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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Money is, by far, the most heavily traded financial asset in global marketsThe Dollar and Its Alternatives In a camp that is liable to be raided by coons, porcupines, or other predatory animals, the meat [and] fish should be cached under piles of stones twice as heavy as you think such beasts could move. . . . Bears will demolish any such pile that one man could build. H. KEPHART THE SYMBOL OF FINANCIAL MARKETS that fatten personal wealth is a well-fed bull; the symbol of financial markets that savage personal wealth is a hungry bear. The carnivorous imagery of market terminology is deep-rooted. Man, as flesh-eater, has survived in the wilderness primarily by two carnivoredriven skills: the ability to hunt and fish for food (vegetarianism being the luxury of residents of agricultural societies with functioning food markets), and the ability to protect himself against becoming food for some other predator. How does one measure the investors diet? In terms of money. When one has enough money beyond basic nutritional needs, one can acquire stocks, bonds, bank deposits, real estate, and other forms of savings. Poverty is the absence of wealth, as measured in money. Financial survival is the accumulation of enough income-producing financial assets to generate enough money income to live comfortably. Personal financial crisis comes when falling asset values, accompanied by high liabilities measured in money, force investors to the equivalent of killing their cats and dogs to survive. (That some of the failed investments sold to cover margin debts are known as cats and dogs is the Streets sardonic summary of the process.) What is money? Money is, by far, the most heavily traded financial asset in global markets. Investors, travelers, and businesspeople switch from one currency to another, or to a group of other currencies, on a scale that dwarfs the resources of all but the most powerful central banks. Yet most Americans tend to think of the importance of currencies only when some far-off countrys financial system is collapsing because holders of that countrys currency are panicking to get out of it. Television images of Argentinians and Brazilians lining up at banks to try to cash out their plunging pesos and reals show the human drama of wealth destruction when a paper currency suddenly loses its value. PAPER PROMISES Paper money not backed by gold or full exchangeability into other currencies is, in reality, little more than the printed paper promises of politicians. It is therefore subject to inflation risk at all times. In general, if the inflation in the country issuing the currency is at or below the average level of inflation in the leading industrial nations, that currency should be able to hold its own in the global markets. It will trade up or down moderately based on economic, political, and financial developments in its host country or in the countries of other leading currencies that are not tied directly to inflation, but it should qualify to be called a store of value. If the inflation is significantly higher in the issuing country, the currencys value will fall. In essence, thats what happened to the dollar over the period from 1950 to 1980: U.S. inflation was higher than inflation in Germany and Japanthe next most important economies. If inflation in the issuing country is completely out of control, then the condition is catastrophic. This is called hyperinflation. The most famous example occurred in the fragile Weimar Republic in the 1920s. When the Weimar Republic began printing unlimited amounts of deutschemarks in a vain attempt to cover Germanys punitive war debts imposed by the victorious allies after World War I, the money soon became worthless, and inflation skyrocketed to hundreds of thousands percent. The money was literally not worth the paper it was printed on. Proof of that condition came when Neilsons, Canadas leading chocolate company, took advantage of the disaster: It bought hundreds of billions of face value marks for a few hundred dollars and used them to wrap its candy bars. The paper was good quality, and it was cheaper for the manufacturer than buying such paper from local suppliers. Someone in Germany who was worth the equivalent of $10 million in 1921 in bank deposits and cash who did not switch his wealth into hard currencies, such as pounds, Swiss francs, or dollarsor into gold, stocks, or real estatehad only enough wealth to buy a few beers after the hyperinflation had run its course. The biggest losers from the currency collapse were those who held the currency, or who held mortgages, bonds, or bank deposits in a currency that swiftly became worthless. Who were they? The middle class. The truly rich owned companies, farms, factories, and urban real estate; if those assets were subject to bonds or mortgages, then the rich just got richer. The poor got poorer: Food prices rose faster than prices generally, because farmers sought to export their production to hard-currency countries. Lenin and Stalin inflicted similar devastation on the