Tuesday, May 12, 2009

Deflationary Destruction of The US Dollar?

Before I begin this post, let me preface it by saying that I am not a gold bug. I am also not a tinfoil type "moonbat". We are facing extraordinary times that now call for extraordinary measures in order to ensure our survival. What I am about to type below is something that I would have considered to be "crazy" 5 years ago.

Unfortunately, as this crisis unfolds, I believe the measures discussed below should now be considered to be prudent.

I want to survive this financial catastrophe, and I am constantly looking for different solutions that will ensure my survival.

Ok, lets get to it:

As I sit here and watch the US dollar drop on an almost daily basis(btw the way we hit our lowest levels today since Jan.), I have begun to search for alternatives by which I can protect the wealth that I have accumulated. Many believe that inflation or hyper-inflation will destroy the US dollar. Whats proposed below is the exact opposite. Some believe that it will actually be DEFLATION that eventually takes down the dollar.

I read a brilliant interview today in The Daily Bell of Dr. Antal Fekete who is an esteemed author, mathematician, monetary scientist and educator. His insights in this interview were absolutely brilliant in my opinion. This is a long read but well worth it in my view so please take some time to read it.

Dr. Fekete's thesis is very different from your basic Keynesian economist. Any of you that have read me for awhile know that I love thinking thats "outside the box". There are many great thoughts in this interview around monetary policy and why the Fed's monetary approach will eventually result in an epic failure.

I wanted to focus on just a few points here that are most relevant to all of us. Let me highlight a few excerpts from Dr. Fekete and then I will then post some thoughts below:

"Dr. Fekete on why deflation not hyper-inflation will destroy the dollar:

"Daily Bell: Can the current paper money system stand, or is it on its last legs?

Prof. Fekete: Since the eruption of the financial and economic crisis in 2007 we may take it for granted that the regime of irredeemable paper money is on its last legs. However, it may take several more years of agony, because of the colossal ignorance of people concerning money. For example, most people with a better than average grasp of the theory of money expect that the dollar will succumb to hyperinflation. They will be disappointed. The dollar will put up a tough fight and in the end it will self-destruct, not through inflation but through deflation.

Daily Bell: Can you expand on this issue? What makes you suggest that hyper-inflation is not in the cards?

Prof. Fekete: Producers will, of course, try to raise prices as the dollar is weakening further. However, people are not in the mood to spend. If they come into possession of money, they will use it to repay their debts. They have no savings to fall back on in case they lose their jobs. In the absence of buying, price increases will have to be rescinded (as they have been in the case of crude oil, for example) causing many a producer to go bankrupt.

There is a new factor that plays an important role, not present in previous episodes: the parallel existence of electronic dollars and Federal Reserve notes. Only a small portion, less than ten percent, is in the form of the latter; the rest is electronic money. People at home and abroad hoard only dollars that they can fold. It is physically impossible to print them fast enough to replace electronic dollars that the people, firms, institutions and foreign governments may decide to reject. The velocity of circulation of paper dollars is falling to zero while that of electronic dollars is rising beyond any limit. This splitting of the money supply into two components of divergent velocities spells deflation. The component with increasing velocity will have to be written off. The Fed is helpless as the hoarding of its notes assumes unheard of proportions.

Daily Bell: Can the Fed really sterilize the monetary system as Ben Bernanke and others contend?

Prof. Fekete: If by "sterilization" you mean isolating the exploding money supply from exploding prices, my answer is that Bernanke does not want to do that. In fact he is desperately but unsuccessfully trying to induce a rise in the price level, even at the risk of a price explosion. But to no avail: all the new electronic money he is creating goes into debt liquidation and speculation on the long side of the bond market. None of it goes to bid up commodity prices, or the prices of industrial shares, or the price of real estate.

There is a vicious spiral: the more money Bernanke creates, the more rampant bond speculation becomes, the higher bond prices go, the lower interest rates fall, the lower price-level falls, prompting more money-creation by Bernanke, etc.

