Global Currency Crisis:
Part 1: CBO Fiscal Crisis Alert
By Craig R. Smith
Chairman, Swiss America
Aug. 10, 2010

If the Fed is telling the truth, gold prices must be lying. The Federal Reserve Board is claiming deflation is the new boogeyman to fear. Yet, if we have such strong deflationary forces at work, the price of gold should have dropped to $800, not run back up near $1200. The sane, thinking world sees inflation ahead.

Since the Fed is notorious for spreading disinformation to achieve its goals, I say ignore the Fed and look instead at the facts from a disinterested third party, the Congressional Budget Office. Its July 27, 2010 report titled, "Federal Debt and the Risk of a Fiscal Crisis" warns that another fiscal crisis is coming because of entitlements and excessive federal government spending. It is no longer a question of if, but when.

"Sometimes a chart is worth a thousand editorials. The one we reproduce here, courtesy of the Congressional Budget Office, is one of those. It shows the federal debt throughout U.S. history and the daunting slope of what is likely to happen in the next few decades. The federal debt held by the public -- and, increasingly, 'the public' means foreign governments and investors -- has mushroomed from 36% of gross domestic product at the end of the 2007 fiscal year to a projected 62% of GDP at the end of fiscal 2010. 'Policy options for responding to it would be limited and unattractive.' Debt could be restructured, the currency inflated or an austerity program (tax increases plus spending cuts) implemented," reports The Washington Post.

According to the CBO we will have few favorable options when the crisis hits because the Fed has shot most of the bullets in its financial gun. These options would be as follows:

Option 1) The federal government could renegotiate the terms of the $13.5 trillion debt by offering longer maturity times, changing the rates or by defaulting outright. Default may seem impossible, but tell that to the investors who lost billions in the Asian currency crisis, the crushed LTCM hedge fund or the folks in Argentina after Juan Perón's socialist reign.

Option 2) The federal government could initiate massive austerity programs by slashing spending and lowering entitlement payments on Medicaid, Medicare and Social Security as well as extending age requirements on these programs, currently 65-70, to 70-75. The magic number for slashing would be 15% of all government services to achieve the effect necessary to avoid fiscal crisis. We would also require tax increases on all Americans, not just the rich. While an increase on the top 2% would generate $700-800 billion, middle class tax increases (back to pre-Bush tax cut rates) would generate around $2.3 trillion.

Option 3) The federal government could increase the money supply (inflate) and monetize the debt, making the debt far easier to pay off with devalued dollars. Deflation would make paying off the debt much more onerous as wages and prices fall, as opposed to inflation, which causes the value of the debt to decline.

I see no political will to reduce spending or, more importantly, to address the long-term crippling liability of entitlements. It is the third rail of politics. If we were even to suggest default or attempt to renegotiate the debt, bonds would collapse and the dollar would plummet. So the only politically expedient option is to increase the money supply dramatically - causing severe inflation. Inflation will steal the value of earnings and savings from the average citizen, but monetizing the debt would help inflate government's debt away.

Germany and France both employed this approach after WWI. While difficult for the citizenry, it kept both countries at virtually full employment. Inflation also provided an ever-expanding economy as their products became very attractive to other countries due to lower prices; a result of their weaker currency. Inflation ultimately allowed central banks to eliminate the war debt and, in the case of Germany, also allowed them to renegotiate war reparations.

In our current crisis, the Europeans are decreasing spending and want America to mirror their austerity plan. In my opinion President Barack Obama has looked to history to determine a way out of this crisis and has concluded that the United States will take its chances on the German model. His policies will severely inflate our currency. Congress and the Obama Administration have both certainly shown that they have no interest in taming government spending or decreasing the debt.

Fed Chairman Ben Bernanke knows inflation is much easier to start, stop and control than deflation. Deflation is very unpredictable and virtually impossible to stop, especially with the limited tools currently in the Fed's arsenal. Congress would need to enact new powers to fight deflation.

