When Is a Dollar a Peso? (The Answer May Shock You…)

The U.S. dollar is on painful path of collapse. I’ve dubbed this the “pesofication” of the U.S. dollar.

This process represents the end of the greenback as a major world currency. And it is one of the major long-term challenges that Americans face over the next several years…and beyond.

When it comes to the U.S. dollar, inflation is Public Enemy No. 1. And yet the man who is supposed to be protecting the purchasing power of the dollar, Fed chairman Ben Bernanke, remains completely unfazed by the evidence of rising inflation.

Bernanke takes credit for the rise in stock prices since he began his second round of “quantitative easing” last November. But the he refuses to admit that the prices of gold, oil and other commodities, which have risen dramatically in recent years, have anything to do with Fed policy.

Indeed, as far as Bernanke is concerned, the need to pay almost $4 a gallon for gasoline is not his fault and does not indicate any but the most temporary increase in inflation. And even though the Fed solons have raised their inflation forecast for this year, Bernanke still regards the inflation rate as too low, not too high.

The Problem with “Core” Inflation

One problem is that Bernanke looks at the so-called “core” rate of inflation in personal consumption expenditure – a figure reported several months late that does not include anything that is actually rising in price (such as food and energy).

So when other observers see inflation taking off, Bernanke takes solace from the fact that, according to his preferred measure, all is quiet on the inflation front.

Be warned: There is every chance that the Fed will lose control and inflation will spiral. And not just to the ruinous levels we saw in the 1970s, but well beyond them too. And even after that occurs, it is highly possible that Bernanke will refuse to launch any sort of significant counterattack.

Remember, it took a full decade of punishingly high interest rates and the commitment of then Fed chairman Paul Volcker to solved the inflation of the 1970s

This time around, we may not get so lucky.

Inflation may become much more acute – reaching the ruinous 20% to 50% level – rather than reaching and then holding steady at the uncomfortable-but-bearable 10% level.

Game Changer

If we end up with an inflation rate in excess of 20%, the whole game changes. The U.S. dollar will no longer be the dollar; it will be a peso. And not just any peso. It will be a typical-1980s Latin American peso – a currency that devalues on a near-continual basis and is forced to drop three zeros every decade or so.

At that point, the world will no longer accept the U.S. dollar as a reliable store of value; trade-settlements and other international payments will be diverted into other currencies and even the doziest central bank will stop buying U.S. Treasurys.

The dollar will essentially be dead as a major currency.

To play the decline of the dollar, precious metals are the traditional method. You can either buy them directly or through exchange-traded funds (ETFs) such as the SPDR Gold Trust ETF (NYSE:GLD) and the Shares Silver Trust ETF (NYSE:SLV).

Be aware that these ETFs are accumulating an increasing “tracking error.” The volatility of gold and silver prices…and speculative demand for these metals…prevents the ETFs from tracking gold and silver properly. At times, this makes their share prices fall further and further behind those of the actual metals.

Still, poor tracking is better than no tracking. And these two ETFs remain a more convenient way to play the metals than by buying the metals themselves. That’s because retail investors invariably get ripped off when they want to sell physical gold or silver.

For another hedge against this dollar-doomsday scenario take a look at shares of companies or funds in countries not subject to U.S. monetary policy.

The iShares MSCI Germany Index Fund ETF (NYSE:EWG), the iShares MSCI South Korea Index Fund ETF (NYSE:EWY) and the iShares Singapore Index Fund ETF (NYSE:EWS) are attractive alternatives.

Editor’s Note: Martin Hutchinson is a international investment expert. If you want to explore overseas investing as a serious investor, I urge you to check out Martin’s short presentation. It shows how the stock market is rigged in favor of the “über rich” and how you can beat the wealthy at their own game.