Skip to comments.LIVING THROUGH A CURRENCY DEVALUATION
Posted on 05/21/2011 9:45:52 PM PDT by blam
LIVING THROUGH A CURRENCY DEVALUATION
In 1976 I was managing an American subsidiary of a successful large US Company in Mexico. It had been a financial turnaround for our team. Cash flow had accumulated in our bank in Mexico and corporate didnt want the money repatriated to the US. Although we had already paid a 35% income tax to the Mexican government, we would have to pay an additional 30% exit tax to repatriate the money. In addition, we would have to pay high fees for the peso/dollar exchange, in order to make the transfer. The company wanted to expand our successful business and so we decided to keep the money in Mexican pesos to be used for further expansion.
One morning, as my wife and I were on a trip driving on the highway, we heard a national message from the President of Mexico, Luis Echevarria, one of the most corrupt presidents in Mexican history. It is a lie that we are going to devaluate the peso, he said. I stopped at the nearest motel to make a collect call to the US headquarters and I asked my boss, the head of the International Division, to allow me to immediately open a new US dollar account in Mexico. I wanted to convert the pesos into dollars for deposit. My boss, laughing, asked me why I wanted to do that and I responded that the peso was going to devalue. He asked me how I knew this and I told him that the President of Mexico had gone on the radio and announced that rumors of a devaluation of the peso were false, which meant they were true. He continued to laugh but allowed me to do it.
I then called my CFO and directed him to go to the bank and get everything ready for me to sign leaving only the necessary funds to continue to operate. We immediately returned to Mexico City in time before the bank closed. Everything was ready for my signature, but the bank manager was rather bewildered and probably thought I might be overreacting.
One week later the peso was devalued from 12.50 pesos to $1 USD, where it had been for decades, to 26.00 pesos to $1 USD. A few days later it improved to 24.50 pesos to $1 USD. The reason for the devaluation of the peso was simply that it had been pegged to the USD for too long and they rose and fell in unison. Because of better economic conditions in the US, the dollar continued to go up in value and the peso increased in value artificially. Mexican goods were too expensive to trade with other countries and hence the devaluation, which allowed exports to increase. For the first time in decades the peso was allowed to float and since then it has been allowed to freely rise and fall against the dollar. The decision to devaluate the peso was made by the president, which made him unpopular, as well as his economic advisors, which included the Secretary of the Treasury and Chief of the Central Bank of Mexico.
Everyone in the country was in shock. Peoples net worth had devalued more than 53% overnight. The value in savings accounts dropped in half and neither merchants nor consumers knew how to react because they had never been through something like it before. Luckily for me, I had also exchanged my money and my salary had been set in US Dollars when I signed my contract with the company to work in Mexico. For me, it was like getting a 100% raise, since for a long while; my house rent remained the same as well as utilities, clothing etc. I remember that on my bosss next trip, he bought himself a couple of nice suits at a nice discount.
Businesses were unable to immediately raise their prices. They had to do it slowly, and through many sacrifices. The positive side was that the company had a loan in Mexican pesos for an expensive property and was able pay it off with the new dollars at, practically a 50% discount. Before the devaluation, we had been leasing other properties, some of which had expired and had been on a month to month basis. Thankfully, immediately before the devaluation, I renegotiated and signed some of the leases with modest increases for a term of 5 years. After the devaluation occurred, the landlords wanted to renegotiate these leases, but because of the terms, we enjoyed low rents for that period. Later, as we leased new properties, the owners introduced clauses tying the annual increases to the value of the US dollar, which appreciated every year until the recent fall of the dollar in the exchange rate.
Our attorney in his 50s, of German descent, who spoke English and Spanish with a German accent didnt take my advice on the oncoming devaluation. After the devaluation, he was so desperate that he came into my office one day, accompanied by another attorney that worked for him, carrying an old-fashioned suitcase, which he placed on my conference table. He opened the suitcase, which was completely filled with high denomination peso bills. I had never seen that much cash in my life and I was completely surprised. He pleaded with me to accept the money right then and allow him to purchase shares in our company. I told him that this was not the proper procedure, but he asked me to consult with corporate headquarters and insisted I put the money in our safe. As I expected, corporate said no and much to his distress, I returned the money to him.
People were so desperate to exchange their pesos into dollars that the supply of dollars dried up and some, who had them, sold them at a premium in the black market. The situation was so dire that a presidential order was passed banning the banks from allowing customers to open US dollar bank accounts. A few years later, when the peso stabilized, this practice was reversed.
Of course, on my next trip to corporate headquarters, I was received like a conquering Roman hero. My boss kept asking me to tell other executives why I decided that the peso was going to be devalued. My answer was simply that I didnt trust politicians and had decided that the president was telling a lie in his address to the nation. This, of course, was very funny to them after seeing the results. Today, Mexicos financial situation is very much improved and the peso has been appreciating against the USD. Mexico holds more than $120 billion in USD reserves.
As I am writing this, the USD index is at 75.71. This means the USD is already devalued 24.29% and most people dont know what this means. At the latest G7 and G20 meetings, countries have been arguing that the USD must be dropped as the international currency because its decline in value is making the price of all commodities too expensive.
Commodities are priced in dollars worldwide and this doesnt fare well for other countries where there is a growing unrest amongst the population. The world governments blame this on the US government for passing laws allowing the Federal Reserve to print trillions of dollars out of thin air. This money has been used to bail out the banks and to purchase US bonds that countries like China, Japan, Russia, etc. are refusing to continue to buy. The money received by the federal government is spent in the expanded military wars and countless pork barrel programs. The government is unable to control the budget deficits by cutting expenditures because of poor presidential leadership and irresponsible and politicized congress.