Over the last 4 years, we've doubled the money supply! Bernanke is $3 Trillion behind, with 0% interest rates. Our immediate debt is $13 Trillion. Our long-term debt is over $100 Trillion. We are so out of balance right now, that if we inflate the currency and create inflation in the 12% range, annual U.S. revenue wouldn't be sufficient to allow us to pay off the principal alone on our debt! "Central banks may now need to talk about the necessity of inflation...before it is too late." (CNBC.com 7/16/10)

Fed. Chair Bernanke is shocked that we haven't seen inflation yet. It is a phenomenon nobody understands. In fact, we can't even determine if we're inflating or deflating right now. However, eventually, inflation will win out. You can be assured that the slingshot is loaded and the tension on the band is severe. At the first sign of rising prices, millions will rush to spend the backlog of dollars they have been saving because of uncertainty. When that happens, inflation could explode.

The tremendous increase in the quantity of currency caused by the printing of money benefits the economic status of the country printing it, but it decreases the standard of living of a large proportion of citizens. In effect, the massive printing of money hurts the people, but conversely helps the economy.

But this has a cost. According to the CBO, each 1% increase in projected inflation would increase the debt by $ .7 Trillion! In other words, if inflation is projected at 2%, and its actual rate is 12%, the additional debt that would be created is $7 Trillion!

I see no other viable choice except for the federal government to monetize the massive debt we now have, which is increasing at a yearly rate of $1.4 trillion. It is expected to continue doing so over at least the next five years unless major policy changes come out of Congress. This analysis is why now is the time to convert your soon-to-be-inflated dollars into gold.

What do we know for certain?

On July 21, Fed Chairman Bernanke said the U.S. economy faces "unusually uncertain" prospects. Six days later, the CBO stated that, absent a change in policy, further increases in federal debt "almost certainly lie ahead," and, without spending restraint, will cause debt to rise to "unsupportable….unsustainable levels."

The CBO projects that federal debt "will stand at 62 percent of GDP at the end of fiscal year 2010, having risen from 36 percent at the end of fiscal year 2007." (Only once has the figure exceeded 50 percent - shortly after WW II.)

With the aging of the population and rising health care costs, it is hardly a stretch to assume with very high likelihood that government spending will not significantly decrease, and that government revenues will not significantly increase. So what are our available options and the likely outcomes of those implemented options?

A fiscal crisis in the United States is imminent. We've seen significant fiscal hemorrhaging at the state level for the past two years. Bonds, as a reflection of investor confidence, are returning well below 3%.

Prior to the start of the market meltdown in 2008, total U.S. wealth was $100T. Although not ideal, our debts at that time were around $100T. We could have continued to live that way. Although our lifestyles would have eventually eroded, we were not in danger of a complete collapse.

Today the current value of our combined wealth is only $50T. We still have over $100T in debt. Good luck getting a loan from your local bank with that scenario, I don't care how brilliant your business model looks!

To put such amounts in perspective, let's say you started a business on the day Jesus was born 2000 years ago. Business wasn't very good for your start-up, so you lost $1 Million that first day. In fact, business did not improve at all. Your company continued to lose that same $1M every day -- 365 days each year -- until the present day. If that were the case, it would take ANOTHER 700 YEARS before you would have lost $1 Trillion. Still think we're going to "grow our way out" of this mess?


Related Stories:
* The world is facing a serious currency crisis:
"NOT so much a 'forgotten' as a hidden war, the conflict currently playing out in foreign exchange markets among major global currencies marks a failure of economic diplomacy and political statesmanship among world leaders. As such, it can only end in tears. Gold, other precious metals and the commodity complex in general will provide an immediate financial hedge but global trade, investment and other transactions cannot rely on these for stability unless we return to a gold standard or barter system," reports BusTimes. (8-12-10)
GET THE REST OF THE STORY: The preceding featured commentary is part one of a new five part Special Report, "Global Currency Crisis" which is offered free to the public by registering HERE.

Also included is Mr. Smith's brand new CD "The Savage Truth About Money," featuring a recent live interview on The Savage Nation.

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