Currency wars are just one more piece to the ever-evolving puzzle called the global debt crisis. The rhetoric surrounding competitive currency devaluations- centered primarily in the U.S.-  has intensified in recent months. It appears  our leaders are coming to grips with the fact that there is only one way out of this crisis, and that is via devaluation. In the long run, I would be short U.S. government bonds in a big way. I have very little doubt that this is the next big trade you all must be looking for.

A devaluation of the dollar amounts to a de facto default on our debt. Make no mistake about it, our creditors understand this. Do you wonder why gold is being bought on every single dip? At the end of the day, the biggest buyers of gold will be those with the largest holdings of U.S. debt. Put yourselves in the position of a creditor to the U.S. You have vast holdings of debt denominated in a currency that can easily be devalued. Of course you have the option of unloading U.S. debt, but 1) this devalues the rest of your holding while creating conditions for a possible “run on the bank”, and 2) the U.S. is still the #1 military power. These are the kind of real-world political considerations that come into play in economics.

The Fed has manipulated interest rates lower, no question about it. But people make the mistake of thinking the Fed is omnipotent and that this charade can last forever. These are the same types of people who believed the U.S. could suppress gold prices forever. Well last time I checked, gold was trading at $1375. So the ability to manipulate markets is short-term. Trends are driven by fundamentals that can only by exaggerated, not created, by manipulation. In the long run, price and value meet.

I’ve been trying to explain to you that this is a replay of the 1932-1937 experience. Leading up to the explosion in nearly all asset classes during the Depression, people had the exact same deflation fears that many have today. Deflationists are getting all bent out of shape about the 50% collapse in stocks in 2009. Well excuse me, but don’t you think people were a tad more fearful of deflation following the 90% collapse in stocks during the Great Depression? Those who feared a deflationary tsunami back then missed out on a 5-fold rally in stocks. I know it’s hard to believe for most “gold bugs”, but stocks will be one of the places capital flees to.

During the Great Depression, which was essentially a global phenomenon, countries that devalued their currencies first recovered first. France and the U.S. were the last major countries to devalue, and not surprisingly,  the last countries to recover. The relationship between too much debt and currency devaluation is consistent throughout history. This historic relationship suggests to me that the debt crisis in Europe is far from over. The Euro is acting much like gold did during the Great Depression- it is preventing sovereign nations from taking corrective actions. Greece should have just turned their back on the Euro and devalued. Instead, creditors (read: global banks) were made whole while Greek citizens suffered. In an ideal world, those who make bad investments lose. In a corrupt world, banks and governments are attached at the hip, and bailouts for banks are construed as beneficial to the public. This kind of corruption is nothing new- it happens all the time.  Latin American crisis anyone?

I’m sure the technocrats in Europe are patting themselves on the back right now,  but they are just fueling social unrest. You should start seeing European civil unrest intensifying soon; there is no doubt in my mind we are entering a period of political and social instability.

Gresham’s law is starting to play out as this debt crisis continues. As people start to realize that currencies are being devalued globally as a matter of national policy, they will start to buy gold. Believe it or not, this monster rally in gold is flying under the radar for the average person. There is no question in my mind that there will be shortages in gold and silver that will make the supply constraints in 2008 look minor in comparison. I urge you all to step in front of trends instead of chasing them. It is likely that you will see competitive devaluations globally and that all major currencies will fall relative to gold. It is also likely that U.S. bonds will decline precipitously in response. Just like you should have been preparing for this monster gold rally, I’m telling you, you should be preparing for a sell-off in bonds. Let the academics tell you a steep decline in U.S. bonds is impossible- they have been so consistently wrong it’s laughable. The real world of economics and investing is far different than most people realize, and this will be very apparent (if it isn’t already) in the years ahead.