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Does
Washington want to kill the Dollar's No.1 status? It's going the right way
about it...
SO the YIELD offered by 10-year US
Treasury bonds just fell through 3.0%, a five-decade low when reached (and
then breached on the way down to 2.0%) in 2009.
More telling, the real 10-year
yield – the rate of interest paid to new buyers after you account for inflation – just slipped back below
zero, even on the official CPI measure of living costs.
You might think these miserly
returns can't last long. The US government cannot steal from its creditors
indefinitely. Not without T-bonds – and thus the Dollar – losing
a big chunk of that same global demand which awards them "reserve"
supremacy.
But where else would the world
turn for its currency No.1...?
"Gold" says a
mumbling chorus of observers, analysts, US politicos, and – most
especially – investors. But gold lacks the one key quality which today's
global economy appears to demand from its reserve currency:
Unlimited issuance.
You can't create gold at will. Nor
can you destroy it either, not without cyanide to dissolve it. And this
tight, reliable scarcity – the one thing all "money" must have
to retain value, but to which today's currencies are all playing stranger
– sets gold apart. As our chart shows, in fact, the gold price has
quadrupled and more in the last decade, even when you discount the Dollar's
falling foreign exchange rate.
Let's pretend that the Dollar
hadn't lost 27% of its value since Jan. 2000 (as measured by the St.Louis Fed's trade-weighted Dollar Index). The gold
price would still have ended May 2011 at $1115 per ounce. Meaning gold's bull
market is very much ex-Dollar, too.
So too is the swelling of global
currency reserves held by central banks and feeding the global liquidity
beneath commodity and thus consumer prices...
"Reserve currency
status is a global public good that comes with a cost, and people often
forget that cost," wrote Beijing-based academic Michael Pettis at the start of May.
We'll get back to the costs in a
minute. For now, the communal benefits – far as we can see here at BullionVault – are liquidity, simplified trade, and
a bottomless pit for high-saving nations.
Liquidity, because the Dollar is
the most heavily traded currency, with the largest and most heavily traded
financial markets. Simplified trade because, just as mankind still finds
money more efficient than barter, so a single currency for invoicing and
settlement cuts friction and costs. And a bottomless pit because, well,
that's the only thing big enough to hold Asia's massive savings.
"Under-consuming countries
are able to use the Dollar today for the same reason that European countries
used colonialism in the past," says Pettis,
glossing an idea from US Treasury and University of Maryland economist
Kenneth Austin, writing in the Journal of World
Economics – "as a
way of allowing them to export capital and import foreign demand." The
US can't help but meet demand for the Dollar by printing more, in short. It's
the "excessive savers" who are really urging the flood of
greenbacks and Treasury debt, runs the theory, by using the Dollar to hoard
wealth rather than sharing the love by spending what they earn to buy US
exports.
Now, whatever your politics, it's
only this third use of Dollar reserves – Asia's "abuse", in
many economists' view – which seeks long-term value in the US currency.
Yes, gold would be superior for this purpose, at least on the evidence so far
(adjusted for inflation, it's outpaced the returns to T-bond holders –
with interest re-invested – almost 3-fold since 1951). But for the
purposes of liquidity and global trade, what matters most is that other facet
of money: as a means of exchange. And that's a role which gold currently
plays nowhere.
Yes, money needs to retain its
value between receipt and expense...between payday and your monthly
bills...if it is to remain credible. Otherwise, welcome to Weimar at home, or
the Pound Sterling's long post-WWII decline on the foreign exchanges. But the
1920 Mark was not the dominant currency in Europe, let alone globally, and
Sterling's decline – according to Barry Eichengreen's
Exorbitant
Privilege – really got
motoring when Britain's former colonies, now its creditors, suddenly found
themselves burdened with Pounds instead of the already pre-eminent trading
currency, the Dollar.
Yet in the 1950s, "the
Sterling area (35 countries and colonies pegged to Sterling and holding
primarily Sterling reserves) accounted for half of world trade and Sterling
accounted for over half of world foreign exchange reserves," explains Catherine Schenk, professor of International Economic History at the University of
Glasgow. Sounds about even, right? But "in the early post-war
years," says Schenk, "this share was even higher – the IMF
estimated that official Sterling reserves, excluding those held by colonies,
were four times the value of official USD reserves and that by 1947 Sterling
accounted for about 87% of global foreign exchange reserves.
"It took ten years after the
end of the war (and a 30% devaluation of the Pound) before the share of USD
reserves exceeded that of sterling. This rather contradicts...assertion[s]
that by 1945 the dethroning [of Sterling] was complete."
Why the 30% devaluation and this
active "dethroning"...? Contrary to claims that London fought the
Pound's decline, hoping to defend its political power, ability to borrow, and
deep financial markets, "Archival evidence shows that from the 1950s
many British ministers and officials recognized that the burdens of Sterling's
role in terms of cost of borrowing and confidence in the exchange rate
outweighed the benefits of issuing an international currency," Schenk
finds. Which brings us back to the unseen costs of issuing
the world's No.1 currency that Michael Pettis
raised above.
"A lot of analysts argue that
the predominance of the Dollar...reduces the cost of imports to American
consumers and it lowers US government borrowing costs. But both arguments are
seriously flawed, I think. Americans already over-consume, and so it is hard
to argue that they benefit in the aggregate from lower consumption costs,
especially when it comes at the expense of [US] employment...As for borrowing
cheaply, what matters to a government's borrowing cost, as countries like
Switzerland clearly demonstrate, is not major reserve currency status but
rather creditworthiness. Because reserve currency status actually increases
US borrowing [courtesy of Asian savings], it is more likely to undermine the
ability of the US Treasury to finance itself cheaply than the loss of reserve
status would."
Slipping back through 3.0% today,
it's hard to see US borrowing costs being much cheaper if it didn't issue the
No.1 currency. Still, America's "exorbitant privilege" of never
having to settle its trade deficit in anything but its own currency isn't a
benefit that China, or the Eurozone, looks too keen to enjoy for themselves
any time soon. Both regions continue to seek export growth, and so neither
would welcome the exchange-rate rise which would come with being the monetary
lynchpin.
"If there is any chance that
the [US currency's] status declines in the future," concludes Pettis, "it will require that Washington itself take
the lead in forcing the world gradually to disengage from the Dollar."
Negative real interest rates and
the last decade's 27% forex decline – plus
the steady drip of Fed policymakers vowing a "strong Dollar" at the
same time as printing it without limit – look a good start.
Dollar earners, foreign savers and
potential gold buyers take note.
Adrian
Ash
Head
of Research
Bullionvault.com
You
can also Receive
your first gram of Gold free by opening an account with Bullion Vault : Click here.
City
correspondent for The Daily Reckoning in London, Adrian Ash is head of
research at BullionVault.com
– giving you direct access to investment gold, vaulted in Zurich, on $3
spreads and 0.8% dealing fees.
Please
Note: This article is to inform your
thinking, not lead it. Only you can decide the best place for your money, and
any decision you make will put your money at risk. Information or data
included here may have already been overtaken by events – and must be
verified elsewhere – should you choose to act on it.
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