Jittery markets may be near a tipping point

Copyright 2011 by John T. Reed

When I researched my 2010 book How to protect Your Life Savings from Hyperinflation & Depression, I read multiple accounts of about 2,000 years of financial history.

One big point is that financial crises are sometimes triggerd by gradual adding of straws on the camel’s back. But more often, they are triggered by a single substantial shock arriving when the system was weak. See the Kepner-Tregoe book The New Rational Manager for more on the “multiple causes versus single cause” debate.

Since the debt-ceiling debate in July, the financial markets worldwide have been extremely jittery. The Dow falls 300 points and pundits point to some innocuous, expected stat release like new unemployment figures. Say what?

I would not be surprised if some significant shock were to now hit the financial world and tip the world over into a truly epic financial crisis like a run on the dollar or a Great Depression.

A run on the dollar would happen if the holders of dollars and dollar-denominated assets, like U.S. Treasury bonds, worldwide, became convinced that the U.S. government either going to default explicitly on the U.S. national debt, which is a better idea than you probably think, and/or if the world financial markets became convinced that the U.S. government was going to “print” lots of money to make it easier for the U.S. government to pay its bills.

Run on the dollar

A run on the dollar would be a self-fulfilling prophecy. Imagine that you learn probably from TV that the price of gold is soaring, the value of the dollar is plummeting against foreign currencies and that merchants—like gas stations, Wal-Mart, and supermarkets—are suddenly raising their prices by huge percentages and raising them again within hours of the last raise.

You, and everyone else in the world, would immediately recognize that you need to spend your dollars before they lose more purchasing power. You would go to your local stores to try to stock up on everything.

If you read and followed my hyperinflation & depression book, you already did that and you beat the rush. If you did not already do that, good luck.

Probably you will be better off staying home and trying to spend your dollars via the internet and credit card. But I expect that whole system will lock up within 24 hours for a couple of reasons:

• banks who extend credit via credit cards will recognize that they are thereby creating dollar-denominated assets, which are poison during hyperinflation, and they will immediately stop doing that—they probably already have emergency contingency plans that tell them to do that.

• everyone on earth will be trying to spend their dollars at the same time and the credit card communications and computers will be overwhelmed

• everyone will switch to debit cards, which will not have the credit problem, but which have to use the same communications and computers

If you physically go to the store, you will find a near riot. There will probably be fist fights between customers and maybe with store personnel and people try to buy every last thing in the store and clean off the shelves. Parking will be more full than Christmas. People will probably be fighting over shopping carts, too. People will be filling their cars and calling home for their family members to bring the other car. People will be stealing stuff that is left unguarded in the parking lot for a moment. Police will be overwhelmed dealing with traffic jams and parking and fist fights at stores.

You will probably be relatively unsuccessful converting your dollars into hard goods. Yet when you return home, you will see stories on the TV about prices rising even further. When you try to convert your money to foreign currency, you will also find the whole world is trying to do the same. The U.S. government will probably announce an emergency edict preventing Americans from acquiring or owning foreign currency. That is typical in such crises. The government is trying to steal your money via the trick of “printing” too much of it. If you convert to hard goods or foreign currencies, to whom will they sell their newly “printed” money? Without holding you still while they rob you, the government, cannot succeed in paying off their debts with worthless paper. So expect all the exits from the dollar to suddenly be slammed shut.

What will the big shock be that sets off a run on the dollar?

I’m not sure. Here are some current suspects:

• end of the euro currency

• default by one or more of the PIIGS countries

• failure of a number of big banks in strong EU countries

• downgrade of the U.S. by more bond rating agencies

• sale of all its U.S. government bonds by China

• war between the U.S. and some country we are not already at war with

• reelection of Obama and loss of the House to the Democrats

• War between Israel and a Middle-Eastern country

• a costly natural disaster like a hurricane or earthquake

America and most of the world bond market are in denial. Europe, China, Japan, and America are in big financial trouble. The former East Bloc is no economic leader and has its own problems. Brazil as a fabulous future and always will.

The markets are like a cat on a hot tin roof and smoke is rising from all corners of the house the cat is on top of. There is probably still some small time to prepare. After the ’flation hits the fan, your options will be slim to few.

Hi John:

Question for you on your article about jittery markets. Why do you believe that the Euro's demise would have a negative effect on the dollar? I am of the belief that if the Euro dissipates, then we will find ourselves in a better position. The reason why is that there would be fewer "major" currencies in which we'd be in competition with. It would at least buy us some time before the new currencies and/or "old" currencies that countries would revert to (Deutschemark, Franc, Lira, etc.) become prominent currencies to peg against ours.

It is my understanding (and I could be wrong about this), that since the Euro was created, it's basically been beating the dollar to death. I know that our currency has been taking a bloodbath when people try to spend it in Europe. But if the Euro collapses, then we may stand to gain from it. It's my belief that the VAT that's prevalent in Europe would most certainly need to be increased with a collapse of the Euro. In turn, this would result in a potentially large recession in Europe.

Just my thoughts though...great article!

Michael Beifeld
Sr. Account Executive
Herbert L. Jamison & Co., L.L.C.
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I do not believe that the euro's demise will have a negative effect on the dollar. It might have a general negative effect on trust in everything financial. The thought might be that if the euro goes, what's next? or if the euro goes, can anything survive this period? The EZ has a bigger GDP than the U.S. Reinstatement of the mark would probably make that the most attractive currency.
You may be correct, but predicting irrational exuberance or irrational despair is far from a perfected science. On TV, you often see nature specials including aerial video of herds of antelope or buffalo. The herd suddenly changes direction for no apparent reason—spooked by something unseen on the TV. In this environment, owning anything that starts with the word "fiat" may not be good when one big thing that starts with the word "fiat," like the euro, goes belly up.

Jack Reed

John T. Reed