Austria, 1920-21: The government printed money to cover its debts from World War I.

Food and fuel costs exploded. Banks urged their customers to convert Austrian kronen into a more stable currency… even though it was against the law.

A law-abiding widow is wiped out on the day of a bank run. Her diary entry is reproduced in Adam Fergusson’s book When Money Dies…

“Why don’t you think the krone will recover again?” [I asked my banker.]

“Recover!” [he] said with a laugh… “just test the promise made on this 20 kronen note and try to get, say, 20 silver kronen in exchange.”

“Yes, but mine are government securities: Surely, there can’t be anything safer than that?”

“My dear lady, where is the state that guaranteed these securities to you? It is dead.”

We’ve recounted the tale before. We tell it again now for two reasons. First as a reminder that most of the imbalances that caused the Panic of 2008 remain woefully out of balance. But you already knew that.

There’s extra urgency to our telling now: The one “X factor” the pundit class touts as the U.S. dollar’s savior? It might prove the dollar’s final undoing. Bank runs, capital controls, an effective default on the national debt — and all because of the “prosperity” we’re enjoying now.

Our suspicions were first raised in January… when two “opposing” politicos held hands and sang in sweet harmony about America’s energy boom.

“Cheap natural gas is going to allow us to basically reshore manufacturing,” says Chicago Mayor and former Obama chief of staff Rahm Emanuel. As a result, manufacturing will be “coming back in ways we can barely anticipate,” says former Republican presidential contender Steve Forbes. Together they were on CNBC to pitch an event called the “Reinventing America Summit.”

Not that we disagree: It all sounds very familiar if you were following the “Re-Made in America” thesis of our own Byron King more than two years ago. Then it was radical. Now it’s conventional wisdom.

Leave it to us to throw a cat among the pigeons: For as much prosperity as the U.S. energy boom is creating now… it will ultimately set off the next major economic crisis. Indeed, it will tank the U.S. dollar’s status as the world’s “reserve currency” once and for all.

We say this knowing we court the wrath of conventional wisdom…

• “The U.S. shale oil revolution which has been quietly unfolding behind the scenes has now begun to exert a direct influence on foreign exchange markets — to the benefit of the U.S. dollar,” says a report from UBS
• “Global reserve currency status allied with less dependence on foreign investors will boost the currency on a five-year view,” says a strategist at Société Générale
• Because of “the technological advances that enable oil and gas to be extracted from shale,” says fund manager David Donora at Threadneedle Investments, “the dollar will likely enjoy a period of sustained strength.”

Right. Until it doesn’t.

The very thing helping to prop up the U.S. dollar now will ultimately kick out all those props and topple the greenback from its status as the world’s reserve currency. Not tomorrow or even next year. But the destination is set… and our arrival is certain. It won’t look exactly like Vienna in 1921… but it will feel just as awful.

So strap in: Some of the ground we’re about to cover might sound like old hat to you… but we promise you’ve never seen the dots connected in this way before.

U.S. oil production averaged 7.5 million barrels per day during 2013. The increase over 2012 marked the biggest in U.S. history. Indeed, it’s the fourth-biggest annual increase by any country ever… and Saudi Arabia holds the top three spots.

And it only gets better from here. The peak year for U.S. crude production was 1970 — a little shy of 10 million barrels per day. As you see from the “Back to the Future” chart, the U.S. Energy Department projects the nation will once again equal that number by 2019.

In 2005 — only nine years ago — the United States imported 60% of its oil needs. By 2012, that number collapsed to 40%. Check out the chart nearby and you’ll see the percentage is set to shrink even more over the next quarter-century. And make a mental note — we’ll be coming back to this chart later.

As we go to press, a barrel of oil fetches $100, give or take. So every 1 million barrels per day of new supply means $100 million less imported oil every year. Lower import costs, a lower trade deficit, fewer dollars flowing overseas — great news for the dollar, huh? It’s all good, right?

Well, yes… except that now the entire structure that’s supported the global financial system for 40 years is starting to come unglued.

Since 1974, the world has run on “petrodollars.”

The petrodollar arose from the ashes of the Bretton Woods system after President Nixon cut the dollar’s last tie to gold in 1971.

In the immediate post-World War II years, Bretton Woods made the dollar the world’s reserve currency — the go-to currency for cross-border transactions. If you were a foreign government or central bank, the dollar was as good as gold — for every $35 you turned in to the U.S. Treasury, you received one ounce of gold.

Chances are you know the rest of the story: Foreigners recognized Washington was printing too many dollars, the French wanted more gold than Washington was willing to give up and Nixon “closed the gold window.” But without gold, what would continue to cement the dollar’s position as the world’s reserve currency?