Why do falling interest rates necessarily induce lower prices? Now here is the rub: because falling interest rates destroy capital through increasing the liquidation value of debt. I have a whole new theory on that: The Revisionist Theory of Depressions. My main thesis is that a falling interest-rate structure increases the burden of debt (just the opposite that you would intuitively expect!) thereby causing producers to go bankrupt in droves. You can read this special report, now available at the Daily Bell, click here."

Dr. Fekete on the gold's transformation from contango to backwardation:

Daily Bell: Is there any evidence that hoarders of gold and silver behave as you suggest, and not as common sense would dictate? After all, it is a universal feature of the commodity markets that the longs take profits periodically as prices keep rising.

Prof. Fekete: Yes, indeed, there is: the behavior of the gold basis. Basis is the difference between the nearby futures price and the spot price. Contango is the name for the condition whereby the basis is positive; while backwardation indicates a negative basis: higher spot price and lower futures price. Whenever supplies are adequate, contango obtains and the basis indicates what the carrying charges are such as interest, cost of storage and insurance. Backwardation always and everywhere indicates a shortage of the physical metal. Therefore, normally, gold should never be in backwardation, i.e., the futures price should always be higher than the spot price. The basis may be substituted by a spread, i.e., the difference between the price of a distant and a nearby futures contract.

Right now, the gold basis is at a critical inflection point, suggesting that gold may plunge from permanent contango to permanent backwardation for the first time ever. On April 21 Dan Norcini published charts showing the dramatic collapse of the April 09/June 09 and of the April 09/Dec 09 gold spreads at the Comex. The former went from $6.50 at one point to tiny_mce_marker.60 now. The charts indicate that gold is on its way to backwardation later this year. Backwardation in gold is an extremely rare phenomenon with the most serious implications. It shows that supplies of physical gold are drying up as hoarders and the mines are increasingly withdrawing their offer to sell. It is like a chain reaction, at the end of which gold is not for sale at any price.

Dr. Fekete on protecting yourself:

"Daily Bell: What can people do to protect themselves at this time?

Prof. Fekete: Other than praying and hoping, they could get out of debt and keep accumulating gold and silver coins, buying on every weakness in the price. They could also hoard Federal Reserve notes and the notes of the Swiss National Bank of small denominations, in amounts corresponding to their needs for up to two years. To keep money on deposit in a bank is not advisable under any circumstances. And, let's not forget, they should cash in on their life insurance policies."

My Take:

Very interesting isn't it? I think its pretty hard core but brilliant.

Basically there are a few take home points here:

1. Raising cash in this crazy world no longer means holding money in a bank account or treasuries. Raising cash means holding FRN's( Federal Reserve Notes). In other words: Cold Hard Cash! Look at the top of a dollar in your pocket and see what it reads: Federal Reserve Note! As you can see above, the bailouts are being done in the form of electronic money. Less than 10% is printed in the form of FRN's. FRN's are a great thing to have because they offer a zero interest coupon that has indefinite maturity. I have begun accumulating FRN's over the last several weeks.

There could very well come a time where the world will no longer accept our debt after watching the Fed create trillions of "digital dollars". These "digital dollars" could become worthless down the road if the world begins to decouple from the US dollar and begins to no longer accept it as payment. FRN's have a much better chance of holding value because they make up less than 10% of our money supply.

Think about it. What would you rather own?: FRN's which account for less then 10% of the money supply or one of the trillions of "digital dollars". Thats an easy answer if you ask me.

The problem here is you need a safe place to store it. A properly installed safe is a great place to hold FRN's.

2. Buy some gold and silver coins. Let me emphasize: COINS. Coins are preferred because they are much more easily used as a form of money. I would focus my purchases more on the silver side versus gold. Silver is less expensive and would give you more flexability in terms of using it as a currency.

3. Pray that it never comes to this! However, I am afraid we are now approaching the time in which we all need to begin preparing ourselves for the worst because I believe their is no solution to the mess we have dug ourselves into.

The fact that we are about to see a backwardation in gold is very ominous folks. This means that no one wants to sell and nations like China are buying any gold they can get their hands on. My take on gold here is people are not buying it as an investment. They are buying and hoarding it because they believe that we may see the US dollar self destruct. This is protection versus speculation.

Now let me reiterate that I have never been a big gold fan. I also don't believe we are going to see a "Mad Max" scenario. I will continue to keep the majority of my portfolio in FDIC insured accounts and treasuries.

