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A Problem for the U.S. Dollar Worse than Debt

Interest-Rates / US Debt Jun 10, 2010 - 12:28 PM GMT

By: Q1_Publishing

Interest-Rates

Best Financial Markets Analysis Article$19.6 trillion. That’s the Treasury Department’s latest estimate of the national debt to reach by 2015.

The debt has many folks concerned, and rightly so. There is, however, a much bigger problem facing the country and the U.S. dollar.


You see, amassing debt is not good, but it’s hardly the end of the road for a government that’s still generally trusted by the financial community. For instance, Japan’s total debt is 181% of its GDP. That’s much larger relatively than Greece, Spain, Italy, or Hungary.

But while the debt has been attracting all the attention, the real risk to the value of the U.S. dollar is posed by the annual budget deficits. And a little known, tried-and-true equation shows the inflation is coming in a big way.

$100,000 a Second

In 2008 the great credit expansion came to an end. Companies going bust, personal bankruptcies soaring, and a general decline in economic activity has unleashed deflation on the world. The private sector had enough debt and, as a whole, didn’t want anymore.

The government, however, has stepped to keep the credit expansion going. The U.S. government is borrowing $100,000 a second to keep the bubble growing. And that’s where the problem lies.

The current budget situation is a tenuous one. Revenues are down and spending is up creating a massive deficit. Last year’s deficit came in at just over $1.4 trillion. The latest Congressional Budget Office (CBO) estimate of this year’s will be at $1.5 trillion.

And the trend is set to continue well into the future. The CBO’s estimates peg the total deficit spending over the next year to average $970 billion a year. And given the overly optimistic economic expectations including no recession, a record rebound in employment, and record low inflation and interest rates, the deficits will likely stay well over $1 trillion per year.

That’s where the real problem lies. As Peter Bernholz states in Monetary Regimes and Inflation: History, Economic and Political Relationships, “There has never occurred a hyperinflation in history which was not caused by a huge budget deficit of the state.”

More importantly, Bernholz’s research reveals the situation is more ominous than anyone lets on about.
No Hyperinflation, But Close Bernholz’s research of all the past hyperinflations reveals there’s one key factor which determines when hyperinflations occur.

Adam Sharp at Bearishnews.com states in the hyperinflation tipping point, “Economist Peter Bernholz is an expert on the subject of national hyperinflations. He has studied all the major cases of hyperinflation since 1980. His conclusion: The tipping point occurs when a government’s deficit exceeds 40% of its expenditures.”

That’s the key to watch – 40%.

Sure, the $13 trillion debt and expected growth to 90% of GDP and $19.6 trillion in 2015 at over 100% of GDP get all the headlines, but it’s all about spending relative to revenue. And when the deficit reaches that critical 40% tipping point, we’ll call it the Bernholz Equation, it’s game over for the fiat currencies.

The U.S. has hit that point and will likely be unsustainably close to it for the next decade.

The CBO projects the following deficits as a percentage of expenditures:

Clearly, the U.S. government is playing with fire.

And the U.S. dollar is as flammable as ever because you can’t forget those forecast declines in the relative deficit are based on the outlandish assumptions that there will be no recession in the next decade and a record surge in employment.

The Clock is Ticking

Basically, a devaluation of the dollar is coming – slowly or all of a sudden. There’s no way around it. But there are some important variables that signal it’s going to take some time.

First, the U.S. government has an ever-expanding appetite for control over the banks. And banks will likely be more than willing to support the continued government borrowing for quite some time.

Second, the U.S. dollar is still the world’s reserve currency. Every time the markets fall or there’s a liquidity scare, everyone rushes into the dollar.

Third, these are all ten year forecasts. Figuring out what’s going to happen next year is tough enough… ten years from now, impossible. But it’s a pretty safe bet the situation will be worse.

Finally, the dollar is a damaged currency, but it’s certainly not the worst. The Euro is showing its weakness. Japan has been printing yen for years. And there are few currencies which are still trusted as much as the dollar.

In the end, the deficit will prove to be the dollars undoing. The total government debt will continue to grow, but according to Bernholz’s Equation, inflation is coming. And it’s coming in a big way.

If deficits of 40% of expenditures lead to hyperinflations, it’s pretty safe to assume that even the rosy expectations of 20% will be very inflationary.

Precious metals were the best asset class of the last decade and all signs point to it doing even better this decade. That’s why we’re continuing to recommend the best values, with the least downside risk and great upside potential (like those revealed here which soared more than 1600% while gold rose a mere 13%), in the gold market today.

Good investing,

Andrew Mickey

Chief Investment Strategist, Q1 Publishing

Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2010 Copyright Q1 Publishing - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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