After the “oil shock” of 1973–74, in which oil prices shot up from $3 a barrel to $12, Nixon’s Secretary of State Henry Kissinger got an idea and convinced the Saudi royal family to buy in.

The deal went like this: Saudi Arabia would price oil in U.S. dollars and use its clout to get other OPEC nations to do the same. In return, the U.S. government agreed to protect Saudi Arabia and its allies against foreign invaders and domestic rebellions.

The appeal for the House of Saud was obvious — the weight of the U.S. military would keep the family’s 7,000 princes living in the style to which they’d become accustomed.

The appeal for Washington was more subtle — but no less important. Anyone who wanted to buy oil now needed dollars to do so. That meant perpetual demand for dollars and a cycle that goes like this…

• Dollars used to buy oil are deposited in the banking system to support international lending by the major banks
• That lending supports the purchase of American goods — everything from Boeing airplanes to Archer Daniels Midland corn. Oh, and U.S. Treasury debt. Can’t forget that.

“This gave the dollar a special place among world currencies, and in essence ‘backed’ the dollar with oil,” explained Rep. Ron Paul in a prescient speech on the floor of the U.S. House in 2006. “The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.”

Then came his forecast: “The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil, rather than dollars or euros.”

Strange as it might be to imagine… the great American energy boom is hastening that day’s arrival. More to come tomorrow…

Regards,

Addison Wiggin
for The Daily Reckoning

P.S. Regardless of how or when the U.S. dollar eventually collapses, there will be solutions for you to protect your wealth and even profit in the process. In today’s Daily Reckoning email edition I gave readers a chance to discover two specific solutions to the coming dollar collapse, absolutely free. And that’s just one small benefit of being a reader of the FREE Daily Reckoning email edition… Every issue comes jam-packed full of great opportunities just like this. If you’re not getting it, you’re not getting the full story. Sign up for FREE, right here, and never miss out on your chance to get this kind of expert investment advice.

You can read Part II of this essay, right here: Prepare for the Death of the Petrodollar.

About Addison Wiggin

Addison Wiggin is the executive publisher of Agora Financial, LLC, a fiercely independent economic forecasting and financial research firm. He’s the creator and editorial director of Agora Financial’s daily 5 Min. Forecast and editorial director ofThe Daily Reckoning. Wiggin is the founder of Agora Entertainment, executive producer and co-writer of I.O.U.S.A., which was nominated for the Grand Jury Prize at the 2008 Sundance Film Festival, the 2009 Critics Choice Award for Best Documentary Feature, and was also shortlisted for a 2009 Academy Award. He is the author of the companion book of the film I.O.U.S.A.and his second edition of The Demise of the Dollar, and Why it’s Even Better for Your Investments was just fully revised and updated. Wiggin is a three-time New York Times best-selling author whose work has been recognized by The New York Times Magazine, The Economist, Worth, The New York Times, The Washington Post as well as major network news programs. He also co-authored international bestsellers Financial Reckoning Day and Empire of Debt with Bill Bonner.

Ah, the Italians. They’re good for at least one entry in the “Why We’re Ungovernable” series each year, and their latest is the best yet:

“Drug trafficking, prostitution revenue set to boost Italy’s GDP result

Italy has announced it will start including estimated revenues from prostitution and illegal drug sales in official gross domestic product (GDP) figures.

The country’s National Institute of Statistics says starting next year, the GDP result will also include estimates on the value of the black market in cigarettes and alcohol.

The move has been driven by new European Union rules requiring nations to include all activities that produce income in their national accounts, regardless of their legality.

The institute says the procedure would be it will be “very difficult for the obvious reason that these illegal activities are not reported”.

The Bank of Italy in 2012 estimated the value of the criminal economy at 10.9 per cent of GDP.

Theoretically, that could mean Italy’s GDP result with the new calculation will come in far higher than the government’s 1.3 per cent growth estimate.

Eurostat earlier estimated the average GDP increase for EU nations due to the new calculation to be at 2.4 per cent.

The highest rises were estimated for Finland and Sweden at 4 to 5 per cent, followed by Austria, Britain and the Netherlands at 3 to 4 per cent.

The increase for Italy would be around 1 to 2 per cent.

The “grey economy” of businesses that do not pay taxes is already calculated in Italy’s GDP and was estimated to be worth between 16.3 per cent and 17.5 per cent of the economy in 2008 – the last year for which the calculation was made.”

As the above article notes, the concept of GDP relies on economic players reporting their activity. Criminal activities, in contrast, are by definition not reported. So how do state statisticians come up with a number? The same way the US gets its inflation/GDP/unemployment stats, by running assumptions through a bunch of other assumptions and then making some favorable adjustments to what comes out. In other words, since official numbers are largely guesswork (or conscious manipulation), the idea of adding made-up numbers for drugs and prostitution to GDP is really not that big a stretch.

