How does a currency collapse? 05.08.06

What is in store for the U.S. Dollar?

Julian D.W. Phillips

When a currency loses the confidence of its people, its fall becomes exponential, as has happened in Zimbabwe in 1982. An initial event causes a fall in the value of the currency, followed by a stable plateu of limited duration, another fall of deeper value, another, shorter plateau, etc., until the currency is worthless.

When a currency loses the confidence of its people, its fall becomes exponential, as has happened to the Zimbabwe $, where in 1982 one U.S.$ equalled 1 Zimbabwe $. Today around Z$200,000 buys one U.S. $ if you can find someone idiot enough to sell one for the Z$.

In day-to-day terms, the smallest note in Zimbabwe a Z$500 is the size of a U.S.$. The price of a single-ply sheet of toilet paper is more expensive at around Z$867.

The U.S.$ is nowhere near there, but clearly the U.S. Administration has no plan or even desire to rectify the U.S. Trade deficit. Consequently, we are seeing a growing number of Central Banks turning to the Euro for its reserves and away from the U.S.$.

Whilst most observers and particularly U.S. observers like to have tangible facts and numbers with which to mathematically gauge the present and the different possible futures, a collapsing currency situation is not as neatly gaugeable. Indeed it is driven in stages of 'confidence', which are rarely measurable in advance.

For instance we see today the move of the Pension and other long-term funds into the gold E.T.F.' one finds there are no mathematically measurable factors with which to measure the pace of change to these funds. Yes, the number of 'Road-shows' the World Gold Council does affects this move to some extent, but how do you measure the spread of that knowledge and resulting investment in the E.T.F.'s outside of that? How does one measure the forces causing uncertainty and falling 'confidence'.

It is an emotional progression, one that moves in lurches as particular incidents destroy confidence limb by limb. In such a climate a steady degeneration of confidence lead to an effect we shall call a "plateau - cliff" process.
However, were the $ heading for a collapse, the U.S. $, a global reserve asset, nothing in the U.S. such as land or any other fixed U.S. asset would suffice. The asset would have to be accessible by its creditors, outside the States who would have to have a willingness to accept that asset in the case of a default by the U.S. The use of the $ domestically and internationally brings such problems that in the final extreme conditions the $ is inadequate as a global reserve currency.

But for the market to whittle away confidence in the $ would take some time. But we believe that it will happen.
During this process confidence in the currency will be the measuring factor, a nebulous, unstable element in itself. The process of the decay of confidence is described above. But confidence could well go down dramatically from the point we are at now with the $ in the monetary system. Soon the cliffs will extend until the defence of the currency comes, then a long plateau while the dollar is defended, until the heavy falls begin.

The international trading power of the States will dominate just how far the dollar will fall. Of course if the States manages to show it is in the process of balancing the Balance of Payments beforehand [which may not mean the complete elimination of the Trade deficit] the demand for dollars will probably overcome the supply. But inevitably that action will mean a huge recession for the States, which could prove an internal nightmare and cause a global recession of its own.

It is probable that the Administration would isolate the U.S.A. from the rest of the world by severe Exchange Control measures, which will create its own internal boom, sooner or later. We will produce an article, or series thereof, at the right time, on this subject.

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