The Half-Life of the Dollar

I've been studying the US Dollar lately… Looking at where it's been, and wondering where it may be headed in the future.

In February of 2001, the US Dollar would buy about 121 mg of gold. In March of 2011, it will buy about 22 mg of gold, a decline of 82%. This drop has been gradual, and the intervening years have been filled with the sell-offs and rallies that are common to all markets. This period has been characterized by massive and growing public and private debts, central bank manipulation to keep interest rates artificially low, and the creation of trillions of new dollars to keep the financial system liquid and stave off recognition of personal, corporate, municipal, state and federal bankruptcies.

But a closer look reveals that the decline has not been linear, but logarithmic – just like the decay rate of radioactive particles. Physicists refer to the rate of this decay as a "half-life"… Knowing this number lets them answer the question, "How long will it take for the radiation level to fall in half?"

In the case of a currency, how long does it take for its value to fall in half?

It turns out that over the last 10 years, the half-life of the US Dollar has been 4 years. In other words, every 48 months, the dollar loses half of its value! Here is a chart:
USD prediction chart
So unless something changes (for better or worse) we can expect that by the end of 2015, the dollar will be worth about 10 mg of gold (or put another way, that an ounce of gold will cost about $3,000). The key phrase is "unless something changes".

What could change? Invention of a new technology that could extract large quantities of gold cheaply, perhaps from sea water… Or a dramatic rise in real interest rates, the sort of thing engineered by Paul Volker to end the inflation of the 1970s. These things could push the relative value of the dollar up, and the price of gold down.

On the other hand, there could be a dawning realization that the dollar is doomed – that the US Government cannot possibly repay its obligations without simply creating the dollars to do so out of nothing – leading to a dollar collapse. If this happens, the dollar, like so many other fiat currencies before it, will have no value at all. Just like the previous US currencies, the Continental Dollar and the Confederate Dollar, or more recently, the Zimbabwe Dollar, it will become of historical interest only. In this case, it makes no sense to talk about a gold price at all… as the collapse gets underway, the price of gold will go higher and higher without any limit, until no cares about dollars any more. Those holding gold and other real assets will preserve their purchasing power, while those holding dollar-based financial assets such as bank accounts, CDs, T-bills, government and corporate bonds, and even most stocks, will be wiped out.

Psychologists often talk about normalcy bias, the tendency of people to assume that things in the future will be about the same as they have been recently. Usually, this works out fine; but from time to time, a "black swan" appears that causes things to change directions unexpectedly.

But what should we expect the dollar to do? Should we expect that next year its value will about the same as it has been recently? Or should we expect the decay of the last 10 years to continue? I think the latter is the most likely. And then there are the black swans, the things that are very hard to predict, but are always a possibility that must be considered and prepared for.

By monitoring prices in gold, keeping cash balances diversified in precious metals and multiple currencies, and by investing to grow your net worth in terms of gold, you will be well positioned for any eventuality. I am working now on some strategies to take advantage of the half-life of the dollar – let me know if you are interested in hearing more!

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