Gold as Hedge Against Global Currency Crisis - Special Report

Swiss Swiss America Special Report

By Craig R. Smith
Chairman, Swiss America

Introduction: Executive Summary

We are entering a new phase of the global financial crisis as central banks attempt to engineer a "soft landing" from a severe global recession by printing money.

The U.S. Dollar has recently resumed its historic decline, having lost more than 25% of its value since 2001. Today public confidence in more than 200 paper (fiat) currencies worldwide is hanging by a thread.

Investors need to keep an eye on "big picture" geopolitical events as well as emerging market trends in the U.S. Analysts sense that we could be just one major political or economic news headline away from the next global crisis.

The economic problems facing us today have created more doubt and skepticism than ever before. At Swiss America, we often receive questions asking what is coming next or what should be done to avoid loss. The answer is easier than you think, but the time you have to do something about it is rapidly running out.

Nearly a decade ago Swiss America strongly recommended that clients buy precious metals as part of a well-diversified portfolio. Those who listened have seen their wealth grow as much 300%. In 2010 we believe precious metals may be poised to make a bigger move over the next decade than they did over the previous decade.

The stellar performance of gold has gradually created new believers in the incorruptible metal. The global rush for gold is not a false provocation like what we saw in housing. It has been created by strong fundamentals, gargantuan government debt, and the continuation of bad monetary policies in the United States and around the world. The bullish outlook for gold is real. The world may see gold's true value rise for years to come, as it appears the government’s only viable option is to further debase the U.S. Dollar.

I. CBO Warns of Fiscal Crisis

If the Fed is telling the truth, gold prices must be lying. The Federal Reserve Board is claiming deflation is the new boogey man 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 few would be as follows:

Option 1) The federal government could renegotiate the terms of the $13.5 trillion debt by offering longer maturity times or 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. 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 $13T. Our long-term debt is over $100T. We are so out of balance right now, that if we inflate the currency to a not-historic level, 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." ( 7/16/10)

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

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 dollars!

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.

If this analysis makes sense to you, 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 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 eventually erode, 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 1000 YEARS before you would have lost 1 Trillion dollars. Still think we're going to "grow our way out" of this mess?)

II. Currency Crisis in the Making

U.S. debt has become staggeringly incomprehensible, from tens of billions to tens of trillions in less than a decade. Even the mainstream media can no longer ignore the ominous trajectory our nation is presently on.

"Dollar Crisis Looms if US Doesn't Curb Debt," report Reuters: "The US must soon raise taxes or cut government spending to curb its debt, and failure to act will risk a crippling dollar crisis as investor confidence ebbs. The national debt has risen above 50% of GDP (gross domestic product) from 40% two years ago, and within 20 years will blow past a previous record above 100% of GDP set after World War Two without stern official steps."

"IMF Proposes New Reserve Currency" reports Associated Press: "The head of the International Monetary Fund suggested that the organization might one day be called on to provide countries with a global reserve currency that would serve as an alternative to the US dollar. Such an asset could be similar to but distinctly different from the IMF's special drawing rights, or SDRs, based on a basket of major currencies."

According to the Wall Street Journal, "China Takes Aim at Dollar: China has called for the creation of a new currency to replace the US dollar as the world's reserve currency standard. Central bank governor Zhou Xiaochuan recently proposed a sweeping overhaul of global finance that reflects China's growing unhappiness with the US's superpower role in the world economy. In the past, Western nations have routinely dismissed China's currency goals. But this time China is on the offensive, backed by Russia and others in making it clear that the dollar is unsuitable as the world's reserve currency.

According to Porter Stansberry, of Stansberry Research: "The US dollar is going to fall off a cliff over the next 12-18 months. It will be devalued by 55%-80%. There's no way to stop it."

The OMB and the Treasury Department list a total shortfall of about $4.5 trillion coming due in the next twelve months, but the U.S. has less than half a trillion dollars in our currency reserves!

The largest bond trader in the world, PIMCO's website declares: "Today's most widely accepted and well-proven rule of thumb says you must have reserves equal to 100% of your short-term external debt."

Mohamed El-Erian, head of PIMCO, called Greece a "massive wake-up call," saying its debt crisis threatened to infect other nations and push investors into safe-haven bond markets.