It might, however, make for some amusing reports down the road: “Italy’s prostitution sector exceeded Wall Street expectations in the Third Quarter while cocaine sales and car thefts were off slightly, noted Goldman Sachs analyst Vito Soprano…” You’d think the investment banks would have a pretty good feel for black-market trends, since they’re such active consumers of hookers and drugs.

And this isn’t just the Italians being Italian. As the above article notes, the new rules apply to all of Europe. One odd stat: “The highest [GDP] rises were estimated for Finland and Sweden at 4 to 5 per cent, followed by Austria, Britain and the Netherlands at 3 to 4 per cent. The increase for Italy would be around 1 to 2 per cent.” Apparently, crime is a much bigger part of the Scandinavian economies. At the risk of being racist (or reverse-racist or whatever), that’s a bit counter-intuitive.

In any event, the implications are consistent with the theme of this series: When a country borrows too much, life gets more complicated, voters get angry and leaders find it harder to get reelected. And ideas that once seemed crazy begin to look like the least problematic of the remaining options. Adding crime to GDP is about as close to perfect an example as we’re likely to find.

The other “Why We’re Ungovernable” posts are here

Yesterday, I laid out the case for a Chinese real estate crisis.  Lest I be accused of biased thinking (guilty as charged many times over I am sure), today I am sharing the case for Chinese reform and a relatively smooth transition to a more balanced economy.  I agree with GaveKal on this issue (and utilized much of their brilliant research in this piece)—reform in China is required if the leadership’s goal (and we know it is) is to surpass the US economy, challenge the US dollar’s reserve status, and create a solid platform for geopolitical dominance.  I shared this essay with Black Swan subscribers last week.
 

1. China slows but succeeds in its reform process.  China has already made progress even though growth is decelerating.  In fact, the bullish argument doesn’t argue growth is slowing in China; they agree it will likely slow even more (slowing growth is in fact one indication of reform; a surge in growth is likely the result of another blanket liquidity injection leading to more overcapacity, bad loans, and higher speculation that will only make it harder to avoid a financial crisis).  

Read the full issue here

Jack Crooks
President, Black Swan Capital

George Friedman of Stratfor.com recently penned a very interesting and educational essay regarding Hungary, contrasting its history with Germany and Russia and its tenuous futures now that Russia is reasserting itself.  This type of analysis clearly highlights a major problem for the Eurozone—Germany now economically controls the zone, but is increasingly seen as aggressive protector of its business interests, but there seems a major political/military void they refuse to fill.  This is not a confidence builder for the other states, and especially not for the buffer countries of Eastern Europe who are growing justifiably leery about their future as Russia expands again as Germany siphons off the business gains accordingly. This is not lost on an EU populace experiencing EU fatigue both economically and politically, and heading to the polls soon.  It is likely not good for the single currency longer term. 

Please click on the link below to view the issue:
http://gallery.mailchimp.com/dcfeb4b3bc5ba9ed1d447e92e/files/b71ef91d-fd69-45d8-abdf-ea7da75bb417.pdf
 

Jack Crooks

Black Swan Capital

When the Euro was on the drawing boards, the committee to create the Euro came to our seminar in London and took the whole back row. I was there at the beginning and have first hand knowledge about how it was being designed. I warned them at that time the euro would start to fail after 13 years in line with the ECM – that was 2011. The euro officially began January 1st, 1999. Without a single national debt, the Euro could never become a reserve currency for it would lack depth.

The real problem to emerge is that the euro is more than a single currency. It has become something to defend for thousands of political jobs. The real theory has been to federalize Europe for in the mind of the elites, that would eliminate war. What they failed to grasp is that it can also promote war by dictating a one-size fits all policy.

I have written about the audacity of the EU Commission to intervene and remove elected people in Greece and Italy who wanted to leave the Euro. They are in the process of staging political coups to protect the established bureaucrats in Brussels. This is now all about maintaining power – not the Bilderberg meetings and Illuminati.

Tim Geithner has confirmed the coup stating in his book: “At one point that fall, a few European officials approached us with a scheme to try to force Italian Prime Minister Silvio Berlusconi out of power.” Geither writes that he told the President about “this surprising invitation” to change the head of Italy, but they decided not to get involved (publicly): “We can’t have his blood on our hands.”

Those who always blame the CIA need to expand their perspective. They say there is nothing like a woman scorned. I dare say there is. It’s a politician and unelected bureaucrats.

www.armstrongeconomics.com