Does this sound a bit far fetched? A bit unrealistic? I have spent this summer traveling around the Turkish coast by yacht. 3,000,000 Turkish Lira is the going rate for a cup of coffee and a basic car is 20,000,000,000 Turkish Lira.
The Turkish government never planned for a currency with so many noughts; inflation caused through too much Turkish Lira printing forced this upon them! Last year the exchange rate was 2.3 million Lira for one British Pound. This year the rate is 2.8 million Lira. Inflation is currently running at about 20%, which is historically a very low rate of inflation for Turkey. So the value of the currency in the last year has fallen by approximately that much. I can now clearly understand why Turkey is a very large market for Gold!
Why couldn't the same thing happen in the USA, or the Euro area, Or Britain? The simple answer is that there is no reason why this could not happen. They are all fiat currencies that are only backed with a government promise of value and not with an identifiable hard asset. A British Pound was originally a pound in weight of Silver. Unfortunately you cannot buy a pound of Silver anymore for a Bank Of England fiat banknote, because it has been substantially devalued over the years in relation to Silver. It has been clipped - despite still proudly exclaiming on every banknote "I promise to pay the bearer on demand the sum of..." Unfortunately this is an absolute 100% barefaced lie. Otherwise I, like everybody else, would be demanding my pounds of Silver as per the proclaimed promise. The reality is that the British Pound, like any other fiat currency, can simply be printed very much at will and therefore has no real true lasting value. Mr. Bernanke, a Federal Reserve Governor no less, has already publicly explained in graphic detail the workings of the printing press.
So if we can devalue a currency when necessary, how will that impact the level of the Stock market? Please note that I used the word level and not value. I would suggest beneficially, because it allows companies to export more product and gain a currency advantage over foreign competitors. For example let's assume that McDonald's sells a meal in Berlin for 5 Euros and they make 1 Euro net profit. If the exchange rate is 1 Euro to 1 Dollar, they have 1 Dollar of profit to report in there 10Q to the SEC. Now let's assume the exchange rate is 1 Euro equals 1.20 Dollars. McDonald's has now made a magical extra 20% profit. In reality they have made no extra profit as the Dollar has also lost 20% of its purchasing power, but in simple numerical accounting terms they have.
McDonald's is a constituent of the S&P 500 and will now be reporting increased earnings primarily because of Dollar devaluation as will most of the other 499 constituents. So either the PE ratio of the S&P 500 will become more realistic from its current overvalued ratio of approximately 20, or if we were already at a fair value PE ratio of about 15, the market could rise to maintain this fair value ratio with respect to the increased earnings bought on the back of simple Dollar devaluation.
Now imagine the extreme scenario of 3,000,000 dollars for a cup of coffee at Starbucks. It would be quite feasible for the S&P 500 just based on Starbucks earnings alone to be at say 30,000,000 or maybe 50,000,000. If you devalue your currency, you can artificially produce more earnings and therefore influence the future direction of the stock market. HOWEVER the extra earnings produced will not have more purchasing power in the international marketplace as they are denominated in a debased currency. What in reality has changed is the unit of measure of the earnings. Ten years ago it cost 500 Turkish Lira for a cup of coffee. Now it costs 3,000,000. The coffee has not changed - only the unit of measure.
Devaluing the currency unfortunately is not economic nirvana. I will talk about the problems it causes with domestic inflation the potential for a bond revolt and its attendant impact on the housing market next time.
Commodities are surging again and the stock market has also shown some strength recently. Could it be that the markets are anticipating another major Dollar decline? One final thought, we know that shortly the boomers retire. We know that there is a MINIMUM $40 Trillion Dollars shortfall as regards their promised entitlements. It is therefore crystal clear that the boomers are not going to get meaningful government entitlements as they expect. If the stock market is now allowed to fall, private savings and pensions will also be lost. This would be a catastrophe and a political disaster. I believe the boomers will receive what they were promised by Government. Unfortunately, they will be paid in vastly depreciated Dollars.
America, like many Western democracies, is in a desperate race against time to devalue and inflate their way out of a looming debt and entitlement crisis. It is my belief that the major sacrificial cow has to be the Dollar - the opposite of the Dollar is Gold and the other precious metals. Gold is not appreciating against the Dollar. It is simply maintaining value as the Dollar depreciates. This is the job it does best, a job it has done for over 5000 years, which is why Gold had true value in ancient Egypt, Greece, and Rome and still has today. It is why gold has been identified throughout the ages as real, lasting and definable wealth - the currency of the kings. So do you own any? If not, why not?
If we ever reach a situation of $3,000,000 for a cup of coffee, would you rather be holding your present day depreciating paper dollars or physical Gold? The Turks understand the answer to this question through painful personal experience and therefore hold Gold as the ultimate store of value.