http://www.kitco.com/ind/AuthenticMoney/may082006.html
www.goldforecaster.com

*How does a currency collapse? And the U.S. dollar?*

Excerpts From - "Gold Forecaster - Global Watch"
May 8, 2006
 

When a currency loses the confidence of its people, its fall becomes
exponential, as has happened to the Zimbabwe dollar, where in 1982 one
U.S.dollar equalled 1 Zimbabwe dollar. Today around Zdollar200,000 buys
one U.S. dollar if you can find someone idiot enough to sell one for the
Zdollar.

In day-to-day terms, the smallest note in Zimbabwe a Zdollar500 is the
size of a U.S.dollar. The price of a single-ply sheet of toilet paper is
more expensive at around Zdollar867.

The U.S.dollar is nowhere near there, but clearly the U.S.
Administration has no plan or even desire to rectify the U.S. Trade
deficit. Consequently, we are seeing a growing number of Central Banks
turning to the Euro for its reserves and away from the U.S.dollar.

Whilst most observers and particularly U.S. observers like to have
tangible facts and numbers with which to mathematically gauge the
present and the different possible futures, a collapsing currency
situation is not as neatly gaugeable. Indeed it is driven in stages of
'confidence', which are rarely measurable in advance.

For instance we see today the move of the Pension and other long-term
funds into the gold E.T.F.' one finds there are no mathematically
measurable factors with which to measure the pace of change to these
funds. Yes, the number of 'Road-shows' the World Gold Council does
affects this move to some extent, but how do you measure the spread of
that knowledge and resulting investment in the E.T.F.'s outside of that?
How does one measure the forces causing uncertainty and falling
'confidence'.

It is an emotional progression, one that moves in lurches as particular
incidents destroy confidence limb by limb. In such a climate a steady
degeneration of confidence lead to an effect we shall call a "plateau -
cliff" process.

. As confidence is whittled away the currency appears relatively stable.
. Then a particular event will occur that triggers a breakdown and the
currency drops suddenly, like falling off a cliff, until it finds a
short-term bottom and it holds that level for a period as though on a
plateau. The process then repeats itself.
. The degeneration then accelerates, so the fall from the cliff to the
next stable plateau happens more quickly.
. Then the height of the cliff [the fall] extends until it grows at an
exponential basis.
. The final collapse will occur when the currency is completely
discredited and used only by those unfortunate to have no other choice.

Alternatively the currency is changed to a new one, one whose issue is
backed by assets [Such as land - after the Weimar republic] and limited
to a fixed relationship to those assets until confidence is restored by
a healthy economy and a balanced Balance of Payments. This provides a
basis in which to be confident about currency.

However, were the dollar heading for a collapse, the U.S. dollar, a
global reserve asset, nothing in the U.S. such as land or any other
fixed U.S. asset would suffice. The asset would have to be accessible by
its creditors, outside the States who would have to have a willingness
to accept that asset in the case of a default by the U.S. The use of the
dollar domestically and internationally brings such problems that in the
final extreme conditions the dollar is inadequate as a global reserve
currency.

But for the market to whittle away confidence in the dollar would take
some time. But we believe that it will happen.

. Look back a couple of years and we saw the dollar reigning supreme.
. Then warnings were given against it as the Trade deficit began to grow.
. The Fed or the Administration then allied itself to the euro, giving
it the respite it has enjoyed over the last year.
. Now there seems to be a breaking down of the dollar of late and some
Central Banks switching to the Euro out of the dollar. These were three
distinct stages.
. The next stage is for the dollar to fall heavily against the Euro and
Euro oriented currencies.
. Next will come the defence of the dollar until the weight of selling
pressure exhausts the dollar against other currencies [please note the
U.S. has few foreign currencies left in its hands with which to defend
the dollar, but the Fed put in place measures to allow it intervene in
the international foreign exchanges.]
. This could delay the fall for some time, but history has shown that
when a Central Bank defends a rate in the market, it gives in
periodically and devalues. If insufficient it has to defend again and again.
. I have no doubt that Central Banks will use this defence to unload
their dollars back to the States.
. At some stage the U.S. will have to impose Controls to prevent foreign
capital from exiting the States and rejecting dollars coming home. These
are called Exchange Controls.
. When this happens many currencies will begin facing the same problems
as their reserves become suspect too and they cannot defend their own
Balance of Payments deficits.
. At this point for the global economy to function adequately, a new
"Global Currency" will have to be established and be supplied sufficient
so as to regain global confidence. We cannot see this happening without
gold in there to a greater or lesser extent. Of course this will have to
be at prices believed by all nations, not just individuals!

During this process confidence in the currency will be the measuring
factor, a nebulous, unstable element in itself. The process of the decay
of confidence is described above. But confidence could well go down
dramatically from the point we are at now with the dollar in the
monetary system. Soon the cliffs will extend until the defence of the
currency comes, then a long plateau while the dollar is defended, until
the heavy falls begin.

The international trading power of the States will dominate just how far
the dollar will fall. Of course if the States manages to show it is in
the process of balancing the Balance of Payments beforehand [which may
not mean the complete elimination of the Trade deficit] the demand for
dollars will probably overcome the supply. But inevitably that action
will mean a huge recession for the States, which could prove an internal
nightmare and cause a global recession of its own.

It is probable that the Administration would isolate the U.S.A. from the
rest of the world by severe Exchange Control measures, which will create
its own internal boom, sooner or later. We will produce an article, or
series thereof, at the right time, on this subject.