However, I will begin to rapidly increase my FRN holdings. I will also begin accumulating some silver and gold coins. My first choice of the three options above is FRN's. If the crap hits the fan I believe physical cash will still be usable. It may have to be converted into some other form of currency but it will hold its value nonetheless.

As for the stock market, the more I watch it the more I believe its just the tail of some large dog that's manipulating the crap out of it. Exactly who is this dog? The government? The bond market? The trading desks on Wall St? Perhaps its a combination of all of the above? Who knows, my guess is its a little of all three.

What is becoming increasingly clear is our problems now run far beyond our issues in the stock market. Our way of life is crumbling as the oligarch's power over the people continues to increase.

Socialism looms right around the corner if our country continues down the same path.

In fact, if the government doesn't wise up and change its ways, they run the risk of losing power. Germany's economic collapse was the key driver that allowed Hitler and facsism to rise to power. No government has ever survived following a hyperinflation/economic collapse. The freedoms that our founding fathers worked so hard for are slowly falling apart as this crisis begins to unravel.

Don't think it can happen here? Ask a Chrysler bondholder how they feel about their freedoms after being strong armed by the government to sell their bonds at .10 on the dollar. Bondholders NEVER roll over and accept .10 on the dollar without going to BK court. You can bet that they were threatened with their lives if they didn't accept this deal.

Is this how a free capitalistic country works? Don't think so. In fact, it sounds more like an episode of The Soprano's.


teddy bear said...


& song


Jeff said...

Scary times aren't they Teddy?

What an appropriate song on that you tube.

"Heading for Disaster"

This hit from AC/DC should be on there too:


flipdippy said...

Just one problem Jeff...the velocity of the USD can turn on a dime. Even if people hoard and hoard and hoard, it won't take much for there to be too much liquidity even if most of the 'new money' is being used to service debt.

You also forgot to mention that coins are preferrable to bullion because the government could make owning bullion illegal, but they can't take away or make illegal collectible gold coins.

I've also moved a big chunk of my retirement accounts into CEF. Never thought I'd say Buy Canada but I can't bring myself to buy equities or bonds and don't have many other safe options.

Jeff said...


Great points.

Its a tough call here as to how this all plays out. Diversification is my theme these days. One must prepare for many potential scenarios. FRN's is just another way to help protect yourself.

You are very right tho: We are seeing signs of the liquidity leaking into the market. Oil has doubled from its lows.

I still believe like you said that most of the new money is either servicing debt or simply disappearing as its being thrown into financial "black holes" like AIG.

Buy Canada? I am starting to think live Canada!

Great move with your IRA. I wish I had the flexability to move mine!

Gary said...

In addition to cash, I prefer to hold a mix of gold and silver. Even a couple hundred ounces of silver seems a bit too bulky to be manageable. For example, 200 ounces of silver weighs almost 14 pounds, which doesn't sound like a lot, but it is if you think you may need to transport it. The same value in gold is only about 3 ounces. You could carry it in your pocket.

Good post and thanks for the link to the Daily Bell. You have definitely given me something to think about. thanks

I suppose the good news is that even if Dr. Fekete is wrong, gold and silver will still be winners if hyperinflation occurs. Did I really say "good news?" Hopefully, you know what I mean.

Jeff said...


Your welcome...


I know exactly what you mean.

Gold protects you from a variety of scenarios. Its really starting to grow on me.

I just finished reading Richard Russell tonight. Poor guy was raised during the depression and now he is forced to see another one. He said all focus should be on the dollar.

Now it appears Congress is looking into guaranteeing all muni's! Jesus Christ this spending is getting so out of control.

The bond market must stop all of this nonsense.


mekly said...

I wish you would have mentioned the word "fascism" sooner so I could've stopped reading earlier.

Jeff said...


Not expecting that but how can you take it off the table?

Germany's economic collapse is what allowed someone like Hitler to get into power.

I pray that never happens but things like that happen when people are suffering.

I prefaced this whole post by explaining that these are drastic times and history has shown us that anything can happen.

Anonymous said...

Great alternative thesis to the just buy gold crowd.

