Last week at FreedomFest (hard to believe it was only a week ago…!) one of my favorite speeches was by Peter Schiff, CEO of EuroPacific Capital. Peter is always an entertaining speaker, but more importantly, he’s gotten a lot right over the past 10+ years, even when everyone else said he was crazy.

(You can watch his infamous speech to the Mortgage Broker’s Association in 2005/2006 where he predicted the downfall of Fannie and Freddie and the collapse of the entire housing market… and his testimonies before Congress also on the state of the mortgage market if you’re inclined…he is very entertaining and dead-on right.)

Today, Peter is not bothering to question “whether” the dollar is doomed. He is absolutely convinced that it is—it’s simply a matter of time.

He jumped right into “why” at his speech at FreedomFest, and I’d like to share what I can with you from my notes today!

So without further ado, I bring you…

Peter Schiff – Why the Dollar is Doomed

Not one to mince words, Peter kicked off his speech by proclaiming that the best thing that the dollar has going for it right now is that it’s not the euro.


But he was quick to point out that he’s been coming to FreedomFest and other conferences for many years now and talking about the demise of the dollar, and yet, against all odds, the dollar is still managing to thrive, despite the fact that it should be falling.

The question of course is why?

Why is the dollar surviving, and what is taking it so long to collapse (as Peter is convinced it will do)?

Basically, because it is the current “safe haven” and “lesser of all evils”.

The best thing the dollar has going for it is that people think that Europe is in worse shape than America.

And Europe is in pretty bad shape…but America is in worse shape.

When you look at the nations that collectively share the euro currency as a group, they actually have less debt relative to their GDP than does America.

But the European countries (e.g. Greece, Spain, and Italy) cannot print their own currency (the euro) directly and instead must go to the European Central Bank (the ECB) and hope that the ECB will bail them out.

So far, the ECB has been reluctant to do so, but has been caving in lately (with the latest Spanish bailout plan, etc.).

So, the big difference between America and Europe is that we here in America can issue our own currency at will—the Federal Reserve will bail us out “no matter what”…but we are technically in even worse shape than Europe, though all the world’s attention is focused on Europe right now.

We therefore do not have to technically default, because we can simply print as much money as we want.

Right now U.S. bond holders are taking solace in the fact that we have a printing press, so we see yields on U.S. treasuries falling to absurd levels and the dollar maintaining its relative strength (temporarily). But history tells us that the printing press is definitely not a “get out of jail free” card, and one day America’s creditors are going to wake up and realize that they are getting paid back with money that doesn’t have much value (if any at all).

Peter believes the credit markets will wake up and the “bond market vigilantes” will wake up and realize what is going on, but in the meantime the dollar is benefitting from all of the problems happening around the world because the perception is that the U.S. dollar is a “safe haven”…it’s the lesser of all of the evils.

This perception is wrong (one look at the U.S. government’s balance sheet will show you that…), but that doesn’t stop people from perceiving it that way. Peter brought up the fact that history has many examples of false perceptions like this—notably and most recently, the housing market and subprime mortgage debacle.

For years, people didn’t perceive any risk whatsoever in buying those mortgages—they thought it was just fine to loan money to people who couldn’t pay it back because the loans were backed by real estate (and everyone knew that real estate only ever goes up!).

That was the widely-accepted belief, and one of the main reasons that so many people in the mainstream media failed to listen to Peter’s gloomy outlook for the economy at the time (2005-2006) was because it was predicated on the fact of real estate prices going down, and that idea was simply dismissed out of hand…of course real estate prices would never go down.

Unfortunately, though, now Peter talks about what is going to happen to the US economy and the dollar when interest rates rise, and he is met with that same degree of skepticism, because “everyone knows that interest rates can’t rise…”

People say, “Look at Japan! Interest rates have been at 0% for 20 years, so we Americans can keep interest rates at 0% for 20 years, too!”

But there is a big difference between Japan and the United States.

