Today Obama tried to give support to his Treasury Secretary by saying, "No Treasury secretary since maybe Alexander Hamilton has faced such challenges." Funny he should mention Hamilton, because Alexander had a quote regarding our current situation that we are in today. The original constitution had a provision that stated, "the legistature of the United States shall have the power to borrow money and emit bills of credit." Alexander Hamilton voiced the majority of the delegates who won the removal of that term from the constitution. Hamilton said,"to emit an unfunded paper as the sign of value ought not to continue a formal part of the constitution, nor ever hereafter to be employed; being in its nature, repugnant with abuses and liable to be made the engine of imposition and fraud." He was saying that currency backed by nothing more than a government promise is prone to corruption. Later Hamilton became the first Treasury secretary of the United States. He set up the first US Mint and backed US currency by gold and silver. This set off the greatest economic boom in world history.
In 1972, Nixon took US currency off the gold standard. The currency then suffered terrible inflation and Nixon found himself in jail on other charges. Leaving the gold standard made the US dollar a fiat currency. Fiat currency (fiat money) is money that exists because an authority or custom declares it to be money. As Hamilton alluded to, the history of fiat currencies is not pretty.
Just this year the US will issue 2.35 Trillion new treasuries and Europe will have to issue even more! Japan and China already own 65% of all US treasuries. Meanwhile Japan is out of money and China is spending what it has as both economies implode. Since 1830 there have been 4 bursts of sovereign government debt defaults. 1840 and 1940 both saw 50% of soverign governments default at once. The other two events were both over 40%. In arguably the worst financial crisis in history, we currently are seeing only under 20% of governments in default. The debasement of fiat currencies and government defaults will rise rapidly over the next year. Even if the US does not default, it will at least have to devalue its currency to pay for all its obligations.
The investment strategy for this situation is to own real things with real value. No matter what is happening with currency, people will find a way to trade something for breakfast, lunch, and dinner. Own companies (stocks), that are creating a real profit selling real products that people want. These companies also must not have a need to borrow money for the next several years.
Real estate will also hold its value. The roof over your head has real value and the land a building rests on, also has value. Especially now that prices have come down significantly, there should be good real estate deals that will hold value against a declining currency.
Commodities famously hold their value in times of fiat debasement (inflation) because people need the basic building blocks of our lives like oil, sugar, and copper regardless of what is happening with currencies. Companies that are producing these commodities efficiently can also have value. Deep sea oil driller Transocean (RIG) is my favorite.
Everyone is running to gold (GLD), but silver (SLV) may hold better value. Since 600 BC Gold:silver has traded 15:1. Similarly there are 15 parts of silver to every one part of gold in the earth's crust. This ratio started to climb in the 19th century but was back to 15:1 as recently as 1980. It is now trading 70:1.
The Fed today announced that it is going to buy up to 300 billion longer term US treasuries over the next year. That is good if you like inflation, but barely scratches the surface as it is only about 10% of the money the government seeks to borrow. Whether it is inflation or higher interest rates or outright default, treasuries record low interest rates are in a precarious position. Famed investor Warren Buffet said February 28, 2009: "When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he went on. "But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary." If you are bearish on US treasury bonds buy the 10 year double short ETF ticker TBT.
