The Currency Cabal

On October 6th, The Independent newspaper of London set off shock-waves around the world with a report that secret meetings were held between the OPEC states, China, Russia, and others, in which the participants charted a course toward a new world reserve currency. Not surprisingly, the U.S. dollar nosedived on the news. The rout was only stemmed by Saudi and Chinese officials publicly denying the story.

Whether or not this particular reporter got all his facts straight is largely immaterial. If such meetings have not been occurring, they soon will be. All the ingredients to stir financial discontent in these nations are present. It's not a question of if we will move to a post-dollar world, but when.

We have warned continually that if the U.S. government persists in profligate spending, financed by debt and currency debasement, the greatly privileged reserve status of the dollar will be in jeopardy. We have also argued that with shrinking confidence in the stability of fiat currencies, gold itself will resume its reserve role in some capacity, boosting its price considerably. The recent gold surge indicates that this view has wide support.

It is becoming clear that President Obama will offer no "change" from former President Bush II's policy of dollar debasement. It is a policy of covert war on the U.S. dollar. It has been coordinated and executed under both presidents by Fed Chairman Bernanke. While a cheaper dollar serves many interests from the U.S. government's perspective (easier repayment of debt, for instance), it will be a burden for the vendors of dollar-priced oil (OPEC) and the holders of large amounts of dollar-based reserves (China and Japan). As these interests become increasingly antagonistic, a currency crisis threatens.

In the early 1920s, the Pound Sterling was considered 'as good as gold.' At the 1922 Rome central bank meeting, the British were persuaded to allow their notes – which were fully convertible into gold – to become the first paper reserve currency. They would be held and used by central banks in place of each storing its own gold bullion. After the Great Depression, the U.S. dollar – also convertible into gold – emerged even stronger than Sterling and gradually eroded Sterling's influence. In 1945, the Bretton Woods Agreement confirmed the U.S. dollar's role as the world's reserve currency and cemented its status with the creation of the International Monetary Fund and World Bank.

Reserve status has bestowed very great privileges. Most central banks keep gold and U.S. dollar currency ('as good as gold') in their reserves. As a natural corollary of this policy, most internationally traded commodities are priced in U.S. dollars. As a result, governments and corporations buying international products, such as oil, have to change their domestic currency into U.S. dollars.

Furthermore, any country in trade surplus with America has found it advantageous to keep its reserves in U.S dollars and invest them in the U.S Treasury market. This built-in international demand for dollars has enabled the U.S government to finance enormous and persistent national debts. In turn, this has financed a standard of living beyond that which America could afford from its natural trade balance and domestic productivity.

With dollars so ubiquitous, global monetary policy has been essentially outsourced to the Federal Reserve. The downside for most of the planet is that America has been able to set interest rates at a level that best suits its own political needs at the expense of others economic needs.

Although a nation whose currency enjoys reserve status is given a great many advantages, the privilege does come with responsibility. Many nations believe that America has abused its privileges by debasing its currency. The criticism is justified.

First, a cheaper currency represents a covert trade tariff on imports and subsidy on exports. The U.S. government is desperate to boost its economy and may see this mercantilist strategy as in its interest.

Second, 'official' U.S. Treasury debt stands at some $11.8 trillion. But this is only half of the story. The 'off-balance sheet' debts and obligations of the U.S. government add up to an unimaginable $43 trillion and counting! In short, this debt can never be satisfied – at least in real dollars. The government is debasing the dollar in order to avoid the consequences of decades of reckless economic policies.

For some time, there has been talk of challenging the dollar's reserve status. But key nations have refrained in order to test the policies of President Obama. Instead of change, they have seen even more massive spending on health, education, and bailouts.

If this new currency cabal is successful at unseating the U.S. dollar, we will see rapidly rising prices domestically – especially for gold. Severe social and economic disruption may follow. But it is all due to Washington's unwillingness to restructure itself.

As a passing shot, Iran has just announced it will not accept U.S. dollars in payment for its oil. The last nation to offer such a challenge, Iraq, was invaded only months later by President Bush II. Already, President Obama appears to be considering joint strikes against Iran to 'protect Israel and the world from an Iranian nuclear threat.' Of course, none of this will change the fundamental economic dislocation that is causing America's descent. In fact, war is one of the most expensive propositions a government may entertain. One thing is virtually certain: if the missiles start to fly, then gold is sure to soar.

Comments

[Living4Divi...:]

This is a very well-written opinion piece.

"It is becoming clear that President Obama will offer no "change" from former President Bush II's policy of dollar debasement. It is a policy of covert war on the U.S. dollar. It has been coordinated and executed under both presidents by Fed Chairman Bernanke. While a cheaper dollar serves many interests from the U.S. government's perspective (easier repayment of debt, for instance), it will be a burden for the vendors of dollar-priced oil (OPEC) and the holders of large amounts of dollar-based reserves (China and Japan). As these interests become increasingly antagonistic, a currency crisis threatens."

I applaud the paragraph above.

One caveat: Oil is a global commodity. It does not matter significantly to the oil producer if Oil is priced in Dollars or Euros or Whatever. Oil has a real, intrinsic value that is independent of the currency it is priced in. If the Dollar dropped by 50% in value overnight, then the spot price of oil, priced in dollars would double.

Oct 08 07:11 AM

[BuffettMaster:]

Bravo, John. Another well-written piece.

