Structural Money Devaluation In The West
February 17, 2011 by Daniel Zurbrügg
When facing questions about foreign currencies, a common response is, “I don’t care about currencies. I buy my milk, butter and bread in United States dollars, I get paid in U.S. dollars and my mortgage is in U.S. dollars.” However, given the large and potentially severe consequences of today’s economic situation and global structural changes, everybody should be aware of the importance of currency diversification and how you can manage the risk of future currency devaluation.
Many Western nations have entered a prolonged period of deep structural change that will take many years to complete. For decades, Western nations enjoyed increasing prosperity and that resulted in a steep increase of government spending and a never ending increase in the build-up of welfare states. This has caused an accumulation of huge amounts of government debt in many major economies.
Now, changing demographics, chronic overregulation and the wrong economic incentives could make the problem even more severe. Therefore the ongoing liquidity injections, such as the European bailouts or quantitative easing in the U.S., could eventually force a further and potentially severe devaluation of money and currencies.
Loss of purchasing power affects everybody and almost everything. The chart below shows by how much the U.S. dollar has already devalued in the last 10 years against other major currencies: The euro, Swiss franc, yen and Singapore dollar.
*EUR=Euro / CHF=Swiss Franc / JPY=Japanese Yen / SGD=Singapore Dollar / Change in % vs. USD (Base 100%)
This chart illustrates how important currency diversification is and how global investments can help investors to protect against the adverse effects of the domestic situation.
Many investors underestimate the very powerful benefits of proper currency diversification, if they think about it at all, but recent history shows us how important a sound currency investment strategy is. Let’s look for example at the events in the global economy last year, they are highly alarming.
The sovereign debt crises in many countries have worsened significantly and we are facing a situation today where a large number of governments, countries and individual states are facing technical bankruptcy. The situation is most concerning in the U.S. and in Europe where there are plenty of reasons to believe that both regions, and with it their currencies, are heading for a long-term structural downward trend. Of course, central banks and the IMF can put together bailout programs and the Federal Reserve can engage in further quantitative easing programs, but all of these measures will come at a price.
It would be outright foolish to believe that all this liquidity can be created out of thin air without real economic consequences. These consequences do not come overnight but might actually take two to three years until we see the negative impacts — in this case rising inflation — in daily life. The price that needs to be paid longer-term is eventually borne by everybody through destruction of wealth and the loss of purchasing power.
It essentially acts like another tax on everybody at a time when tax rates are already at painful levels. This situation can only be avoided by governments gradually cutting deficits and redirecting spending into sensible expenditures that produce real economic value for its citizens.
Unfortunately, the deficits are increasing. The U.S. government’s debt is on track to reach $15 trillion by the end of this year and is therefore exceeding the size of U.S. gross domestic product for the first time since the years immediately after World War II.
In the absence of dramatic spending cuts, redirected investments and savings programs, this debt burden will most likely continue to rise because just servicing the large debt burden is a real challenge already. The chart below illustrates the sharp rise of the U.S. debt burden since the mid 60s.
Despite the fact that European countries have announced large spending cuts, the situation is not better there than in the U.S. While the deficits might be smaller in the future, the European Union and the euro will face a number of serious challenges in the years to come that could even put the future of the European Union — as we know it — at risk.
The recent bailout programs for Ireland and Greece and potential future rescue operations for troubled member states are a real stress test for the Union. It seems that there is an increasing reluctance among individual member states to help countries which are facing financial distress. This has lead to a rise in anti-Euro sentiment in certain states, especially Germany and France. In France, the far right wing party “Front Nationale” is becoming a lot more popular and their main political goal is to exit the European Union and its common currency system, not a very encouraging prospect for Europe.
The enormous liquidity injections that we have seen in the past three years are a very big and risky experiment, with the outcome remaining highly uncertain. It is understandable that today’s central bankers are very concerned about the reemergence of deflation and its destructive effects on the economy. One only needs to look at the situation in Japan, where the economy has been in deflation for most of the last 20 years.
However, Japan is a different situation given that its economy needed a lot of restructuring, a process that has still not been completed. Japan’s debt situation looks even worse at first glance; however, taking into consideration the large private savings of its people, Japan can better afford the significant debt burden because most of it is financed from domestic sources, a truly significant difference to the situation in the U.S. today.
The Federal Reserve will probably continue to keep rates at these very low levels in an effort to stimulate the economy as much as possible. But eventually the market demands a higher yield for U.S. government debt, given the fact that its financial situation continues to deteriorate. This could lead to a further decrease of the U.S. dollar and rapidly rising price levels through the import of inflation.
Don’t forget, many goods such as food, energy and commodities are priced on a global level. Given this situation, it is even possible that we might see stagflation (rising inflation with little to no economic growth) appearing on the horizon.
With the outlook for the U.S. dollar and the euro remaining quite negative, it is highly important to keep some savings and investments in other currencies which are stronger and might be gaining in value in the years to come. There are plenty of attractive currency investments to choose from globally.
Don’t expect central banks to print less money and don’t hope for governments to spend the tax money more wisely. The only way to protect against the forced currency destruction is to be proactive and start investing globally.