Russian ruble. In Russia and Germany, the private cash and bank savings of the middle class was virtually wiped out. Money under the mattress became worthless. The bourgeoisie lost heavily and became dependent on the Communist Party for survival, whereas members of the upper class were simply shot. Hyperinflations lead to political revolutions. Currency devaluations, in which a currency loses 10 or even 50 percent of its value, may also lead to the collapse of governments. Nations such as Britain have had to accept such humiliating repudiations of their national money, but without resorting to dictatorships. When the pound broke through its support levels in 1992, George Soros became known as the man who broke the Bank of England because he bet heavily in the currency market against the pound, and ultimately the pound fell to a lower but not disastrously lowerlevel. Since currency markets began to flourish in the decades after World War II, all currencies values have been primarily expressed in terms of the U.S. dollar. Therefore, the most important story for investors in terms of long-term wealth planning is to focus on the outlook for the dollar. This may seem obvious to American readers, but its also applicable to readers abroad. The dollar is one end of a series of teeter-totters in the playgrounds of currency players. The other end of each teeter-totter is the alternative currencythe euro, the yen, the Canadian dollar, the Swiss franc, the Thai baht, and so on. Because the dollar is the worlds reserve currency, the story of global inflation since World War II is largely the story of the rate of decline in the purchasing power of the dollar: When the dollar rose in value against the other leading currencies of the world, global inflation rates moderated or fell; when the dollar fell in value, global inflation rates and the price of gold tended to rise. The importance of that statement for investor survival is that the dollar experienced a powerful bull market from 1995 to 2002. Since then, it has entered a bear market. To make that statement is to invite a host of questions from investors. What is the meaning of a bull or bear market for the dollar? Should we be buying gold? Should we be switching into euros? What does a dollar bear market mean for U.S. stock prices? Answering those questions requires a review of the history of the dollar over the past 75 years. But, you may be saying, this book is supposed to be an Investors Survival Guide, not a textbook on global currency trends. Do I really need to go through a lot of history in order to design my own wealth accumulation program? Yes. It is quite likely that the biggest investment challenge youll face in the next decade will come as a result of a crisisor a series of crisesin the exchange rate value of the dollar. This is not a book about playing the stock market. Its about survival, and, as billions of people learned in the last century, when your countrys currency gets into trouble, youve got troubleunless youve protected yourself. THE ALMIGHTY AND NOT SO MIGHTY DOLLAR The dollar became the unofficial global wealth standard during the Great Depression. Most of the nations in the rest of the industrial world were indebted to the United States in dollars, and America was by far the richest nation in the world. When President Roosevelt revalued gold from $20.67 to $35 an ounce, the United States sucked in gold from all over the world, as bullion holders and gold miners eagerly swapped their metal for dollars. The dollars de facto role was made official at the Bretton Woods Conference in 1944. By then, the United States owned most of the worlds known supplies of gold bullion, and it agreed to make those reserves available to foreign official holders of dollars (governments and central banks) at a fixed price of $35 per troy ounce, an agreement that laid the basis for Europes postwar economic recovery. To ensure the ready availability of gold to foreign central banks, and to discourage Americans from speculating against their own currencys valuesince Americans collectively held most of the worlds tradable financial assetsWashington decreed that it would be illegal for American citizens to own gold bullion. Until the early 1960s the new system of gold exchangeability worked well. But, as French president Charles de Gaulle complained, the requirement that other central banks hold dollars in their official reserves gave the United States the ability to undergo worrisome levels of inflation without its currencys value being punished: The other central banks were forced to keep swallowing dollars. In short, it meant the United States had no market-imposed discipline on its governments economic policies, even when those policies led to a sustained Current Account deficit. The Current Account is the balance between exports and imports of goods, services, and short-term interest payments, and is primarily driven by the trade balance. As de Gaulle noted, the effect of these unforeseen consequences of Bretton Woods was to give the United States the license to export its own inflation. |
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