US dollar fall: gold seems safe again as reserve
Saturday, 6 February 2010
Shihabul Arefin Khan
Dominance of US dollar is weakening fast in the currency market, thanks to ever widening of US American trade and fiscal deficits. The US currency dominance riding on the disastrous fallout of World War II and subsequently swap for oil deal with Arabs has started losing its strength.
The double impact of the growing U.S. trade deficit and fiscal deficit are seriously threatening the value of the U.S. dollar. This has been further worsened by the Federal Reserve Bank's recent policy to bail-out sickening financial industry and the disastrous wars in Afghanistan and Iraq. To cope with the fund pressure, the US is printing out unlimited amount of dollar, leaving real value of money on the wane. So, the greenback is losing its role as the world's main currency reserve status.
Gold is gaining momentum in the midst of US currency turmoil. Actually, it is not just a bull market in gold, but a "bear market for paper currencies".
U.S. dominance began in early 20th century, when the country cemented its position as the world political and economic power. The U.S. pursued an aggressive policy of expansionism, exerting its political and economic influence around the globe. After establishing itself as the world super-power, it made all-out campaign to control everything-ranging from political, economic and monetary aspects.
Gold had been accepted and preferred medium of exchange. The classic gold standard began to take shape in 1871 in Europe and elsewhere. From 1871 to the beginning of WWI, the currency of all the major trading countries of the world was pegged to gold. Gold coins circulated as medium of exchange daily. Gold was deposited in commercial banks and lent out. Banks kept sufficient reserves of gold in order to meet demand of their depositors.
The gold standard prevented imbalances in trade accounts between countries. Gold acted as an independent automatic adjustment mechanism. This prevented a country to drift away too far from the balance of trade.
The gold standard also stopped governments from acquiring large budget deficits. With a limited amount of credit available, government borrowing would drive up interest rates, making it more difficult for the private sector to borrow and invest. And if the private sector cannot borrow and invest profitably, the economy suffers. Government budget deficits spilled over into trade deficits leading to more gold flowing out; leading to eventual return to balanced trade.
The undesirable side effects of deficit spending made governments to strive to maintain balanced budgets.
In July of 1944, delegates of 44 nations gathered at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire in USA. In that historic meeting, among other economic landmarks, came the Bretton Woods Agreement, which established US dollar as the World's reserve currency. The Agreement pegged the dollar to gold at $35 per ounce and all other major currencies were pegged to the Dollar at fixed rates. The critical point here is that the value of dollar was backed by gold reserves of US government, and foreign governments were able to exchange $35 U.S. Dollar for an ounce of gold on demand.
Thus, US Dollar became the reserve currency of the world.
By virtue of using its own currency, the U.S. has run tremendous trade deficits without repercussions simply because the dollar is the reserve currency of the world. The truth is, between 1945 and the early 1960s, the world enjoyed relative monetary stability thanks to the Bretton Woods Agreement. However, the arrangements put in place in 1945 became strained in the second half of the '60s.
Other countries, beginning to realise that they were holding large amount of US Dollars, began redeeming the dollar reserves for gold. At first there was not a lot of concern, because the amounts were relatively small. But, in the second half of sixties Washington became very worried. In August 1971, President Nixon decided not to exchange dollars for gold at the agreed upon rate.
A 1971 President Nixon decree repealed the Gold Standard keeping physical possession of gold against the physical currency (dollar); thus making the "real money" into "fiat currency". This paved the way of unbridled expansion of dollar without being backed by real asset. This may be construed as the root of Fall of the Dollar.
After President Nixon "closed the gold window", the US leadership worked feverishly to develop a new system of international monetary management. In December 1971, a meeting at the Smithsonian Institute by a group of 10 countries (G10), all industrialised, created the Smithsonian Agreement.
This Agreement effectively ended the fixed exchange rate system established under the Bretton Woods Agreement. The new agreement envisaged reestablished an international system of fixed exchange rates without the backing of gold or silver and allowed for the devaluation of the US dollar.
The Smithsonian Agreement, which President Nixon hailed as "the greatest monetary agreement in the history of the world", led to an approximately 8% devaluation of the US dollar and revised the price of gold from $35 to $38 per ounce. However, the Agreement failed to impose discipline on the US government and with no other mechanism in place, the pressure against the dollar on gold continued. The gold became a floating asset. Towards the end of 1971, it reached $70.30/ounce of gold and has kept on rising.
This is when the industrialised nations of the world started to abandon the devalued peg against the dollar. By February 1973, all resemblance to the Breton Woods currency exchange or the Smithsonian fixed rate of exchange markets was closed.
During late '60s and early '70s several crucial events occurred that substantially affected the dollar landscape.
l In 1967, occurred Arab-Israeli war where Israel took over the Gaza Strip, The West Bank, the Golan Heights and the Sinai Peninsula. Six years later in 1973, the Arab forces retaliated by reclaiming some lands.
l The Arab placed an "oil embargo" against the west to pressurize them to withdraw Israeli troops from Arab territory. That led to 1973 oil crisis.
l In US, high inflation from the '60s, staggering war expenditure in Vietnam, sky-high oil price, the gold reaching $800 an ounce nearly caused the dollar to collapse in the '70s.
l Before the Vietnam War, America had $30 billion in gold reserves. But it spent nearly $500 billion in the war alone. It ran a tremendous budget deficit.
l All the central banks tried to convert their dollars into gold. America could not honor its obligations. So America was forced to severe ties between the dollar and the gold.
l Also the Smithsonian Agreement failed miserably. It ultimately all the countries opted to adopt free-floating exchange rates.
