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Tuesday, October 5, 2010

The Five Most Dangerous Words For Your Investments....

“Things are different this time”, are the five most dangerous words for your portfolio. Just look back at the dot com bubble and the real estate bubble for proof of the “this time is different” mantra. If you hold the "this time is different" mentality then looking  the current situation one might think that a further decline in the dollar will not happen since that would be different, and instead it will rally. There are many articles floating about discussing that the Dollar will rally significantly at this juncture due to pessimism. While there is a possibility the Dollar will rally, there is a significant head and shoulders pattern that will turn back any major advance particularly against the economic, monetary and political background of today. Additionally, I think the “this time is different” crowd is actually incorrect from a longer historical perspective.

Throughout history all FIAT money, which is not backed by anything other than a government’s promise to pay has always fallen to zero. When we as US Citizens think of money going to zero we conjure images of Weimar Germany, Zimbabwe or even Argentina.

While it is true that a currency collapse has not happened in the United States in living memory, but be certain it has happened on these shores; perhaps you have heard the phrase “not worth a Continental”.  The Continental was the first US currency issued by the Continental Congress to use as paper money to fund the American Revolution and became worthless by 1781. The Continental was replaced by the Continental Congress with the US Dollar in 1785. Then in 1789 after the Constitution was ratified the First Bank of the US was founded and under Section 10 of the Constitution it specifically forbids any state from making anything but gold and silver as money. A short while after this the Coinage act of 1792 created the Philadelphia mint and defined the value of a Dollar as a specific weight of gold; they went even further as to put a provision in the act that invokes the death penalty for anyone debasing the currency.

Why did the founding fathers and congress adopt the measures above including the death penalty for debasement of currency, because they wanted this “time to be different”. The Founders of the US were highly learned men and knew the destructive power of both FIAT currency and oppressive government as well as how they can go hand in hand. The first dollar standard lasted until 1862 around the time of the Civil war. The very costly Civil War needed to be financed so a new semi- FIAT money was introduced to help finance the war. This new Semi-FIAT currency was referred to as the “Greenback”, and was actually a US Debt obligation redeemable in Gold at some future specified date, in other words they were still backed by a promise to pay in gold. Overlapping from 1860 to 1914 the US was on a gold standard and there was price stability and almost inflation for this period, although there were a couple of panics and short lived depressions, which goes to show that no system is perfect.

Once again the Dollar was allowed to float and essentially become a FIAT currency from 1915-1925. The need to pay for World War I, drove the delinking again from gold since there was not enough gold to support the paper needed to pay off the debts of the war. From 1926 – 1931 the US moved back to a gold standard and the rest of the world pegged their currencies to the US Dollar and British Pound, as the pound was backed by the Dollar. The Great Depression rolled around and people and countries began to cash their Dollars and Pounds for gold essentially causing a run on the Gold Bank. In fact we will see a repeat of this forcing Nixon to close the gold window in 1971, but I am getting ahead of history here.



In the depths of the Great Depression the US floated its currency along with many countries around the world which caused all kinds of economic distortions, sound familiar, and also contributed to the landscape leading up to World War II.  This floated FIAT currency scenario lasted from 1931 to 1945.

The period of 1945 to 1968 the US was back on a gold standard as decreed in the 1944 Bretton Woods Accord in New Hampshire,. The seeds to unravel the gold standard which was constraining government were planted in 1963 with the disappearance of the Silver certificate and its replacement that did not allow an exchange of “lawful” money. Then under the Coinage Act of 1965 President Johnson reversed  the original coinage act signed in to law by George Washington, paving the way for silver to be removed from all US coinage and Silver certificates to be treated the same as Federal Reserve Notes. Finally, with another run on the Gold Bank by countries namely France Nixon closed the gold window and we have had the grand FIAT currency experiment form 1971 to present.

At no other time in history have ALL the world’s currencies been FIAT at the same time.  We are living through that which George Washington and the rest of the founders were trying to avoid using Section 10 of the Constitution. The founders knew that given the chance the government would grow itself in to a leviathan and debase the currency to keep growing, the point of section 10 was to control government and protect the citizens from continuing lower standards of living.

So could the dollar rally? Yes the dollar could rally from the current point as sentiment has become bearish, but it could also continue its decline just as easily. Every asset fluctuates; there are periods of rises and declines, which is normal just like the tides. The point I am trying to make here is that if the dollar gains in value and remains a viable currency over the longer term  given the current situation, then this ”time would be different” . I don’t know whether the Dollar will disappear or just become worth a whole lot less, but either way it won’t be good. In this light one needs to be in the right assets and continually monitor them to protect themselves. The assets should include but but not be limited to: precious metals, commodities, companies that produce things that are needed giving them pricing power and certain technology companies that can grow and prosper.



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