(Here he segued into the “fiscal cliff” for a minute…)

There is a lot of talk now in the media about the “fiscal cliff”—what will happen at the end of the year when the Bush tax cuts expire (and a few tiny budget cuts come in). The idea is that if we cut government spending, even by a little bit, we are going to go over some kind of “fiscal cliff” as if that government spending actually contributes to the economy…but as Lacy Hunt said at the Casey Conference, once government spending reaches a certain percentage (and we are far, far over that!) it subtracts from our economy (and many would argue that all government spending subtracts from our economy!).

Anyway, the actual “fiscal cliff” according to Peter has nothing whatsoever to do with what everyone is supposedly afraid of—it is just an excuse not to go through with the promised spending cuts.

The real fiscal cliff is what happens when interest rates go up…because they will have to go up eventually.

Why Must Interest Rates Go Up?

Once again, we must look at Europe. Greece, Italy, and Spain are in trouble because they cannot pay the interest on their debt. Interest rates have risen, because the creditors who have been buying their bonds are waking up to the fact that they aren’t going to get paid back and so it is more expensive for these countries to borrow.

(KFG Note: That is it in a nutshell right there…the entire global fiat monetary system is based on “confidence”, and when that confidence is shaken, which it will be, interest rates will rise.)

The same thing will happen in America…just because we can print money doesn’t mean our creditors are going to accept it.

Once our creditors realize that the money we print is not going to return to them the purchasing power they expect, they will demand higher interest rates, just like they are demanding higher interest rates in Europe.

And is the U.S. economy positioned to handle an increase in interest rates?

Not at all!

Everyone is worried about Spain because interest rates are around 7%…and the worry is how long can the Spanish economy survive rates that high? They cannot afford to borrow more money at 7% interest, and they cannot afford to pay their existing interest payments.

So…what about America? What would happen to the US economy if interest rates went to 7%?

Well, assuming that happened when the national debt was at $20 trillion, (and that is just the tip of the iceberg, the funded portion of our national debt…), when it gets to $20 trillion, what is 7% of that?

It’s $1.4 trillion PER YEAR.

Is it possible the U.S. economy can pay that kind of rate of interest?

In a word, no.

Right now, our debt is all financed with short-term paper. Our cost of funding our current national debt is “only” $300 billion per year, because the Federal Reserve has interest rates at 0% and the Treasury is making the mistake of financing on the short-end of the curve—they are doing the same thing that subprime borrowers did when they bought houses using an introductory teaser rate (1% for the next 6 months!).

We are in the same situation as Greece or Spain…we are going to have to default. We are going to have to restructure. The Federal Reserve knows this is coming…and that is the real reason interest rates are still at 0%.

Peter is shocked that more people don’t see this.

Most people are wondering, “If the economy is recovering, why does the Fed still have it on life support?”

We are not recovering at all— our economy is surviving only on the basis of quantitative easing (money-printing).

Peter likened our economy to a bicycle with training wheels…most people thought that the Fed came to the rescue of our economy and put training wheels on the bike (our economy…) and now that the bike is moving along on its own, it’s time to take the training wheels off.

Many people believe this analogy, but they are missing something crucial—the Fed knows that QE aren’t the training wheels— they are the only wheels! If they take the wheels off, the bike will fall over!

So now everybody is speculating whether or not we are going to have QE3.

Many think the U.S. economy is capable of growing, but it can’t grow without a real recession first. We need to purge the economy of its imbalances and liquidate our bad debt.

None of that will happen until interest rates rise, but instead the Fed is keeping them down which prevents that from happening. So when the Fed says, “we will only have QE3 if the economy needs it” that means QE3 is coming!

Peter likened it to a heroin addict who says, “I’ll only take more heroin if I need it…”. The U.S. economy is addicted to cheap money, and if you take it away, “the whole thing implodes.”

But what does that mean for the dollar?

If the Federal Reserve decides that it has to keep interest rates down because the pain of allowing them to rise is too great, then what will suffer is the value of the dollar.