"As we stand today, we prefer to take interest rate risk like government bonds in Germany which has much better conditions than in the United States," El-Erian said in an interview.

He said the United States faced structural issues which its politicians and policymakers would have to address this year.

"When it comes to currency risk, we like to take it in places which have the strongest fundamentals. What we are focusing now on is to see where the strongest fundamentals are," he said when asked about the fortunes of the U.S. Dollar.

U.S. reserves, even counting all our gold and oil, are just 11% of our short-term debt, not 100%. The U.S. has been piling up bills by the billions and now trillions, and somebody will have to pay them soon. How? By printing more money of course. And that will devalue the dollar against more than 200 foreign currencies.

With every bailout, with every industry takeover, with every unaffordable new program, we have been getting closer and closer to the precipice. And now we're very close indeed. How will we be able to tell when we're teetering on the edge? Our main creditors will let us know, but not a day ahead of time.

Beware of Chinese Bankers

The politics of replacing the dollar as the world's reserve currency may impact the markets like World War III. The U.S. will not go gently. But for the past six months, China has been quietly sidestepping the dollar by opening currency swap lines with China-owned Hong Kong and several Asian countries, including Indonesia, Malaysia and South Korea.

Currency swap agreements are contracts that enable countries to trade with each other directly, without having to swap for dollars first. China has now expanded its club to include Brazil, Argentina, and Belarus.

Worse, Russia is setting up its own commodity exchange (not based on the dollar) to compete with the CBOT (Chicago Board of Trade), NYMEX (New York Mercantile Exchange), and NYBOT (New York Board of Trade). Soon Kazakhstan, Venezuela, and other OPEC or commodity-rich nations will join the revolt.

Around the world, people will quietly begin shifting their personal and corporate cash into Euros and other more stable currencies.

There is a myth that China's welfare is so tied to ours that it has to back the buck and keep sending its trade surplus back to America to buy Treasuries. The truth is, China has been quietly adjusting its holdings to shorter-length maturities. Can you blame China? It’s losing a ton of money!

Charles Dumas, director of Lombard Street Research, summarizes: "China makes 1-2 percent on its (largely) dollar reserves. It then loses up to 10 percent on the exchange rate and suffers a Chinese inflation of 6 percent for a total return in renminbi of about minus 15 percent. That is a loss of $270 billion a year, or a stunning 7-8 percent of gross domestic product."

The crowds are edging toward the exits. When the real panic hits, U.S. politicians will find it almost impossible to borrow money to finance regular budget deficits, much less pay for expansion programs or pork-laden pet projects. And this will all happen within 24 hours. Individual citizens will have a totally different problem. We will be able to get dollars; they just won't be worth as much. That is why action is required now!

III. Debt Crisis Goes Global

"There has never before been a potentially catastrophic combination of so many virtually bankrupt major sovereign states (US, UK, Spain, Italy Greece, Japan and many more) and a financial system which is bankrupt but is temporarily kept alive with phony valuations and unlimited money printing. But governments will soon realize that they are not alchemists who can turn printed paper into gold," reports Egon von Greyerz of Matterhorn Asset Management in Zurich.

The U.S. national debt has now topped 12 TRILLION, causing the buying power of the U.S. Dollar to fall to just 2 CENTS compared to the first fiat dollar printed in 1913 by the Fed. No wonder that .25¢/a gallon gasoline now costs close to $3.00/a gallon and a new car that was under $3,000 now costs $30,000.

"$1.9 trillion deeper in debt," reports Associated Press: "The Democratic-controlled Senate has muscled through a plan to allow the government to go a whopping $1.9 trillion deeper in debt. The party-line 60-40 vote was successful only because Republican Sen.-elect Scott Brown has yet to be seated. Sixty votes were required to approve the increase. The measure would lift the debt ceiling to $14.3 trillion. That's about $45,000 for every American."

Astronomical federal debt, coming due as the Baby Boom generation begins to collect Medicare, Medicaid and Social Security, is enormous enough to derail the recovery.

