Dollar Disaster

The dollar is falling.

It’s falling in terms of how much corn, wheat, soybeans, beef, copper, silver, and gold it can buy. It’s falling against the euro, the yen, the pound, and the Swiss franc. It’s even going down against some third-world currencies.

In one way or another, this will affect just about every American alive today. It will bring higher prices for gas, imported goods, and American goods that compete with them. Plus, it implies a looming danger to bonds, stocks, and virtually all other traditional investments.

Yet, most people don’t understand it … and among those that do, few seem to care.

Maybe it’s because they haven’t lived in a third-world country where the currency was chronically shaky. I have.

CENTRAL BRAZIL, 1953

Over a half century ago, my father, who was a romanticist at heart, decided he wanted to buy a second home in the tropics. He dreamed of going there to escape Wall Street winters, write quietly and contemplate the world economy from afar.

Finally, in 1953, after three years of searching, he found his dream retreat, thousands of miles to the south, in the central highlands of Brazil.

Its name was Tres Ranchos, the amalgamation of three ranches that merged into one.

It had a fast running brook and a large patch of virgin forest. A few miles to the north, near the village of Curumbá, a tributary of the distant Amazon tumbled into a pristine waterfall from multiple directions, like a miniature Niagara.

A few miles further to the North was an open, largely uninhabited plateau which years later would be transformed into a bustling super-modern capital city. I remember vividly the hand-written sign posted seemingly in the middle of nowhere: “Future site of Brasilia.”

Two other American families also discovered this remote paradise. Janet Gainer, who played the leading role in “A Star Is Born” in 1937, lived nearby. So did Mary Martin, famous for her role in Peter Pan, along with her son Larry Hagman, who, many years later would become a TV star in “I Dream of Jeannie,” and “Dallas.”

But Hollywood glitter was very far away from my world in Brazil and meant nothing to me. I was too young and too busy with my favorite activities — exploring the jungle and collecting Brazilian coins.

Exploring the jungle on my own was not nearly as dangerous as you might think. The wild animals were my “friends,” and they never threatened me.

Collecting Brazilian coins, however, was another matter entirely. Even though time went by very slowly for me at seven years of age, I could tell my coins were losing value quickly.

I knew because many of them were “reis” or “kings” — the previous Brazilian currency. I couldn’t buy a darn thing with them. They didn’t even have collector value. In fact, it took one THOUSAND of the old reis to make just ONE cruzeiro, the Brazilian currency at the time, which, in turn was worth no more than four American pennies.

One day, I threw some of my coins into the brook, and, in retrospect, it probably was not such a bad decision.

In the years that followed, Brazil suffered a whole series of 1000-to-1 currency conversions — from the old cruzeiro to the new cruzeiro … to the cruzado … back to the cruzeiro and more.

Each time, anyone collecting, saving or investing in the previous currency would have been wiped out, their wealth decimated.

Almost five decades later, Dad and I sat down to figure out how much the old “rei” might be worth today. The answer: ONE QUADRILLIONTH of Brazil’s modern-day currency, the “real” or “royal.”

After we had counted all the zeros, Dad smiled at me and said: “Fortunately, you were not so careless with the nickels and dimes you saved in American money.”

FIGHTING THE DOLLAR DECLINE

Dad believed deeply in the dollar. Mostly it was because of his economic analysis. But partly it was also because of his fervent sense of patriotism.

Even back during the Eisenhower Administration, when the dollar was still solid as a rock, Dad was so alarmed by the danger of a future decline in the currency that he formed the Sound Dollar Committee, a non-profit organization that lobbied for a balanced budget and a strong dollar.

He and Eisenhower won that battle. But since then, I fear that we’ve lost the war.

AT THE MERCY OF FOREIGN INVESTORS

Indeed, the damage that has been done to the underpinnings of our dollar today remind me, in some ways, of the damage that was done to Brazil with its many currencies over the years.

Of course the United States is different from Brazil, and our dollar will not fall like the rei, the cruzeiro, or the cruzado.