When hoarding federal reseve notes, should they be new notes only?

I have a small horde of the old notes.

Jeff said...



Good question.

Since there is no maturity date on FRN's I wouldn't think it would matter.

New notes wouldn't hurt of course. I think the key thing to do with accumulating FRN's is ,aking sure you keep them in lower denominations.

This will make them easier to use. I have a hard time getting change for a $100 bill as it is right now.

I can only imagine how difficult it would be during tough times.


SPECTRE of Deflation said...

Great analysis! Nice to see that some folks are thinking this through to it's logical conclusion. The last figures I saw show almost $7 Trillion in deposits against $365 Billion cash on hand at the banks. You do not want to be at the end of that line.

Speaking of the velocity of money, you might want to check the M1 Money Multiplier which went off the cliff many months ago. It ain't coming back anytime soon for those that are thinking inflation. We stand at $61 Trillion in debt against current GDP of $14 Trillion. The ratio is a truly scary number. We were never above 270% at the worst of the Great Depression. We are borrowing .46 cents of every dollar spent by our govt. GULP! We are toast.

SPECTRE of Deflation said...

The problem with Gold is that it holds too much value moving forward to allow for day to day bartering while silver can function for this purpose flawlessly.

jg said...

Welcome to the 'doom and gloom' crowd, Jeff.

I hold my long-term money overseas, 100% in gold and silver bullion and gold and silver mining stocks.

You may want to consider opening an account at www.goldmoney.com. It allows you to hold gold overseas -- out of the reach of the Feds -- with easy electronic control of such.

Lastly, for day to day purchases, once (not if) we reach Financial Armageddon, consider buying 'junk silver' coins, pre-'65 coins that have high silver content. These will become the coin of the realm, as they are small denomination and readily verified.

Jeff said...



Great points.

Yeah the balance sheets of the banks are flat out horrifying.

I haven't looked at the M1 mutliplier in awhile so thanks for the update.

Deflation will rule the day. The reflation trade sure got creamed today!

Jeff said...



I will check out your site. As this crisis deepens holding gold overseas sounds like a very smart thing to do.

The politicians in Argentina pretty much pulled out of their country right before it collapsed.

Welcome to THTB.


Jeff said...

Post should be up around 6:30

Dave said...

I don't buy the deflation of US money supply due to lack of paper money. The stocks-to-flows ratio is mentioned as 50 (50 years) for gold and 1/3 (4 months) for copper. Wouldn't the ratio for paper money be a couple days, like 1/200? If deflation threatened to worsen due to some sort of collapse of "electronic money," it wouldn't be too difficult for the Fed to print new bills, banks to print equity certificates, etc... and then disperse them. Banks will not be so insolvent as to magically lose all records of all client holdings, and be unable to somehow make them accessible. Are printers that hard to come by? Are we talking about ink shortages? I don't get it.

teddy bear said...

Argentina? here you are ;)



teddy bear said...

US Budget


Outlays - Receipts = Deficit (+)/Surplus(-)


Year Sum of Deficit/Surplus (-)
1981 -17 190
1982 -9 704
1983 3 308
1984 -11 493
1985 -11 386
1986 -9 928
1987 -38 742
1988 -13 769
1989 -40 654
1990 -41 829
1991 -30 009
1992 -14 603
1993 -7 817
1994 -17 454
1995 -49 722
1996 -72 404
1997 -93 939
1998 -124 603
1999 -113 459
2000 -159 497
2001 -189 796
2002 -67 170
2003 -51 043
2004 -17 624
2005 -57 707
2006 -118 851
2007 -177 674
2008 -159 282
2009 20 907

April is usually one of the best months to reduce deficit but not in 2009 ;)

Jeff said...


Point takenn.

However, much of the $9 trillion is not real. A lot of it is guarantees. Its not real money. Most of it is debt. a lot of this debt is worthless.

If the Treasury printed $9 trillion would result in instant hyperinflation. A loaf of bread in this country would be $1000.

Would it not make more sense to allow the debt/electronic dollars to be defaulted on and disappear and let the bad companies that the guarantees protect fail?

The world is going to realize that these guarantees are worthless. Monetizing the debt would be a monetary disaster.