Why You Should Get Out of the Way of the Dollar Crushing Freight Train

Tied to the tracks
Do you know if you are tied down to the same tracks on which a behemoth sized freight train is hurtling toward you?

It’s a pretty important question.

Now, you might not believe it if I told you, but if you hold any significant amounts of dollars or dollar backed bonds, they are tying you down to these tracks.

How you untie yourself and how to get out of the way isn’t rocket science, but digging deep enough to discover the dollar’s ultimate fate is a little more difficult.

So let’s see what’s coming down the tracks.

More money than you can shake a (hockey) stick at

Take a look at the graph below (from here):


It shows the amount of base money that has been created, like it always is, by the Federal Reserve.

Notice the giant hockey stick like shape? Graphs from the peak of the housing bubble and stock market bubble look eerily similar.

But there’s a big difference between then and now, and that is this: there is no limit to how much money the Federal Reserve can create out of thin air. The hockey stick could point a lot higher, and already is poised to do just that.

Just days ago the Federal Reserve showed it’s hand:  It increased it’s balance sheet from $900 billion last September to $1.8 trillion today, and is in the process of increasing it to $3 trillion by the end of the year.  This from the New York Times:

But to the surprise of investors and analysts, the committee said it had decided to purchase an additional $750 billion worth of government-guaranteed mortgage-backed securities on top of the $500 billion that the Fed is already in the process of buying.

In addition, the Fed said it would buy up to $300 billion worth of longer-term Treasury securities over the next six months. That would tend to push down longer-term interest rates on all types of loans.In effect, the central bank has been lending money to a wider and wider array of borrowers, and it has financed that lending by using its authority to create new money at will.

Since last September, the Fed’s lending programs have roughly doubled the size of its balance sheet, to about $1.8 trillion, from $900 billion. The actions announced on Wednesday are likely to expand that to well over $3 trillion over the next year. (From here)

Base money is what banks multiply through fractional reserve banking.  When the base increases, a similar increase in prices will occur if the base money isn’t bought back with the assets of the Federal Reserve.

The assets the Federal Reserve are buying today  are likely to drop in value.  The only reason the Federal Reserve would buy government guaranteed mortgage backed securities is if they weren’t worth what they bought them for.  Plus any rise in long term interest rates would cause both the mortgage backed securities and long term treasury bonds to fall in price.

If that happens, how much of the base money will they be able to mop back up?

Can you hear the train’s engine car starting up?

Scared foreigners

Every increase in the money supply and government spending makes foreigners ever more hesitant to hold onto dollars.

While 2008 saw a flight to the dollar, foreigners are starting to seriously question whether it is a safe place for their money.

Just look at what one of the top leaders from America’s biggest creditor had to say on Friday the 13th (March 2009):

Chinese Premier Wen Jiabao said Friday that he has “worried” about the safety of U.S. assets — meaning the Treasury bonds his government owns. Whatever Mr. Wen’s political motives, his concerns about the integrity of U.S. sovereign debt are timely and apt.

President Obama’s stimulus plan and new budget will require an additional $3 trillion to $4 trillion in new borrowing over the next two or three years, and that’s if the economy recovers smartly. Adding it all up, Federal Reserve Chairman Ben Bernanke earlier this month estimated that U.S. public debt-to-GDP would reach 60% over the next few years, up from 40% before the financial panic hit — and the highest level since the aftermath of World War II. (…)

Mr. Wen called on the U.S. to “maintain its credibility, honor its commitments and guarantee the safety of Chinese assets.” Little wonder: China, like other trading nations, has a big stake in this fiscal free-for-all. Although it doesn’t release detailed data, roughly two-thirds of Beijing’s $1.9 trillion foreign-exchange reserves are likely parked in U.S. Treasury debt. (From here)

China is getting nervous, and isn’t the only one.  Their fears about the dollar losing value are far from unfounded, as we saw above with how much money the Federal Reserve is creating out of thin air.

If the leaders of America and the Federal Reserve don’t take this warning seriously enough, we could end up with  a real horror story.  A massive flight from the dollar.

And with foreigners now holding 50% of America’s public debt (up from 5% in the 1960s, see here), foreigners selling the dollar would not be of minor significance.

It would derail the dollar.

From caboose to kaboom

Today, most people think of America as the engine of the global economy. But America is not the engine. It can only consume so much because it borrows so much, which means it’s really the caboose.

After all, if foreigners didn’t lend Americans so much money, we wouldn’t be able to consume so much.  When foreigners start selling dollars, the result will not only be that other countries will stop pulling America around like a caboose.

Instead, it will be as if the engine car turned around and slammed full force into the caboose.

The dollar will plummet.  The only question is how far.

And that depends on how the Federal Reserve reacts to this impending crises.

Pain now or printing and much more pain later

When foreigners all around the world start selling en masse, the Federal Reserve will have two choices:

  1. Print more money and buy back the treasury bonds
  2. Let interest rates skyrocket

If the Federal Reserve keeps printing Money, the dollar will fall to a small fraction of its former value.  If it lets interest rates skyrocket, long term bonds will plummet, and the dollar will hold some of its value.

But if interest rates skyrocket, the Federal Reserve won’t be able to mop up the extra dollars it is creating today.

So whatever it chooses to do, the damage will have been done.  The value of the dollar will already be toast.

You can probably hear the freight train on its way.  Now what’s the best way to jump out of the way?

Sell dollars, and buy what?

It’s a common idea these days that since foreign stocks, currencies, and commodities have all taken a beating, that dollars are the only safe thing to hold.

The truth is exactly the opposite.  As any value investor will tell you, buy when things are cheap.

The dollar is not cheap today.  But many foreign stocks are extraordinarily so.

So jump out of the way of the oncoming freight train and start exploring foreign waters for good deals.

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