The news wires were abuzz last week about the global credit squeeze. Bankers are unwilling to make loans when they can’t calculate risk. What risk? Here is a big one: Many of their clients have derivatives exposure, which means that lenders can no longer calculate their credit worthiness. In the banking world, the standard “safe” answer to any loan question in the absence of data is almost universally no. I surmise that if this situation gets any worse, governments may step in and make loan guarantees. (Meaning that the taxpayers would shoulder the risk instead of the bankers.) That may be the only thing that will get bankers to start making new loans to derivatives holders–which include nearly every major corporation, these days.
With the sub-prime contagion spreading, there is the potential for a sharp break in the U.S. stock market. That will surely push the Federal Reserve to lower interest rates. (With the hope that the increased liquidity will stave off a recession.) But lower interest rates will discourage foreign investment and may spell doom for the U.S. Dollar. The Chartist Gnome tells me that if the U.S. Dollar (USD) Index drops below 80 for more than one week, all bets are off for the dollar. In a recent commentary, Jim Sinclair sized up the massive liquidity injections by the Federal Reserve and the European Central Bank. His conclusion: These moves will badly tarnish the dollar and will likely push the USD Index down to around 72. I concur. In fact, I wouldn’t be surprised to see a breakdown to the 65 level.
There could be a major devaluation of the dollar–whether formal or informal–within the next few week or months. If foreigners start dumping their dollar-denominated assets, watch out! This could even snowball into a full scale dollar panic. The Chinese have already threatened to jettison their U.S. Dollar holdings. If carried out, that alone could have huge implications. Economist Peter Schiff has an even gloomier prediction than mine. He predicts that the US Dollar will lose half its value.
What does all this mean for the average American? Already, the weaker dollar has made some imports painfully expensive. Does the next few months spell ruin just for the bankers and big stock traders, or does it spell ruin for most Americans? I think that inevitably everyone that holds dollars will suffer. Granted, bank accounts are insured by the FDIC to up to $100,000 per individual. But that won’t mean much if our currency tips over into hyperinflation. That will make bank deposits effectively worthless in very short order. So how will this play out? I’m not entirely certain. Credit squeezes are traditionally deflationary. But government invention like last week’s is highly inflationary. (To better understand deflation, see Bob Prechter explanation of credit squeezes, deflation, and economic depression.) I’ll still predict an inflationary outcome. Governments love inflating their way out of monetary crises. It is much less painful for them that way. (Deflation is painful for everyone involved.) And since inflation is a hidden form of taxation, it will be the citizenry that ultimately bears the burden. (Just ask the average Zimbabwean how the past 10 years has treated his real net worth.)
My advice: Shift the majority of your investments out of anything dollar-denominated, right away. The only exception would be holding no more than 20% of your assets in short-term TIPS, which are automatically inflation adjusted. (Series I US savings bonds are also inflation protected, but I discourage investing in such long term bonds.) To be ready for mass inflation, you’ll need your wealth primarily in tangibles. That way, if the dollar loses value, you’ll be protected. I’m talking about silver, gold, productive farm land, and hard goods like tools, guns, and common caliber ammunition. The timing? Again, hard to predict, but look for some continuing large ripples in the financial waters for the next two months. Then, perhaps in October, be prepared for some massive wave action. Historically, major move in the US equities markets tend to happen in October. Be prepared.