"Will Baby Boomers Bankrupt Social Security?" asks CNBC: "The National Research Council and the National Academy of Public Administration studied the growth in three major entitlement programs- Medicare, Medicaid, and Social Security. The report, Choosing the Nation's Fiscal Future concluded that spending was outpacing tax revenue so much that 'any efforts to rein in future deficits must entail either large increases in taxes to support these programs or major restraints on their growth - or some combination of the two.' Given that no one in power is serious about restraining the deficit, we are rapidly heading toward a crisis."

"Chilling" and "infeasible" are the words U.S. Comptroller General David Walker uses to describe the budget outlook. Perhaps the best word to describe America's looming debt/credit crisis is irresponsibility, at all levels.

Most economists consider deficits in excess of 3% of a nation's annual economic output GDP (Gross Domestic Product) unsustainable. The United States' $1.56-trillion deficit this fiscal year is estimated at 10.6% of its GDP. The White House forecasts the deficit to stay above 3% of GDP for the rest of this decade. So by traditional economic measures, the present deficits are much too large to sustain.

The Financial Times reports, "Moody's warns US of credit rating fears": Moody's Investors Service fired off a warning on Wednesday that the AAA sovereign credit rating of the U.S. would come under pressure unless economic growth was more robust than expected or tougher actions were taken to tackle the country's budget deficit. In a move that follows intensifying concern among investors over the deficit, Moody's said the country faced a trajectory of debt growth that was "clearly continuously upward."

Our forefathers’ dream was that "government" would begin inside each citizen, self-government. The size, role, and intrusion of today's Federal government would be shocking to our founders.

How will our kids and grandkids survive the coming currency devaluation and inflation when the U.S. Dollar collapses under the weight of OUR generation's entitlements, deficits and DEBTS? This collapse will begin in 2010 unless something is done now to stop it.

Debt has become America's drug of choice. "Buy now - pay later," our mantra of the last 40 years, has put a heavy burden on our money system, our communities and our families. It’s time to start living within our means.

IV. Banking Crisis Risk

Along with 9.5% unemployment, the growing likelihood of a double-dip recession, higher taxes, trillions more in government bailouts and a healthcare takeover, experts are calling the impending commercial mortgage crisis a "$1 Trillion Time Bomb.”

"So far, banks in general have been reluctant to take losses on their commercial books. This 'delay and pray' strategy is preventing most banks from issuing new loans as they prepare their balance sheets for potential future losses." - The Wall Street Journal

The sub-prime mortgage crisis and subsequent financial crisis have already triggered a dramatic rise in residential mortgage delinquencies and foreclosures. Foreclosure filings in the U.S. exceeded 300,000 for the eleventh straight month, up 6% from a year ago.

An estimated $1 trillion in toxic assets was produced in the sub-prime lending crisis, and it is far from over as millions of ARMs and other loans cannot be refinanced today.

What will happen when the $1-2 trillion in commercial mortgages taken out between 2005-2008 come due? What if the banks cannot or will not lend or refinance property at current market values? Here are a few thoughtful warnings in the headlines:

“Defaults on Banks' Commercial Mortgages Seen Rising Above 5%.” – Bloomberg: "Defaults and late payments on loans bundled into CMBS (Commercial Mortgage-Backed Securities) could surpass 7% by the end of this year as banks anticipate more losses amid falling rents, according to Real Estate Econometrics LLC."

"Too-big-to-fail banks have become even bigger. The problems are worse than they were in 2007 before the crisis," said Joseph Stiglitz, a Nobel Prize- winning economist to Bloomberg. "The Fed faces a 'quandary' in ending its monetary stimulus programs because doing so may drive up the cost of borrowing."

"I think the worst is yet to come," warns Peter Cohen, former Lehman CEO on CNBC. "I think we've got a tough year, year and a half to get through. Things aren't getting any better in the financial system. They're getting worse."

"Economist warns of double-dip recession" - London Financial Times: "The world has not tackled the problems at the heart of the economic downturn and is likely to slip back into recession. Government actions to help the economy in the short run may be sowing the seeds for future crises."

V. Gold: More than a Commodity, a Stable Currency

“The age of Precious Metals is at hand. If you've been procrastinating on diversifying a portion of your assets out of the dollar, all good options may soon be closed,” reports Lee Bellinger’s Independent Living.

If gold were simply a commodity, supply and demand would dictate price. But ever since 2001, gold's image has been transformed from a commodity to what it truly is: the ultimate global currency, inflation-proof and immune from collapse.