I have been planning around the obstacles that come with our flawed monetary policy. So far, it has been a profitable endevaour. (Although I fear for the average American's net outcome). Consistently, fleeing America has yielded fruit. Low hanging fruit relative to opportunities here. Certainly, holding dollars is contrary to the profit motive, and possessing dollar-denominated debt is positive. I have to wonder - if I am doing it, how is it that foreign entities are unable to make the move as well? Are they all shackled together so tightly as to act as a single entity? It certainly looks like it.

Meanwhile, gold and oil have proven to be very valuable investments, as have mainland Chinese manufacturers.

But I think it is now time to ponder the next step, else we not stay completely ahead in the game.

Oct 08 08:22 AM

[CautiousInv...:]

After terminating the Bretton Woods agreemnt and ending the gold standard, the US should have balanced in own interests with those of the globe by exercising custodial duty and care in managing the world’s reserve currency. Instead, it developed highly deformed economic policies built upon consumer spending, current account deficits and massive borrowing (gorging) from current account surplus countries. It’s hard to reconcile these predatory policies with other efforts to provide stabilizing support.

The fraudulent actions of the Fed and the Treasury over the last ten to fifteen years have brought the world to what appears to be a tipping point, something that will finally precipitate a change in what has long been a de facto equilibrium. A sea change is near because countries with capital surpluses will not continue to lend the deficit countries and be repaid in depreciated fiat.

Much of the current discussion is focused upon the rebalancing of the SDR, which will be occurring in 2010. The SDRs that China refers to, and which have received increased attention of late, represent a multi-currency basket under the auspices of the IMF. The prposed basket is weighted as follows: 44% US dollar, 34% Euro, 11% Yen and 11% Pound Sterling. The dollar weight is presently 64% and decline from 64.6% to 44% equals 20.6%; 20.6% of $6,894 billion (total global reserves) equals $1,420 billion - or about ten percent of US GDP that would be shifted out of the US dollar to achieve SDR weighting.

Bernanke’s acknowledged, if implemented, the dollar would take a serious hit.

Oct 08 11:12 AM

[Mark Bern:]

If China is denying it, then it's probably true!

Oct 08 11:38 AM

[morph366:]

I enjoyed reading this article and could not agree more with the sentiment of this sentence-
"Although a nation whose currency enjoys reserve status is given a great many advantages, the privilege does come with responsibility."

It is the sense that the US has abdicated its responsibility with respect to being the custodian of the reserve currency, in order to look after its internal agenda, which is driving the move towards another - more diversified - model for international settlements

Oct 08 11:56 AM

[Living4Divi...:]

CautiousInvestor-- I think you meant to say that "Global Central Bank reserves of currency holdings (not SDR holdings) are 64.6% US Dollars. "

you have misquoted a paragraph from an article by Douglas Rediker, in which he was speculating about a hypothetical change to global reserves of US Dollars held by foreign central banks.

Central bankers hold mostly currencies. They hold very little if any SDRs.

The correct statements are:
1. The CURRENT SDR weighting is 44% US dollar, 34% Euro, 11% Yen and 11% Pound Sterling.
2. The SDR will be revised, but the change in composition of the basket will not be drastic.
3. The SDR is not widely held, so any change to the SDR composition will have little effect on the Dollar.

On Oct 08 11:12 AM CautiousInvestor wrote:

> After terminating the Bretton Woods agreemnt and ending the gold
> standard, the US should have balanced in own interests with those
> of the globe by exercising custodial duty and care in managing the
> world’s reserve currency. Instead, it developed highly deformed economic
> policies built upon consumer spending, current account deficits and
> massive borrowing (gorging) from current account surplus countries.
> It’s hard to reconcile these predatory policies with other efforts
> to provide stabilizing support.
>
> The fraudulent actions of the Fed and the Treasury over the last
> ten to fifteen years have brought the world to what appears to be
> a tipping point, something that will finally precipitate a change
> in what has long been a de facto equilibrium. A sea change is near
> because countries with capital surpluses will not continue to lend
> the deficit countries and be repaid in depreciated fiat.
>
> Much of the current discussion is focused upon the rebalancing of
> the SDR, which will be occurring in 2010. The SDRs that China refers
> to, and which have received increased attention of late, represent
> a multi-currency basket under the auspices of the IMF. The prposed
> basket is weighted as follows: 44% US dollar, 34% Euro, 11% Yen and
> 11% Pound Sterling. The dollar weight is presently 64% and decline
> from 64.6% to 44% equals 20.6%; 20.6% of $6,894 billion (total global
> reserves) equals $1,420 billion - or about ten percent of US GDP
> that would be shifted out of the US dollar to achieve SDR weighting.
>
>
> Bernanke’s acknowledged, if implemented, the dollar would take a
> serious hit.

Oct 08 03:39 PM

[BullnBear:]

UUP and UDN are telling me that this is a dangerous market; GLD and SLV prices are confirming this.

Another great article but very frightening from a potential ramification standpoint.

Oct 08 04:23 PM

[Jim P. Smith:]

The problems of the global economy are much much bigger than just which is the best reserve currency to hold, and how much in payment obligations the US has.

Just for kicks, tho', is that $40+ trillion figure in present value terms or is that a nominal figure?

Oct 27 04:30 PM