Gold has broke through some of its all-time highs today, October 7, 2009, reaching as much as $1043/oz. But that is not the end of the excitement for all the gold bugs and other lovers and investors in the yellow metal. Gold might be making a comeback as a contender for one of several currencies to be used as part of a “basket of currencies” to replace the US dollar as the world reserve currency. It is still speculation at this point, but the BRIC countries have discussed it and some of the Gulf states are also open to the idea of using gold in which to buy and sell oil.
All this has some analysts like Martin Murenbeeld speculating on whether a return to the gold standard might be more than a mere possibility. Murenbeeld discusses these questions in a report he wrote, “The New Gold Standard.” According to Murenbeeld, gold is going to play an increasingly larger international role again, as it once did when there was a gold standard.
What’s A Gold Standard?
The gold standard refers to the periods of time in which a given currency (or all the world’s currencies, once the US dollar became the world reserve currency in 1944) is backed by gold. This means that if someone is given a dollar bill (or a rupee, or a yuan), it represents a promise that they can turn it in for its worth in gold. In this way, the fiat (aka., paper) currency kept its value, because users knew how much gold they were worth.
Importantly, the gold standard also provided unquestionable confidence in the currencies used. Why? Because there is only so much gold on the planet. It’s a real asset. You can’t destroy it (just change its shape, melt it, etc.). You can’t print it, either. Or counterfeit it, more importantly.
In 1971, soon after worldwide creditors came calling for their money in gold, Richard Nixon got rid of the gold standard which backed the US dollar. In effect, as many analysts will tell you, Nixon scammed nations around the globe by removing the very asset which gave all their US dollars value.
What’s Wrong With the US Dollar?
Aside from merely domestic issues such as outrageously ballooning budget deficits, trade deficits, and a national debt – none of which some analysts expect can ever be repaid to worldwide borrowers – aside from that issue on an ethical and logistical level domestically, with all the problems that might cause for the US internally -
There is an inherent conflict of interest, becoming more and more apparent to creditors world wide, that it is only in the US’s best interests to use the USD as the world reserve currency. When the world reserve currency was originally designated as the US dollar back in 1944, the US economy was in its prime. It was a creditor nation and it had political favor with the rest of the world. Most importantly, in 1944 the US dollar was backed by gold. So not only was the US economy good, it was good for its gold, too.
Today, the US dollar is backed by nothing — a mere piece of paper with rapidly dwindling value – each time week-long auctions of US Treasuries are held on newly created notes, the value of each dollar, by mere virtue of the number of them in existence, dwindles. Conveniently, this makes it easier for the US to “pay off its debts” with nations worldwide since old debts are paid in more numerous and less valuable dollars. Many have called this the “invisible tax” from the point of view of domestic consumers, but on a global scale it has just as deleterious effects. You can read about the history of the recent world reserve currency developments here:
Zhou Xiaochuan’s Proposal For World Reserve Currency is Accepted by UN (March 29, 2009)
U.S. Dollar Up For Debate At G8 Meeting (July 5, 2009)
Supracurrency Coin Proposed As New World Reserve Currency (July 12, 2009)
U.S. Dollar Must Be Replaced As The World Reserve Currency (Sept. 8, 2009)
World Bank Pres: Don’t Take Reserve Currency Status For Granted (Sept. 27, 2009)
The “Competitive Debasement” Of Fiat Currencies Worldwide
Truth be told, all currencies around the world right now are fiat currencies. And all fiat monetary systems use the same means of monetary control – they print money and they raise/lower benchmark interest rates on their money. But because the USD also serves as the world reserve, it has an added degree of obligations and privileges which this role confers. Moreover, no other country in history has engaged in as much money printing as the US has been in the past year in particular.
What happens when the US dollar weakens this much? Well, countries like Canada and the European states find it harder to export their own goods to the U.S. because all of a sudden these goods (priced in Euros and Canadian dollars) start looking more expensive relative to the US dollar via the exchange rate.
Because nations worldwide obviously want to support their domestic export industries (for obvious reasons), there is much incentive to attempt to weaken their own currencies as well so that they do not appreciate so much against the dollar. All the worldwide stimulus in the wake of the 2008 credit crisis was not empty “mimicking” of the United States, as though other nations couldn’t think of other alternatives or just wanted to “do what the US does” – it’s the simple fact that they didn’t want to hurt their own economies in the process.
The CEO of Canada’s Agnico-Eagle has referred to this in a nice turn of phrase called “competitive debasement” of fiat currencies worldwide. It doesn’t matter if Spain or Norway or China’s economy has perfect balance sheets – if their main trading partner is the U.S., they will be motivated to weaken their own currency and keep it artificially low.
Hence the attraction of gold. You often hear the question “what’s the alternative to the US dollar?” as though it implied a move away from capitalism and into the “socialist” currencies like the Euro or the yuan. This is very misguided. If international currencies were fairly valued, you would be surprised how many of them would rise and by how much against the USD. To say nothing of how much the value of gold would rise if it becomes more widely held in world reserves – a process that shows signs of starting to happen. China is even actively encouraging its citizens to buy gold as an investment now.
So What IS the Alternative to the USD as World Reserve Currency?
Rather than replacing the world reserve with SDRs (special drawing rights), which would effectively just introduce another currency layer into the equation, Murenbeeld supposes that a handful of currencies will be used – and gold might be one. In particular, the basket may also include more of the currencies of the other BRIC nations – India (rupees), Brazil (real) and Russia (rubles).
Given the relatively quick clip at which these international economic developments have occurred (see the coverage I’ve given the story in the links above), I personally would not be surprised to see these moves well in place in practice by the end of 2010. No dramatic legal move or international statement is even necessary – China just continues to quietly diversify its reserves, and other countries continue to diversify their trading partners if they can.
I also don’t think it would be as dramatic a shift as many are making it out to be – it might have important symbolic significance, but what does that really amount to? What counts is economic order. And where goes fiscal confidence, so goes fiscal practice. The US economy is going to be what it is anyway, even if its currency continues to play a dual role. In other words, maybe it will have to take some of its very own hardline “free market” medicine and not receive another worldwide bailout. But this, according to that theory, should be just what it needs and would benefit from.
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