Hello again valued reader, welcome to the second part of our insight into the next global financial crisis (a.k.a GFC MK II). Those who have any money invested in the ASX could be forgiven for thinking the financial apocalypse has arrived this week, however the kind of losses we’ve seen in our local market will be small compared to what’s waiting for us if the USA accidentally unleashes fiscal fury upon a global scale.

To recap, the US Federal Reserve has been printing money with the goal of supporting domestic US inflation, and has been using that printed money to buy US Treasury Bonds (or government debt) and in general driving asset prices up. To put a cherry on the top they’ve also set interest rates extremely low. Up to speed? Great, but I’ll warn you that things get super depressing from here.

All this inflation support (printed money and low interest rates) drives investors to purchase assets (especially shares) as inflation erodes money left in the bank. This can drive up share prices higher than they naturally should be, especially as share demand becomes dominated by people seeking to get any kind of return for their hard earned cash.

But the price bubble action is only the entrée to our unappealing main course of complete global financial meltdown.

The US dollar holds a special place in the world’s financial system (as well as the vaults of the world’s central banks) as it is commonly used as a means of foreign exchange (or FX). This means countries can use US dollars to trade with each other, as well as purchase commodities like oil that are priced in the currency. Countries like China have mountains of US dollars ready to go in their vaults, and as such get really pissed off when they see the value of these dollars eroded by US inflation, especially the kind created on purpose by the US Federal Reserve.

Many countries and global investors also choose to purchase US Treasury bonds and accordingly receive interest and other payments in US dollars that become less valuable in real terms (i.e. the amount of goods per US dollar) as the US prints more money back at home. By now you’re probably wondering why all this matters.

The answer is quite strange, and it’s as simple as this: The US dollar as we know it isn’t actually worth anything.

Bang, hope you all enjoyed that epic plot twist. Let me explain further, the US dollar is only worth anything because the US government says it is and the US Federal Reserve manages it as the currency of the USA. There are other more technical reasons, but the US dollar of today is known as a fiat currency, where the intrinsic value comes purely from the fact the US government says every US dollar has intrinsic value. Of course this only works if people (and countries like China) believe that what the US government says is true, and to this point in time they do. If that sounds like a terrible way to ensure the stability of a currency you’d be heartened to know that until 1971 every US dollar was redeemable for a certain amount of gold (known as the Gold Standard). As such, the US dollar until 1971 was worth a dollar because you could redeem it for physical gold. You now scratch your head and wonder why this is not the case today. The simple fact is the US government of the time began to realise they couldn’t store enough physical gold to support the paper US dollars circulating the world, and thought it would be easier to just print paper money and tell people that everything would be fine.

Time to go full circle and bring this apocalyptic analysis to the bitter end. As the US economy deteriorates further there can only be two outcomes, the first being that the US Federal Reserve finally gives up stimulating the economy and lets it lapse into recession, thus triggering global stocks to fall through a network effect exactly like GFC MKI. This will likely decimate the ASX, however this outcome is the one we should all prefer. The second potential outcome is that countries using the US Dollar as a FX reserve collectively move to another currency or means of exchange (like gold), which will effectively and catastrophically devalue the US dollar and cause market chaos exponentially worse that outcome one. If this all sounds far too insane to be true let me leave you with some facts to research (as this post is already far too long, unless you’re at work).

  • Countries like China are getting rid of all their US dollar FX and acquiring as much gold as possible to use for trade or as a guarantor of their own currency
  • The Eurozone (especially Germany) is doing the same
  • The International Monetary Fund (IMF) has stepped in to restore global market confidence twice in recent history
  • The US is again acquiring gold as a means to revalue their currency if the crash occurs (when the dust settles, the US will likely reinstate the gold standard, effectively causing the price of gold to skyrocket as there will be less gold per paper dollar due to US Federal Reserve money printing)

GFC MKII Part III will cover how to invest to protect yourself should this crisis occur (but as we said in Part 1, we really really really hope it doesn’t). Pro tip: it definitely involves buying gold. Want to be informed when part III is released? Well simply subscribe below.