The question for many people after reading today's economic headlines is simply: "What should I do and when should I do it?" All you have to do is use the same logic of some of the world's best investors in your own portfolio.

Economist and investment adviser Dr. Marc Faber recently told a Tokyo audience of 700 pension and sovereign wealth fund managers that he suggests getting out of US stocks and buying farmland and gold. According to a report from the UK Times on the address: The world's most powerful investors have been advised to buy farmland, stock up on gold and prepare for a "dirty war." Faber, the notoriously bearish market pundit who predicted the 1987 stock market crash a week in advance, vies with economist Nouriel Roubini as a rival claimant for the nickname “Dr Doom.”

In Tokyo Faber advised top investors who control billions of dollars of assets to start considering the effects of more disruptive events than mere market volatility. "The next war will be a dirty war," he told fund managers: "What are you going to do when your mobile phone gets shut down or the internet stops working or the city water supplies get poisoned?"

His investment advice, which came in the first keynote speech of CLSA's annual investment forum, recommended that fund managers buy houses in the countryside because it was more likely that violence, attacks and other acts of a "dirty war" would happen in cities.

He also said that they should consider holding part of their wealth in the form of precious metals "because they can be carried."

Marc Faber joins a growing number of analysts and financial news agencies predicting future financial trouble and a flight to buying physical gold. Bloomberg News recently reported on the many experts now forecasting gold's increase and the dollar's demise.

"I absolutely believe it's heading into a bubble, but that's why you buy it," said Charles Morris, who manages $2.5 billion at HSBC Global Asset Management's Absolute Return Fund in London. "A bubble is good," he said, forecasting the metal may rise to $5,000 in five years (which is why) 11 percent of his fund is in gold."

One of the best known currency and commodity investors, George Soros, is loading up on metals.

Soros is helping drive gold prices up by doubling his bet in the market even he considers a "bubble" as Goldman Sachs Group Inc., Barclays Capital and HSBC Holdings plc predict more gains before it bursts.

The list of people embracing the idea of gold ownership is growing long and distinguished. However you may believe there is plenty of time left before you need to take action. You may even agree with the pundits who suggest the U.S. economy is on the rebound and plenty of opportunities will remain to buy gold. But if you are looking for advice on when to buy and don't know whom to ask, you need not look any further than billionaires George Soros and Warren Buffett.

Everyone, unless he or she lives in a cave or under a rock, has heard of Warren Buffett's company, Berkshire Hathaway. It was ranked the best investment firm of the 21st century. Berkshire's Vice-Chairman, Charlie Munger, wrote an article titled, "Basically, It's Over." His reference was to the death of the U.S. economy as a whole.



The problem with printing money these days, of course, is that there is no value backing the money. The government isn't on a gold standard, which is why individuals need to secure their own gold standard.

In the past, we generally suggested a position in precious metals of between 5 and 15%. These days, we are generally suggesting a 10% to 25% position in precious metals, just to protect yourself and your assets.

When the currency collapse happens, all the social safety nets will disappear. We might even see civil disobedience as happened in Greece. We all must ask, "What could happen if I don't own gold?"

Investors are scared, and non-investors are confused. 70% of those polled who were under age 55 believe that the stock market is rigged. The stock market is designed for traders, but even they can't win in the long term. When the 10-year bond rate is less than 3% you should be scared! People don't know what to do with their money, but they don't know enough about gold.

We must educate people to help them. We don't have much time. This collapse may be delayed / held up / prevented for quite a while, but it is inevitable. One day you'll go into a “dollar” store and all the items will cost $150. You'll stop by a shop to pick up a sandwich for lunch that costs $1000. Your monthly electric bill is $2500. That's the day you'll be thankful you prepared properly. That's the day you'll know you did right by your family by moving your savings from politician paper dollars to the security of inflation-proof gold.

If you haven't participated in the greatest gold bull market ever, it is not too late. The recent pullback represents a great opportunity, but you must act now! Contact Swiss America at 800-289-2646 to discuss how to seize this golden opportunity now.

Disclaimer: All of the above facts and information is believed to be true, however errors are possible. All investments have risk and past performance is no guarantee of future performance.

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