But I have been back to Brazil over 30 times. I know almost every region except the Pantanal, near the border with Paraguay and Bolivia. I am always in touch with family in São Paulo and Brasilia. And I can tell you flatly: the historical paths of the United States and Brazil ARE BEGINNING TO CONVERGE.

Brazil’s economy has forever been at the mercy of foreign capital — from major banks, big corporate investors, the World Bank, the International Monetary Fund and others.

Why? One key reason is that it continually ran deficits and always needed money from abroad to fill the gap.

The United States, in contrast, was the opposite of Brazil. It was the U.S. that provided the primary source of capital throughout the world. It was the U.S. that owned big stakes in foreign economies. So we certainly didn’t need THEIR capital to sustain us.

Today, all that has changed. Today, like a third-world country, we depend HEAVILY on foreign capital.

Every time we run a deficit in our federal budget, our government officials must go, hat in hand, asking for money from central banks and investors in Europe, Asia and even Latin America.

Every time we run a trade deficit, spending more on imports than we make on exports, our officials run back for STILL more money from Europeans, Asians and Latin Americans.

Now, after thousands of such trips, and billions of such transactions, a significant chunk of America’s wealth has literally been sold off in parcels or thrown into hock.

DAY OF RECKONING

For many years our day of reckoning was postponed.

You’d understand why if you could talk to a large foreign investor; and not long ago, that’s what I did.

“I have massive amounts of dollars I need to invest,” he said. “I’m not particularly fond of the United States, and I don’t even like the U.S. dollar. But the dollar is king, the only true world currency. So I have no choice. The U.S. financial market is the only game in town big enough to satisfy our needs. I HAVE to keep a pretty substantial portion of my money in dollars, whether I like it or not.”

He wouldn’t have said the same thing for countries like Brazil. There, he DID have a choice. Whenever he lost faith in Brazil, for whatever reason, he pulled out in a big hurry along with thousands of others, sending Brazil’s financial market into periodic crashes.

This was the key difference that separated the United States from Brazil. Whenever Brazil slacked off or did the wrong thing financially, it got slapped down, hard. But when the United States made similar mistakes, it usually got away with it.

And so it was that we merrily ran huge deficits and borrowed to the hilt, as if nothing were wrong. And despite it all, foreign investors continued to pour more and more money into America.

In the 1980s, it was primarily cash-rich Japanese who led the way, investing billions into U.S. stocks and bonds, helping to lift the Dow and the Treasury bond market out of their worst slumps of the postwar era.

In the 1990s, it was mostly Germans that played that role, helping to drive the big tech boom.

But now, after two decades of massive, virtually nonstop capital flows into the U.S. from abroad, some people are beginning to realize that maybe, just maybe, it was not such a good idea after all.

THE WORST RELIANCE ON FOREIGN CAPITAL SINCE FRANKLIN

Our reliance on foreign investment is now the greatest since October 26, 1776, when Benjamin Franklin departed from Philadelphia for Paris to solicit financing for the American Revolution.

At the last reckoning, foreign investors owned an estimated $1.3 trillion in U.S. government securities … plus another $1.2 trillion in corporate bonds … plus more trillions in other U.S. assets.

And suddenly, more of these investors are waking up each morning to the discovery that, in the new millennium, the U.S. financial markets may not be the only big game in town any more.

No, these foreign investors won’t dump all their American holdings overnight. But to cause major disruptions in our markets, they don’t have to. All they have to do is make some adjustments in their relative allocations — a few percentage points less to the dollar, a few more to stronger currencies. That alone will cause serious dislocations in U.S. financial markets.

You saw a small taste of that phenomenon last week. The Treasury Department announced that net foreign purchases of U.S. securities plunged from $49.9 billion in August to just $4.19 billion in September, the lowest since September of 1998. Not many people on Wall Street paid much attention, but the few that did started selling aggressively.

And never forget: What the Treasury Department announced last week was just a decline in net foreign BUYING. What will happen if we see actual net SELLING?

I witnessed this type of thing happen in Brazil many times, and I can tell you from personal observations: It’s devastating. When foreign investors are selling, they’re not just selling the currency. They’re selling all the INVESTMENTS they bought with the currency — stocks, bonds, private businesses, real estate, and more.

