Is the $US headed for an Icelandic moment?

When world-wide real estate hit the skids in 2008 all three major Icelandic banks failed leaving the government-backed banking insurance on the hook for losses bigger than Iceland’s GDP. Iceland was essentially bankrupted by their version of the FDIC.

It took a European Union bailout and austerity pledges to keep Iceland from absolute default. With no ability to ‘print money’ to pay off debts like we have in the US the Icelandic Krona was decimated in terms of its foreign exchange value.

In the space of just months the buying power of those holding Iceland’s currency plunged by about 75%. The innocent citizens of Iceland who had nothing to do with its banking foibles were robbed of three quarters of their accumulated wealth.

Why should Americans care about something so far removed from us?

Because we’re already well on the way to a similar fate. Outlandish deficit spending, our $14 trillion national debt and the quantitative easing programs have been gradually undermining our own currency on world markets. See the chart below for all the proof you need of what’s already taken place…

The 2008 world-wide credit crisis briefly reversed a sustained downtrend in the dollar’s foreign exchange value as investors simply looked for the safest looking place to hide. Since the middle of 2010 though, the downward trajectory has resumed with some intensity.

As the $US is gradually replaced as the world’s reserve currency we could easily see the dollar’s chart fall off a cliff just as Iceland’s Krona did. When that happens- your nominal bank and money market balances will look just as healthy as ever but the price of everything imported will be double to triple today’s levels.  America’s standard of living will never be the same ever again.

Knowing this is coming seems obvious. Preparing to preserve your true wealth is trickier. When the sh*t hits the fan Washington is likely to declare a form of economic martial law and start changing the rules as we’ve always known them.

If you think that’s not possible here, think again. President Obama cared nothing about the ‘rule of law’ when dealing with the GM and Chrysler bankruptcies. He simply declared a ‘Force Majeure’ and did what he wanted to while screwing with the rights of secured creditors.

When Americans realize that their dollars are rapidly losing value there is likely to be such a surge of inflation that there will be a run on all retail stores to buy whatever doesn’t spoil before it will cost much more.

Price controls and rationing are almost certain to follow and freezing of bank accounts (with only small monthly allowances for living expenses allowed) is a distinct possibility.

You can do some things now that are sure to pay off if this scenario plays out. Prepay for any services or merchandise that you can for as far in advance as is allowable. In a normal world we would choose to hold our money earning interest until bills come due. Have you noticed that you’re earning pretty much nothing on your bank reserves currently? The risk of prices escalating dramatically is much greater than the few basis points of interest you might get for delaying payments.

If you have adequate storage space- buy as much of everything you typically use (that has an indefinite shelf life) as you can. Pretend you’re stocking your personal Costco in your basement or attic. When inflation starts heating up you’ll be ahead of the masses in getting what you need to live and your ROI on the cash tied up in inventory will probably be the best percentage returns you’ll ever make. They’ll be tax-free to boot!

If you can identify an actual non-US currency you think will be immune to the coming storm you could consider transferring some of your dollars into it. The problem will come with where it will be held physically and being sure you could access it after any financial emergency rules are put into place.

Once the initial panic subsides, equity (stock) values should reflect true ‘mark to market’ valuations at the newly inflated levels. After all, real companies hold real assets that will still be producing income. Those assets will reflect the new replacement values. Multi-national firms should fare better than strictly domestic companies as they will still have lots of foreign currency revenues that will offset the $US weakness.

Companies that hold hard assets like oil, gas, minerals, real estate etc. should hold up very well after any near-term panic sell-off dies down. The good news is that life will go on. People will still go to work and children to school. We’ll be back to a much simpler, less materialistic way of life.

When will all this happen? Nobody knows. We could linger in our gradual dollar downtrend for years or perhaps foreign buyers stop rolling over their treasury bonds and things worsen very rapidly.

If you wait for the problems to be recognized by the masses it will be too late to take effective action to protect yourself. In a worst-case scenario even the US government will be unable to keep the peace and we’ll regress to a Wild West atmosphere where you’ll need to protect yourself and your property from those who are desperate and have nothing left to lose.

I’m hoping we don’t get to that stage but it’s not completely off of the probability scale.

Dr. Paul Price  BeatingBuffett.com

March 12, 2011