The US has agreed that something needs to be done. One of the most favored proposals at these meetings is to use a basket of currencies which is to include the USD and backed partly with gold to serve as a new world currency. This proposal would mean a devaluation of the USD of 50% for the US to be able to participate in the program. It is not clear if it is 50% off the current value or if it will be 100% of face value.
As long as we dont repay our national debt, cut government spending, increase interest rates or stop the Federal Reserve from printing more dollars out of thin air, the plan to change the dollar from being the international currency will become a reality. Some countries are already using their currencies to trade with each other, especially in oil purchases, to bypassing the present purchase of US dollars to make the payments. Several countries are buying gold and silver to replace some of the dollar reserves and hedge the value of their dollar reserves. Mexico recently purchased nearly 100 tons of gold to replace some of their dollar reserves. We still dont know how much American gold is in Fort Knox as no audits have been completed since the 1950's. The rumors are that there are no gold reserves remaining. We know that the US mint is purchasing gold blanks from Australia to make American gold coins. Either way, this is bad news for the US dollar and also for any of us living in the US.
My experience with the peso devaluation makes it necessary for me to move my investments away from paper into physical gold and silver. I am doing this more as a defense mechanism to ensure my net worth is not devalued. Economic think tanks are already undergoing feasibility studies to predict the ramifications of the devaluation both domestically and internationally.
It is going to be a very tough time for the US and I anticipate the Mexican devaluation will pale in comparison to our dollar devaluation, not only to this country, but worldwide. What is the answer for Americans? Many feel that owning physical silver and gold in coins and bullion will serve as an increasing source of value with which to barter. In Mexico, the US Dollar was the logical answer since it was stable and had appreciating value at the time.
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The only trap in this story is if the Euro blows up, the USD will sky and we will see silver under $30. I’m saving up for that moment: I don’t expect it to last. But IMO it could be the last best oppty to buy silver for a hell of a long time.
Economic think tanks are already
undergoing conducting feasibility studies to predict the ramifications of the devaluation both domestically and internationally.
Maybe that's why I liked it.
My comment to my buddy when I emailed it to him was that it was easy to read.
Mauldin is pretty good, IMO. Not actionable, but pretty good.
I swear I DID NOT read this before forming my opinion to “wait til sub-30 before reloading silver”!
Unless otherwise proven, IMO $35 is a short-to-mid-term TOP for silver, not a bottom. 2-3 years from now, it will be another story.
Why would silver go down with the Euro?
You’re not stating it (my assertion, and of course, it’s only my assertion/opinion) quite right.
Because should the Euro tank, the USD will sky. Silver priced in dollars should then become cheaper. As will oil and most other commods.
I do NOT expect as much downward reaction for gold, because I believe there will be (safe-haven) gold buying from Europe, continued gold buying from China, and, gold and silver have changed their relative behavior somewhat over the past month.
Silver is NOT the same kind of monetary metal as is gold.
Keep in mind that I am not forecasting a *permanent* whacking of silver. When investing, we want to think about what will happen *after* an event, and *after after* an event. I very much believe that silver is a superb LT investment, but as a LT watcher of silver, I would suggest that it is going to reclaim much of its historic personality. During this past runup, we saw silver shoot the moon, and while it has done that before, that is representative of only a miniscule fraction of its historic behavior. It *never* (well, almost never) acts that way. Its LT personality includes 1: Violent volatility far more common in the downwards direction, 2: Looooong, drawn out periods of time when it does essentially nothing, boring everyone to death, 3: a very, very slow, pained inching up of price, usually having serious trouble at “round numbers”, and 4: a vicious habit of creaming those “late to the party”. Silver is one vicious bastard to trade. And of course, stuck as it is at $35 for the mid-term (IMO) the physical really cannot be traded what with the buy-sell spreads.
Remember this well:
Silver didn’t even poke over $10 until 2006.
Silver spent about 1/4th of 2008 sub-$10
Silver did not really, definitively leave $10 behind until 2009.
Silver needs extensive time in “rehab” if it really wants to be able to boast that it owns these price levels. Silver remains bullish above $28, a very important chart support level. Silver mewbies have no conception of how long silver took to get to $7-$8-$9, and what a pained journey it was. When I started watching silver in 2000-2001, a 7 cent daily move was modestly notable. A 12 cent move was a twice-a-year event. Most days it moved 3-4 cents.
My thoughts were that the flight from Euros would drive silver prices higher along with other things....
But...I'm just a retired chip-maker, I try but I can't know everything.(ahem)
The relationships between and among these things are not especially easy to discern...but IMO, this one is fairly plain.
Be careful with silver, that is my take. IMO, $35 is an interim *TOP* not a bottom. There no hurry to reload here. None, zero. The chart on silver is very bearish, but I acknowledge that (amateur) sentiment is pretty bullish.
Needs time in rehab, I can’t express it any simpler. There is chart support at 31 and 28. There is only “round number” support up here at 35. No professional silver investor that I am aware of bought in any quantity over $35...and maybe even $30. They simply could not believe it. Oh, I confess, I bought 20 silver dollars at roughly Ag = $40 just to get some buying ya-yas out, but that is miniscule compared to what I own.
Silver needs to do its thing of boring everyone to death before it makes its next move, or at least its next UP move. There are so many stranded longs...IMO, there will be no upside until lots of that dissipates. There is nothing that will change that other than the passage of time.
I'm done buying for a while any way regardless what prices do.
I'm all 'stashed' out.
BTW, get you a few nickels while they're still cheap too.
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