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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