Rising interest rates are a bitter-tasting medicine we have to swallow if we are going to heal the economy, but of course the voters don’t like the taste of that medicine and the politicians don’t want us to swallow it, so the Federal Reserve will probably decide that it must delay this as long as it possibly can.

Right now the world is still convinced that despite all of the money we are creating, there is no inflation.

Even though creating money is the very definition of inflation, people are looking for the consequences and for the actual increase in prices, which is difficult to notice considering that the government is the one keeping track of prices (much like the fox guarding the henhouse).

The government keeps telling us that “there is no inflation”, despite the fact that the cost of living is rising, but at some point, prices will be obviously rising in America.

(KFG Note: all of the money that has been created is sitting in the banks and not making its way out into our economy yet in the form of loans, so the effects of all of the money-printing have yet to be seen in dramatically rising prices).

And they will be rising at a rate that is far too fast for the government to pretend that it’s not happening.

What will happen then?

Is the Fed going to raise interest rates to fight that inflation the way we did under Paul Volcker in 1980? They will resist that. Imagine what would happen…we had a pretty bad recession in Reagan’s first term when interest rates went to 20%.

We just discussed what would happen when rates hit 7%…20% is unfathomable.

And yet we’re in much worse shape than we were in 1980.

Monetary policy has been worse during this last decade than it was during the 1960’s, so ultimately the rate of interest that would be required to restrain the inflation would probably be even higher, but the problem is that now we couldn’t survive the cure, based on how big the implosion would be.

Therefore, the Fed is going to try to keep interest rates at 0%, even though inflation is getting out of control. The Fed is going to say that a little inflation is good for us and convince us that it is better than having to suffer deflation.

The other reason the Fed doesn’t want to raise interest rates to try to stop inflation or support the dollar is because of the banks.

Remember, we bailed out all of these big banks with the TARP. JP Morgan just recently lost close to $10 billion on one of their structured products, but the Fed knows that if interest rates were allowed to rise, the losses to JP Morgan, Morgan Stanley, Citigroup, and to BofA would be enormous.

All of these big banks would fail if interest rates went to 7% (where they are right now in Spain…we are worried how the Spanish banks will handle 7%, but what about the American banks? They’re all levered up, too!)

American banks have long-term treasuries that are paying 3-4%; they have long-term mortgages that are yielding 3-4-5%, and that “positive carry” works when you can get money for free from the Federal Reserve.

(KFG Note: Not a bad deal at all…borrow infinite money at 0% and turn around and make 4% on it…free money!)

But if they have to pay 7%, or 5% or 4%…suddenly that doesn’t work.

People tend to focus on the benefits of these mortgage refinances for consumers…and yes, homeowners get to refinance at a lower rate, but the loser in that transaction is the lender—it’s the bank who holds that paper and who now has a lower yielding asset, but can survive because the Fed props it up with low rates.

But when those rates go up, that positive carry turns negative and all these big banks implode, so by raising interest rates we will bankrupt all of these big banks.

What happens to the Federal government if interest rates go up to a reasonable level to contain inflation?

The Federal government has to restructure and admit that it can’t pay its bills and that it can’t pay 100 cents on the dollar. So we will have an implosion in the bond market.

And what happens to the Fed’s balance sheet?

Thanks to Operation Twist, it is loaded up with long-term treasuries, and Congress will have to bail out the Federal Reserve.

The long and the short of it is that the dollar is doomed.

In order to save it, we need to raise interest rates very high, but we can’t even take them off of 0%.

1% used to be the floor under Greenspan, but Bernanke can’t even raise them to 1% without toppling the entire economy!

Now you understand the predicament and understand that it is not a matter of “if” the dollar it will collapse but “when”, and the only question is—how much value will it lose and will we do the right thing in time to prevent it from losing ALL of its value?


So there you have it…the dollar is eventually doomed, but will probably continue to do well in the short-term while Europe and the rest of the world struggle.

What do you think about the dollar? Please let me know in the comments, and thank you as always for reading!

To your financial success,

— Kung Fu Girl