Last week, Martin Wolf, chief economics commentator for the Financial Times, stated in an interview that there is no reason to worry that the dollar will be replaced as the reserve currency for the global economic system:
“I’ve never been very worried about this,” he asserts. “The reason for that is there really is no alternative. The Chinese are not going to offer – and they cannot, given where they are in development, I think, for a decade or more – a genuine competitor for the dollar.”
Check out the video to see why the Chinese renminbi and other global currencies could not fill this roll(sic)…
This is the mainstream belief of many economists and politicians. And this belief is dangerously wrong.
It wasn’t always this way. From 1815 to 1913, many currencies were convertible into gold. This meant that coins in circulation were minted from gold (and silver for smaller denominations); any paper currency in circulation could be taken to a bank or the U.S. Treasury and exchanged for its equivalent value in gold or silver. The problem for the government is that this system puts a limit on the level of government spending. If the government tried to exceed this limit, it caused distortions in the economy.
This gold standard was abandoned after 1913. The world economy experienced two World Wars and one Great Depression in the aftermath of this decision. Determined to avoid such problems in the future, the Allied governments held a conference in Bretton Woods, New Hampshire in 1944. The aim of this conference was to decide what the post-war world economy would be like. This conference established the dollar reserve system. The dollar was deemed convertible to gold at a price of $35 per ounce until Nixon closed the gold window in 1971. The dollar is no longer convertible into gold; it is backed only by the ‘full faith and credit of the United States’. This means that the only reason the dollar has value in trade for goods and services is because the U.S. government says that it has value.
The Chinese are warning that if the Federal Reserve continues to devalue the dollar, they will begin to look for a substitute world reserve currency. China holds $1.268 trillion in U.S. government securities, and the Chinese fear that dollar devaluation will erode the value of these investments. One option would be for China to sell off these securities. This would result in a massive devaluation of the dollar.
Another scenario would be for China or some other country to announce the creation of a gold-backed currency. China has been buying gold in large quantities, and could one day announce the ‘new renminbi’ backed by gold.
This could result in a massive devaluation of the dollar, and possibly the abandonment of the dollar as a reserve currency altogether. If foreigners abandon the dollar in favor of the new gold-backed currency, they would sell off their holdings of U.S. government securities and use the proceeds to purchase the new currency. When the value of the dollar collapses, hyperinflation would likely arise. The end result would be that the dollar would die, resulting in chaos and the death of the U.S. economy. Paper dollars would become worthless, and residents of the U.S. would be forced to turn to barter to survive.
It can’t happen, you say. Well, consider the fact that China has been buying gold in large quantities. The threat of a new gold renminbi is real. In Currency Wars, James Rickards outlines a scenario where Russia introduces a new gold-backed currency. It is just a financial ‘war game’, but Mr. Rickards describes the complete ignorance of the other players who refuse to believe that it could happen, including some of the top officials in the U.S. government and financial sector. This is the ignorance (or perhaps arrogance) demonstrated by the quote at the beginning of the post. This threat is real, and would have grave consequences for U.S. citizens.
Never say never. After all, the idea that the dollar might no longer be the reserve currency for the world is inconceivable.
“Do not be angry with me when I tell you the truth.” — Socrates
According to reports, not only are foreign governments, such as China, ceasing to buy US Treasury debt, China has started to sell off its holdings, substituting gold in the place of US Treasury debt.
With the world moving away from using the dollar to settle international accounts, as the Fed prints more dollars the rate at which foreign holders of dollar assets sell off their holdings will rise.
To get out of dollars requires that the dollar proceeds from selling Treasuries, US stocks and US real estate be sold in the currency markets. The selling of dollars drives down the exchange value of the US dollar and results in rising US inflation. The Fed can print money with which to purchase Treasury debt, but it cannot print foreign currencies with which to purchase dollars.