While there's been a number of diaries concerning the dollar's decline, there is a disturbing lack of putting it into historical context. Before we can know where we are going it's important to know where you've been. Unless you know what it means in the grand scheme of things its impossible to know what to do to protect yourself.
So without further delay, here is my $.02
First of all, this isn't the first time that the dollar has taken a dramatic decline. In 1985 the dollar index was well above
140 and was killing our manufacturers. The central banks of the world got together at the Plaza Accords and agreed to sell the dollar in order to push it down. The dollar index fell for two years and largely ended with a
stock market crash and a bear market in bonds. However, the drop also cured our trade deficit for awhile.
...At least that is how the financial history is written. The truth is a little different.
The fact is that the dollar index that everyone looks at only measures the dollar to 17 nations, 12 of them are european. That is hardly a reflection of the countries we trade with.
When you look at an actual trade-weighted dollar index the story changes. The decline from 1985 to 1987 looks rather mild. And even the decline since early 2002 leaves the dollar far above even mid-90's levels, and light-years above 1970's levels.
It's because of most people focusing on the more limited 17-nation chart that they miss the bigger picture. They see the dollar at a multi-decade support level and think the dollar's decline is over.
Given this overvalue of the dollar, is there any wonder why our trade deficit is so large? Our manufacturers cannot compete.
Is it not obvious that the mild decline in the dollar that we've experienced so far is nothing compared to the drop that is still to come?
Most people focus on the euro's assent and stop there. But the euro has already increased about 50% and has it's own flaws, so is unlikely to climb against the dollar much more.
The place to look is to the far east, which brings to light all sorts of other issues. China and Malaysia have hard pegs of their currency to the dollar. They also have huge trade surpluses with us. They then print currency and use that money to buy our bonds in order to keep their currency low. Right now they own close to 40% of all our debt.
It only makes sense that at a certain point the creditor will no longer want to loan the debtor increasing amounts of money. What happens then?
It's a game of Old Maid and no one wants to be stuck with the Queen.
A lot of things can happen, but it is hard to believe that there won't be any financial "accidents" along the way. Most likely things will get ugly. There is too much leverage built into the system, and too many people are embracing risk (for instance, the historically low yields for junk bonds), for everyone to get through the exit door without a panic. Historically, currency corrections are never over until they "overshoot".
When Warren Buffett, the greatest investor in American history, warns of financial chaos then you better sit up and take notice. Other legendary investors like Soros, Templeton, and Gross are also sounding alarms. And remember, this is AFTER the major dollar index has declined by 30%.
So what do you do?
First of all, get out of debt. Ignore every other piece of advice anyone gives you until you are out of debt. It wasn't long ago in this country that people had "mortgage burning" parties. Americans used to hate debt. Those people survived the Great Depression and knew the problems that debt could inflict.
What then? Many people suggest "safe" investments like bonds. But in case you haven't noticed, our bond market is owned by fickle foreign investors. China alone could send it crashing, and higher interest rates are sure to happen in the near future.
Stocks? Unless you know what you are doing then avoid them because the stock market is sure to take a hit before this is over.
Housing? It's dependent on the bond market. Asian central banks own huge amounts of Fannie Mae and Freddie Mac bonds.
So what's left? There are various commodity futures and foreign currencies that I dabble with. But there is one investment that is sure to do great every time the dollar declines that everyone is ignoring: gold.
It's not just that the Constitution mandated using gold and silver as money (not paper), or that gold has been money for 5,000 years.
The thing about gold is that it has no debt attached to it, unlike paper money. It doesn't care what happens to the debt markets (aka bond markets).
Gold is not always a great investment, but it is a great investment in times of financial crises. Think of Argentina. In 2001 they were in a similar situation to us. They had an overvalued currency, trade and fiscal deficits, and foreigers owned much of their debt markets. They ended up having to devalue their currency by about 70%. People retirement savings were grabbed by the government (think that couldn't happen here?). Pensions were wiped out.
But what if you had your savings in gold instead of paper?