There is no better way to describe the international monetary system today
than through the statement made in 1971 by U.S. Treasury Secretary, John
Connally. He said to his counterparts during a Rome G-10 meeting in November
1971, shortly after the Nixon administration ended the dollar’s
convertibility into gold and shifted the international monetary system into a
global floating exchange rate regime that, "The dollar is our currency,
but your problem.” This remains the U.S. policy towards the international
community even today. On several occasions both the past and present
chairpersons of the Fed, Ben Bernanke and Janet Yellen, have indicated it
still is the U.S. policy as it concerns the dollar.
Is China saying to the world, but more particularly to the U.S., “The yuan
is our currency but your problem”? China’s move to weaken the Yuan against
the US dollar is in fact a huge response to America’s resistance to reforming
the international monetary framework. It’s telling American policy makers
that the longer they delay acting on reforming the international monetary
system, the harder and longer they are going to make it for the U.S. to climb
out of their trade deficit and depreciate their currency to where they need
it to be.
China has been preparing for this moment for several years by accumulating
gold through its central bank but also by using banks/corporations and
individuals. It has in recent years signed several international agreements
to bypass the US dollar in international trade and use preferably the Yuan.
It has created an alternative
World Bank (Asian Infrastructure Investment Bank) and a gold
fund to invest in gold mining for more than 60 countries. The project is
being overseen by the Shanghai Gold Exchange (SGE) and it is likely that the
newly mined gold will be either traded on the SGE or be sold directly to the
PBoC and other central banks. It has also bought a large amount of gold and
kept the exact amount as secret as possible.
The international
monetary system is in crisis and ready to collapse. It has been since at
least 1971 but it seems we are very close to the end (within five years). The
International Monetary Fund (IMF) is working discreetly to have the Special
Drawing Rights (SDR) replace the US dollar as the international standard. Since
the delinking of the dollar from gold in 1971, the US dollar has been the de
facto international standard. The IMF itself makes no bones about its
ambition to establish the SDR as the global reserve currency.
In a 2009 essay,
Governor Xiaochuan of the People’s Bank of China (the Chinese central bank)
also called for a new worldwide reserve currency system. He explained that
the interests of the U.S. and those of other countries should be “aligned”,
which is not the case in the current dollar system. Xiaochuan suggested
developing SDRs into a “super-sovereign reserve currency disconnected from
individual nations and able to remain stable in the long run”. What does he
mean by “disconnected from individual nations”? The present SDR is a
mathematical formula of the price of its composing currencies of “individual
countries” with no backing whatsoever. Does he imply some kind of link to
gold? That would explain many other statements in favor of gold by China’s
officials and their aggressive encouragement of Chinese institutions and
individuals to buy gold.
Julian D.
W. Phillips, of Gold Forecaster, says, “What has become clear in the
actions of the Chinese government and the central bank is that they are
determined to accelerate the Yuan’s passage to a reserve currency, hopefully
with the cooperation of the IMF, but if not, they will walk their own road.”
However, this is not the final objective of China. Its target is to eliminate
the “exorbitant privilege” of the dollar, not just to join the “club”. China
doesn’t want to destroy the dollar, only to eliminate its “exorbitant
privilege”.
With a different approach, but also very aggressively and more so since
the U.S.-EU sanctions that amplified the new cold war, Russia has also
accelerated its gold buying. Russia and China have also started a new payment
system to avoid the U.S. dominated and controlled international payment system.
Elvira Nabiullina, Chairwoman of the Russian Central Bank, said, “Recent
experiences forced us to reconsider some of our ideas about sufficient and
comfortable levels of gold reserves.” Also in a recent CNBC interview, Ms.
Nabiullina remarked on Russia’s increasing gold reserves, saying, “We base
ourselves upon the principles of diversification of our international
reserves and we bought gold not only last year but during the previous years.
Our gold mining industry is very well developed and it is ready to supply
gold.” Dmitry Tulin, who manages monetary policy at the Central Bank of
Russia, said, "The price of gold swings, but on the other hand it is a
100% guarantee from legal and political risks." Russia is boosting gold
holdings as defense against “political risks”.
In 1997 Robert Mundell, Nobel prize of economics, wrote in an article, “The
problem with the pure dollar standard is that it works only if the reserve
country can keep its monetary discipline.” Aristotle said something similar
2,500 years ago: “In effect, there is nothing inherently wrong with fiat
money, provided we get perfect authority and god-like intelligence for
kings.” It is evident that since at least the collapse of Bretton Woods the
U.S. has not kept its monetary discipline and has no intention to do it.
Dr. Mundell, in the same article, said, “The United States would not talk
about international monetary reform … because a superpower never pushes
international monetary reform unless it sees reform as a chance to break up a
threat to its own hegemony … The United States is never going to suggest an
alternative to its present system because it is already a system where the
United States maximizes its seigniorage … the United States would be the last
country to ever agree to an international monetary reform that would
eliminate this free lunch (exorbitant privilege of the dollar)”. He seems to
have been right. The U.S. is dragging its feet. The U.S. has not yet ratified
the IMF reforms agreed even by the U.S. government in 2010. I doubt it will
pass before the U.S. election at the end of 2016. This has upset not only
China and Russia, but also the European Union and most of the international
community.
During the 2008 crisis that almost succeeded in bringing down the current
international monetary system, gold made a stunning comeback into the system.
During the crisis, gold became the only accepted guarantee in order to get
liquidity. What was significant was that after having been ignored for
decades, gold was coming back into the international monetary system via
settlements of the Bank for International Settlements (BIS). These
transactions themselves confirmed that gold was coming back into the system.
They revealed the poor state of the financial system before the crisis and
showed how gold has indirectly been mobilized to support the commercial
banks. Gold’s old emergency usefulness has resurfaced, albeit behind closed
doors at BIS in Basel, Switzerland. Since the 2008 crisis both China and
Russia have accelerated their purchases and accumulation of gold by any means
possible as it can be observed in the chart below.
Since 2010 we have been in a G-0 world (no dominating power), in currency
and gold wars and a new cold war. The world desperately needs a new world
order and a new international monetary system. Will it happen after a major
collapse and possibly war or through collaboration and consensus avoiding a
war? It is evident to me that, as Dr. Mundell said in 1997, “Gold is
going to be a part of the structure of the international monetary system for
the 21stcentury, but not in the way it has been in the past.” What
form will it take? It’s hard to say now. In this adversarial environment of a
cold war and currency/gold wars I can hardly see a fiat monetary system
succeed (fiat SDR). That requires trust and consensus at the international level
between countries. A détente, disarmament and collaboration environment was
there between 1990 (end of cold war) and 2008 (start of new cold war and
currency wars), but no more.
In the conflictual environment we are now in, it looks more and more to me
that gold will impose itself as the de facto money. Jim Rickards, in Currencies
after the Crash, edited by Sara Eisen, said, “When all else fails,
possibly including a new SDR plan, gold is always waiting in the wings as a
stable, widely accepted store of value and universal money. In the end, a
global struggle between gold and SDRs for supremacy as “money” may be the
next great shock added to the long list of historic shocks to the
international monetary system.” Any fiat SDR international settlement
currency will only be postponing the inevitable “big reset” to some form of
gold standard.