People have been enquiring about the following: will the dollar be devalued, when will the dollar be devalued, will the dollar collapse? They want to know what to invest in when the dollar collapses. They worry what will happen if the Congress and President can’t sign a debt increase and spending authorization tonight and the government is shut down.

   If the U.S. government is shutdown tonight at 9:00 p.m. Pacific time nothing really serious will happen for a few weeks and then Congress and the President will eventually reach an agreement. A shut down that results in the Democrats agreeing to the Republican’s demands would actually be bullish for Treasuries and the dollar because it would show the U.S. is trying to improve its finances. However, if a shutdown is blamed on the Republicans and they are seen as giving up and surrendering to the Democrats when a budget agreement is finally reached then the world’s capital markets will see the dollar and U.S. Treasuries as continuing to degrade in quality, which would lead to higher interest rates, low bond prices, lower stock market prices. All that is being negotiated are spending cuts of 2 to 4%. If the U.S. was a corporation or a family and they had a consultation with their banker while seeking to increase their debt they would be told to cut spending far deeper than 2 to 4%.

     So if the worst happens and deficit spending continues unchecked then one should prepare for dollar devaluation but if it does happen it will happen gradually and slowly.     

     The world needs to keep any one large nation from devaluing too much because that steals business away from other countries and disrupts world trade. Further the world needs its reserve currency (the dollar) to be stable so the world has a vested interest in propping up the dollar. An analogy would be the giant U.S. banks that are deemed to be “too big to fail” are treated more leniently by bank regulators so that they are allowed to function even though should have been shut down by the FDIC. Another analogy would be when regulations were changed in 2009 allowing banks to stop marking non-performing loans to market value and instead report those loans at book value. In both cases the government is trying to cover up the weaknesses of the large, unhealthy banks in order to avoid the catastrophic cost of shutting them down. In the case of the world’s capital markets and governments they have a vested interest in pretending that U.S. government Treasuries and the dollar are as good as they have been in the past.

     There is no realistic alternative to the dollar as a reserve currency. The Euro is not up to the task, because its debt market is a lot smaller than the dollar, has a lot of hidden risk and may break apart. The ECB may break its mandate to have sound money and engage in a desperate act of money printing should a chain reaction of sovereign defaults occur in Europe. The Renminbi will gradually become an international currency over many decades but may not be ready to be a reserve currency for another 30 years. Gold can’t be used in lieu of the dollar because there is not enough gold to act as a substitute for the dollar’s role as a reserve currency. Using SDR’s from the IMF is a fantasy because SDR’s are fiat money based on contributions of fiat money from the very governments that caused this imbalance, so why would an SDR be better than a basket of shaky Euros, Yen, and the dollar? SDR’s are analogous to mortgage backed securities that were a blend of poor quality mortgages that somehow were repackaged as AAA quality debt. How can a blend of various shaky, deteriorating currencies inside of an SDR be any better than simply buying the ingredients of an SDR on your own?

   The dollar’s unique position is like what Winston Churchill said about democracy: it is the worst system in the world, with the exception of all others.

    So the U.S. dollar and Treasuries are in a unique situation where the world has a vested interest in propping them up above fair value.

    However, the invisible hand of the free market wants to make Emerging Market countries currencies go up against the dollar, even though the world’s governments don’t. Ultimately the markets are stronger than governments so the EM currencies will increase against the dollar. So go long on Emerging Market foreign currency, but don’t panic. Avoid the Euro and Yen.

   I have written about this in “Treasury bonds to be OK” and “Will the dollar be devalued”?

    This is my independent financial advice.