This page looks at the different ways a financial crisis or collapse could play out and how it might affect you. For a simple explanation of the causes of a financial collapse please see my video "
Our money system is based on a fractional reserve banking system. In very simple terms this means our banks only have to keep on deposit 10% of all their customer deposits, they then lend out the other money on the assumption that people do not always want access to their money. In fact on 3% of all dollars in existence and 6% of all Euros exist in the form of bank notes - the rest is just number on computer screens. If there was a mass panic and everyone rushed to the bank to withdraw their money their would not be enough bank notes to cover this and the whole system would collapse. This is called a run on the bank and a bank holiday is where the government huts down all the banks to avert a complete collapse of the system. In the US there has been such runs on the banks and banking holidays in 1907 and 1933.
It is May 2010 and we are experiencing a huge government debt crisis in Europe that has only just begun and will spread to more countries and eventually the USA. The banks and financial institutions on the world lent this money and therefore risk collapse if the problem gets worse. Therefore a run on the banks at some point is a high probability.
Inflation is an increase in the money supply. If the money supply increases at a faster rate than the creation of goods and services then prices increase. Many financial commentators are predicting that the outcome of the current financial crisis will be super even hyperinflation where prices increase weekly, daily or even hourly. They believe that because central banks are printing money at a huge rate to bail out banks and other sectors of the economy and that are committed to carrying on doing so.
Deflation
Deflation is a collapse in money and credit often brought about by a banking crisis and a collapse in confidence in the banking system. In a deflationary environment the value of money goes up because there is less of it about, as countries, corporations and individuals default on all their debt this destroys the number of dollars or Euros in circulation thereby making them more valuable. (See our article How Money is Created for a more detailed explanation) Some financial commentators rather than believing in a hyper-inflationary scenario believe the current crisis will lead to a severe deflationary period. We are seeing a huge amount of defaults like never before in history and a destabilization of the banking system.
Points to Remember
- Our money is backed by nothing, it is only as good as the confidence in governments and the banking system. As governments default on their debt, this affects not only them but also the banks that leant the money, rocking confidence in the whole system. Yes default reduces the amount of currency in circulation but a currency without confidence is worthless. You could have what looks like deflation suddenly morph into hyperinflation because there is no confidence.
- Deflation can be very painful (high unemployment etc) creating political pressure to act. Governments can print money to try to get their way out of deflation - Fed Chairman Bernanke has committed to printing whatever it takes to avoid a depression.
What happens in a Deflation
- Because money becomes more valuable in terms of good and services this drives prices down but also creates higher unemployment.
- Businesses go bust as they cannot get credit to invest or just maintain themselves.
- The areas of the economy that survive are the essentials people need (food etc), things they cannot live without (tobacco, alcohol) and impulse buys (chocolate etc)
- Civil unrest
- Historically both hyperinflations and deflationary depressions have lead to political extremism and ultimately war(Napoleon, Hitler etc) to divert attention away from national problems.
How You Can Protect Yourself•
- Review your employment situation, how insulated would you be from such a deflationary situation, you may need to consider moving into a different employment.
- Get yourself out of debt now and out of the mentality that you can live using your credit card as a buffer.
- Become resourceful and learn how to make and grow your own food.
- Remember however scarce the money may be, the reality is that you are the money, you create the value, so instead of being out there trying to compete for scarce dollars or Euros try to set up networks with other people and ways to trade and exchange goods and skills.
Formal Currency Devaluation
What is a Formal Currency Devaluation
This would be where the government introduces a new currency and offers to exchange the old currency at a rate of 3 to 1 or even 10 to one.
Why Would The Government Do This?
Almost every country in the western world is ladened with too much debt. We see Greece in the news on the verge of debt default but there are 19 other countries in the wings some in even worse a state than Greece (the UK and the USA to name but two). It is simply not possible to pay off all of these debts - the USA for example has debts in excess of 14 trillion and future unfunded liabilities (forecasted future payments of social security, medicare and medicaid) of over 100 trillion dollars. A formal devaluation is one way out of this.
Points To Remember
A formal devaluation may only be a temporary fix to the debt woes. The very system is based on the creation of more and more debt to keep its self running, a formal devaluation does not change the nature of the system we would have to fundamentally change the way
What Happens As A Result of a Formal Devaluation
The banks may be closed for days or weeks during the transition. So you would have no access to your cash or use of ATM or credit cards.
Savings, bonds, CDs, life insurance policies, denominated in the old currency would now buy a fraction of what they did.
The devaluation is form of debt default so under the new currency interest rates would be very high as the governments would have to pay a higher premium to convince the markets to lend them money. This would cause a huge deflationary depression.
High unemployment.
Benefit payments cut
Government spending cut drastically affecting public sector jobs
How Can You Protect Yourself
For the initial devaluation take same kind of steps for the hyper-inflationary scenario
For the following deflationary depression do the same as for a deflationary scenario
Complete Currency Collapse
In the deflation section we spoke about how currencies are backed by nothing other than confidence in the financial and political system of the issuing country or authority. All currencies in the world today operate on this system. The current government debt defaults will undermine confidence in the banking system and the governing authorities thus undermining the value of the currency. This confidence call also be undermined by social and political developments o watch the level of growing unrest in a country, political disillusionment, political radicalism.
Points to Remember
Currencies are valued relative to each other. For example EURUSD is the number of dollars one Euro will buy which today stands at around 1.24. If this goes up then this means the Euro is strengthening and if it goes down this means the dollar is strengthening. Strength and weakness in these cases are relative. If the Euro is collapsing then it automatically looks like the dollar is strengthening - this does not mean that the dollar is strong or safe, it just means for this time it is less worse off than the Euro. In serious currency crises it is therefore important to look to see how currencies are performing against hard assets like gold, silver and oil to gauge whether it is collapsing or not. It is May 2010 and while the Euro has been falling against the dollar, the yen , the canadian dollar and so on , ALL currencies have been falling against gold. Look at our section on gold and how it behaves for more of an understanding.
Currencies can collapse in a deflationary as well as an inflationary environment
How Can You Protect Yourself
The effects will be exactly like that in a hyper- inflationary scenario.
Additionally though a currency collapse may reflect huge political and social instability so prepare further for longer periods of civil unrest, disruptions to supply etc
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