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One
of the facts of life over the last 40 years has been that the U.S. dollar is
the world’s sole global reserve currency. This is despite the
fundamental factors underlying the U.S. balance of payments, which has been
awful over that entire time. Nevertheless, the dollar ruled the global
monetary system through these four decades and appears to be doing so still. But
is that coming to an end? Next week there is a meeting of the BRIC nation
over the use by the U.S. of the SWIFT system to block Iran from selling its
oil. The BRIC nations are buyers of that oil. Their views on Iran’s
nuclear policies do not go as far as refusing to buy their oil. The SWIFT
system is the system used to make international payments and covers most
acceptable currencies.
This
use of the international monetary system as a war machine has surprised and angered these nations who are
meeting next week to discuss this and, no doubt, to work out ways to prevent
the U.S. from exercising such power. If they succeed, they will have
formulated a way to bypass the U.S. dollar as the dominant currency with
which to pay for oil. Once this hold has been broken, we may see a steady
move away from the U.S. dollar as the sole global reserve currency.
It
is critical for investors to understand the importance of this and how the
situation came about in the first place to understand the full ramifications
to the gold and silver price. These will be dramatic!
How the U.S.
Dollar became Optimus Prime
Most investors were not around when the
ailing dollar moved from a suspect currency to number 1. When the Gold Window was closed by President
Nixon, the dollar weakened and the gold price took off to heights never been
seen before. The author had just moved up to the main desks of the
Stockbroking firm he was with as Exchange Controls were implemented in the
U.K., and a huge flight of capital was exiting the U.K. as its role as the
center of the British Empire disappeared.
At the time it seems insane to cut the
link of the dollar to gold. From 1968 to 1971 Europe had been receiving
dollars from the U.S. forces stationed in Europe and called them Eurodollars. European nation were not
happy to receive this currency and were busy converting as much as they could
to gold. Led by the cantankerous and difficult President de Gaulle
Switzerland, Germany, Italy and France were the main sellers of dollars for
gold. After the war the U.S. had around 26,000 tonnes
of gold. Steadily, the Europeans and others bought gold. Over time, France
ended up with more than 3,000 tonnes; Germany over
3,000 tonnes; Italy more than 3,000 tonnes and Switzerland more than 3,000 tonnes U.S. gold holding dropped to over 8,000 tonnes and felt they had to halt the gold hemorrhaging
because they knew full well that gold was money when push came to shove. Even
the U.S. had to guard against ‘shove’.
So when Europe was faced with receiving
more dollars, you would have thought that there would have been outrage, but
Europeans quietly accepted the fait
accompli.
Why? Yes, it was the globe’s
leading power and driver of the world economy, but its currency was deeply
flawed. After all, the U.S. Trade Balance was in a permanent deficit, with
little likelihood of a change.
The Oil Price
Prior to the closing of the gold window
by President Nixon, the oil price stood at $8 a barrel. Afterwards it moved
steadily up to $35 a barrel and the gold price rose eventually to $850 an
ounce from $42 an ounce. But the dollar won out and had to be accepted by
everyone!
By then the shortfall in total global
oil supplies came from the countries surrounding the Persian Gulf. Each of
them had a fragile basis and needed to rely on a greater power to guarantee
the existence of the ruling party or family. The U.S. provided this on
condition that oil suppliers priced their oil in the U.S. dollar. This was a sine qua non (without which, no!). So oil suppliers outside of the U.S. (except for Russia,
who could not oppose alone) depended for their security on the U.S. as they
do today (except for Iran). The U.S. made it clear to Russia, et al that this
area and their oil comprised a U.S. vital
interest over which, if they felt the need to, meant they were prepared
to go to a nuclear war.
The world was vulnerable to this
situation, extremely vulnerable. All nations bar the oil producers capable of
supplying their own needs, needed to import oil. Most nations’ oil
imports comprise 25% or more of their imports. Without it, the world’s
economies just would not function. Hence the U.S. held the key to world
dominance, oil. You can imagine the U.S. government facing President de
Gaulle and telling them calmly that they had better accept the U.S. dollar in
payment for all things imported and must purchase the U.S. dollar to pay for
all things American, as well as oil. It was checkmate! Failure to obey would
have led to a major oil crisis for the disobedient nation.
It was also clear to the Persian Gulf nations
–if they changed from the U.S. dollar to any other currency in payment
of their oil—would then lose power. That was Saddam Hussein’s
main mistake and where is he now. Kuwait in turn, received the support of the
U.S. as they were toeing the dollar line. Today, Iran is not toeing that line
and is being closed down by the U.S.
It was a small step for the dollar to
become the sole global reserve currency where it stands at the moment. At the
time Europe bowed their heads and accepted the dollar while Persian Gulf
nations received great wealth and power over their people. The rest is
history.
Gold, the
Remaining Enemy
The entire process undermined the value
of the dollar in terms of value, while its role as a means of exchange
extended throughout the world. Gold, on the contrary, reflected that loss of
value and rose 20 times, its pre-1971 price. To
reinforce dependency and to build trust in the dollar, the gold sales of the
seventies and eighties through 1999 were aimed at destroying trust in gold as
money. It was written out of the system, gold production was accelerated so
that the gold price tumbled from $850 to $300. It was described as a barbarous relic and relegated to the
sidelines of the metals market as a commodity. But a rose by any other name,
smells as sweet. Likewise gold may have been discredited but it remained the
money of last resort, evidenced mainly by the retention of gold in the
reserves of the developed world until today.
However, the history of money shows that
when a government or even many governments institute a paper currency system,
dependent on government and banking systems for its value and reputation, it
is only a matter of time before it loses its name and value. The more
powerful the government controlling the currency, the longer the system
lasts. It is now just over 40 years since the dollar cut its link to gold. Let’s see where we are in the currency experiment.
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