regimes have frozen assets, confiscated gold and imposed capital controls.

The US has not been immune to these acts. In fact, America has been a leading advocate of dollar debasement from the 1770s to the 1970s, through the Revolution, the Civil War, the Great Depression and Carter-era hyperinflation.

The fact that a currency collapse has not happened in a generation just implies that the next crash is overdue. This is not a matter of guesswork — the preconditions are already in place.

Today, the US Federal Reserve is engaged in the greatest gamble in the history of finance. Beginning in 2007, the Fed fought off economic collapse by cutting short-term interest rates and lending freely. Eventually, rates reached zero, and the Fed appeared to be out of bullets.

Then, in 2008, the Fed found a new bullet: quantitative easing. While the Fed describes the program as an easing of financial conditions through the lowering of long-term interest rates, this is essentially a program of printing money to spur growth.

The Fed is attempting to inflate asset prices, commodity prices and consumer prices to offset the natural deflation that follows a crash. It is basically engaged in a game of tug-of-war against the deflation that normally accompanies a depression.

As in a typical tug-of-war, not much happens at first.

The teams are evenly matched and there is no motion for a while, just lots of tension on the rope. Eventually one side will collapse, and the other side will drag the losers over the line to claim victory.

This is the essence of the Fed’s gamble. It must cause inflation before deflation prevails; it must win the tug-of-war.

An attack on your stocks

In a tug-of-war, the rope is the channel that conveys stress from one side to the other. In the contest between inflation and deflation, the rope is the US dollar.

The dollar bears all the stress of the opposing forces and sends that stress around the world. The value of the dollar is the way to tell who is winning the tug-of-war.

This particular tug-of-war is actually a full-on currency war. It is not really a game but an attack on the value of every stock, bond and commodity in the world.

In the best of all possible worlds for the Fed, asset values are propped up, banks get healthier, government debt melts away and no one seems to notice.

But by printing money on an unprecedented scale, Bernanke has become a 21st century Pollyanna — hoping for the best and quite unprepared for the worst.

How bad could that worst-case scenario get? In tomorrow’s Money Morning, I’ll reveal the disaster that the Fed’s money printing is about to set off — and what that could mean for investors based in Australia.


James Rickards,
Contributing Editor, Money Morning

James G. Rickards is the editor of Strategic Intelligence, the newest newsletter from Agora Financial. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.

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