Iconic Chart Shows Biggest Devaluation of Our Generation

Yesterday, China’s central bank said its foreign-exchange reserves have hit $3.0 trillion for the first time in its history. China is awash in dollars. The U.S. itself has too many dollars floating in its financial system. Is it any wonder the U.S. dollar is collapsing in value against a basket of currencies made up of other major currencies?You own a company and you have one customer that accounts for 25% of your sales. Your customer is in another country and pays you in currency from his country. Unfortunately, you have a few other customers who also pay in that currency.

As the years go by, you start to accumulate more and more of the currency of your customer’s country. You take some of that money and buy assets in that customer’s country, like stocks, bonds, real estate, and anything you feel has value. You even buy some bonds issued by the government of your client’s country.

But after 30 years of taking in your customer’s money, even though you are investing it back in your customer’s homeland, you are still left with too much of a currency you really don’ t want.

That’s where China sits right now. Yesterday, China’s central bank said its foreign-exchange reserves have hit $3.0 trillion for the first time in its history. China is awash in dollars.

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Aside from China, the U.S. itself has too many dollars floating in its financial system. Is it any wonder the U.S. dollar is collapsing in value against a basket of currencies made up of other major currencies?

The chart below is worth a thousand words. It is an iconic chart showing the collapse in the value of the U.S. dollar against the six major currencies: the euro; yen; pound; Canadian dollar; Swedish krona; and Swiss franc.

Chart courtesy of www.StockCharts.com

The U.S. dollar is only five percent away from falling below its record low set in early 2008. Will it happen? Sure it will. What will happen then? Interest rates will rise to support the dollar. But, by then, it will be too late. Inflation will already have taken hold in America. Forget about supporting the plummeting dollar, we’ll need high interest rates just to fight off all the inflation created by years of printing dollars.

Michael’s Personal Notes:

A reader wrote yesterday with a question that I believe is on the minds of much of our audience:

“Mr. Lombardi, if interest rates are higher because of inflation, the dollar will be stronger. Then it will make gold and silver less attractive. Is my understanding correct?

Unfortunately, dear reader, you have it wrong. Higher inflation will result in items requiring more dollars to purchase them. The more dollars required to buy an item, the less the dollars are worth. Precious metal prices rise rapidly during periods of rising inflation and interest rates.

The best way to see this is to look back to the early 1980s. The price of gold bullion hit $850.00 per ounce in January of 1980. In 1980, U.S. inflation averaged about 13% for the year. Coincidently, the Federal Funds Rate, our bank rate, hovered around 13% for most of 1980.

Bottom line: higher interest rates and higher inflation lead to rising precious metal prices.

Gold bullion prices have yet to surpass their 1980 inflation adjusted high of $850.00 an ounce. Adjusted for inflation, gold would have to be trading at approximately $2,500 per ounce today to be equal to its 1980 price.

Where the Market Stands; Where it’s Headed:

A tired, but still living, bear market rally has the Dow Jones Industrial Average opening this morning up 6.1% for 2011. I’ve been waiting for the final blow off for this bear market rally and I have yet to see it materialize.

To see the rally that started in March of 2009 fade away at this point, to see the market just slowly moving lower without a big bang…that’s not how bear markets end. And that’s why I still see some more life in this rally before the bear takes the chips away from investors again. However, any way you look at it; we are getting very close to a top for the bear market rally.

What He Said:

“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour waits…people are spending in America today at an unbelievable clip. 1932, 1933…who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.