When they’re selling the Brazilian currency, they’re selling Brazil … and Brazil goes down. When they’re selling the American dollar, they’re selling America … and America can go down as well.

RUN-AWAY, OUT-OF-CONTROL DEFICITS

My father saw what deficits did to Brazil, a country he loved. So he gave most of his life to stopping something similar from happening to America, a country he loved even more.

Today, I wish I could do something to stop it, too. But at this point in time, I can’t, and nor can you. The forces aligned against us are simply too massive, too powerful and coming on too soon:

* THE RUN-AWAY AMERICAN CURRENT ACCOUNT DEFICIT, which includes the trade deficit, is approaching $500 billion dollars — the worst of all time, even in proportion to the size of our economy (as a percent of GDP).

Five hundred billion is a huge number. It means that this year alone, ANOTHER $500 billion in extra U.S. dollars will wind up in the hands of foreigners — mostly companies and business people that sold their goods to the United States, collected the money, and are now trying to figure out what the heck to do with it.

In the past, foreigners with U.S. dollars were content to just recycle them back to the United States by investing them in our stocks and bonds. But now, based on the Treasury Department’s stats I just told you about, it looks like they may be changing their mind.

This is a bad sign. Very bad.

* THE-OUT-OF-CONTROL FEDERAL BUDGET DEFICIT is going to be over ONE TRILLION DOLLARS in 2004. That’s more than DOUBLE what the government is currently estimating. That’s also about 8% of GDP, worse than any other major nation in the world, even Japan.

Where do I get that one-trillion number? From the Federal Reserve’s Flow of Funds, Table F4. Right now, even in calendar year 2003, the Fed’s tabulation is showing the deficit is running at the average annual rate of over $800 billion.

Next year, with the addition of $87 billion just approved for Iraq … plus a couple hundred billion for Medicare reform and more tax breaks … the real deficit in this country will EASILY surpass $1 trillion!

* THE WAR. At first, it seemed to be just a war on terror — mostly us against them. Now, it seems to be morphing into a war OF terror — mostly them against us … and against nearly all of our allies as well. This, too, shakes worldwide confidence in the U.S. dollar.

* THE ELECTION. Many foreigners don’t seem to like Mr. Bush very much. But they like uncertainty even less. To the degree that they believe Mr. Bush’s second term in office might be threatened, they’ll sell the dollar. And they will probably continue selling until he defeats his opponent next November … or until the opponent is sworn in and establishes credibility abroad.

* RISING INFLATION. A falling dollar implies rising values for nearly everything else — especially world commodities. When commodities rise, though, it raises the specter of future inflation, which in turn, drives foreign investors to buy inflation hedges and sell still more dollars.

* LOW OFFICIAL INTEREST RATES. If you were Federal Reserve Chairman Greenspan, and you wanted to stop the dollar decline, what would you do? Well, when foreign investors turn sour on your currency, there’s just one handy way to lure them back in. You offer them juicier bait — higher yields on their money.

What do you do if they still don’t bite? You have to offer them STILL higher yields.

But that’s not what Mr. Greenspan is doing. In fact, the interest he’s offering right now is the lowest in over 45 years.

This is not exactly a good way to run a country. But there’s not much you can do to change that, except to get a good chunk of your money OUT of dollar investments.

What’s the alternative to the dollar? I provide the details in my Safe Money newsletter. But here are four general categories you should look into:

* Special mutual funds that are deliberately designed to go up when the dollar goes down.

* Foreign currency bank CDs you can buy in the United States.

* Select gold investments. They are now mirroring the dollar almost every week: When the dollar rises (which has been rare), they fall. When the dollar falls (which has been far more common), they rise.

* Energy and other natural resource-related investments that are bound to benefit from a falling dollar.

All of these investments do involve risk. So if you’re an American citizen or resident and you can’t afford any risk whatsoever, most of your money still belongs in safe dollar investments.

Let’s just pray the dollar decline is either not as deep as I currently expect … or is not as long-lasting as I currently fear.

Good luck and God bless!

Martin

Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com

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