These factors led to the loss of faith in dollar as world reserve currency and international exchange currency. So the US worked desperately to find a way to persuade the entire world to keep accepting dollars.
The then US foreign secretary, Henry Kissinger met with King Faisal of Saudi Arabia and convinced his government that OPEC denominates all oil sales in US dollar in exchange for its backing to monarchy. This paved the way to establish US Dollar as the only means for purchasing the indispensable energy source for the whole world. Subsequently, as the most prominent member of the OPEC, Saudi Arabia played the critical role of conniving with the US to establish US Dollar as the global currency for trade and means of exchange.
America has posted a trade deficit since the 1970s and it has been rapidly increasing since 1997. The Tread Deficit hit a record high of $763.6 billion dollars in 2006. In 2008, the total US trade deficit was $685.9 billion, which improved by $5.5 billion between 2007 and 2008, thanks to higher exports, a result of the declining dollar.
The dollar is the reserve currency of the world and many countries hold sizable dollar denominated debts like US treasury securities. Foreign countries literally hold trillions of dollar reserves with China alone holding $1 trillion.
U.S. has sunk into indebtedness to an unsustainable level. In tandem with this, the Budget Deficit is bulging like anything. Currently US budget deficit is 13% of its GDP, which is $1.5 trillion plus. The ever accumulating US debt now stands at more than 12 trillion dollar.
Rob McEwen, a legendary investor in gold, commented on Dollar succinctly, "Money supply has expanded so rapidly that there are a lot more dollars looking for a steady home. Governments cannot help themselves. They want to help the economy. They are printing money. They are going into debt on a horrific scale. And that will depreciate the value of the dollar."
The writer is assistant vice president in International Leasing and Finance services Limited. He can be
reached at shihab@ilfsl.com
Dominance of US dollar is weakening fast in the currency market, thanks to ever widening of US American trade and fiscal deficits. The US currency dominance riding on the disastrous fallout of World War II and subsequently swap for oil deal with Arabs has started losing its strength.
The double impact of the growing U.S. trade deficit and fiscal deficit are seriously threatening the value of the U.S. dollar. This has been further worsened by the Federal Reserve Bank's recent policy to bail-out sickening financial industry and the disastrous wars in Afghanistan and Iraq. To cope with the fund pressure, the US is printing out unlimited amount of dollar, leaving real value of money on the wane. So, the greenback is losing its role as the world's main currency reserve status.
Gold is gaining momentum in the midst of US currency turmoil. Actually, it is not just a bull market in gold, but a "bear market for paper currencies".
U.S. dominance began in early 20th century, when the country cemented its position as the world political and economic power. The U.S. pursued an aggressive policy of expansionism, exerting its political and economic influence around the globe. After establishing itself as the world super-power, it made all-out campaign to control everything-ranging from political, economic and monetary aspects.
Gold had been accepted and preferred medium of exchange. The classic gold standard began to take shape in 1871 in Europe and elsewhere. From 1871 to the beginning of WWI, the currency of all the major trading countries of the world was pegged to gold. Gold coins circulated as medium of exchange daily. Gold was deposited in commercial banks and lent out. Banks kept sufficient reserves of gold in order to meet demand of their depositors.
The gold standard prevented imbalances in trade accounts between countries. Gold acted as an independent automatic adjustment mechanism. This prevented a country to drift away too far from the balance of trade.
The gold standard also stopped governments from acquiring large budget deficits. With a limited amount of credit available, government borrowing would drive up interest rates, making it more difficult for the private sector to borrow and invest. And if the private sector cannot borrow and invest profitably, the economy suffers. Government budget deficits spilled over into trade deficits leading to more gold flowing out; leading to eventual return to balanced trade.
The undesirable side effects of deficit spending made governments to strive to maintain balanced budgets.
In July of 1944, delegates of 44 nations gathered at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire in USA. In that historic meeting, among other economic landmarks, came the Bretton Woods Agreement, which established US dollar as the World's reserve currency. The Agreement pegged the dollar to gold at $35 per ounce and all other major currencies were pegged to the Dollar at fixed rates. The critical point here is that the value of dollar was backed by gold reserves of US government, and foreign governments were able to exchange $35 U.S. Dollar for an ounce of gold on demand.
Thus, US Dollar became the reserve currency of the world.
By virtue of using its own currency, the U.S. has run tremendous trade deficits without repercussions simply because the dollar is the reserve currency of the world. The truth is, between 1945 and the early 1960s, the world enjoyed relative monetary stability thanks to the Bretton Woods Agreement. However, the arrangements put in place in 1945 became strained in the second half of the '60s.
Other countries, beginning to realise that they were holding large amount of US Dollars, began redeeming the dollar reserves for gold. At first there was not a lot of concern, because the amounts were relatively small. But, in the second half of sixties Washington became very worried. In August 1971, President Nixon decided not to exchange dollars for gold at the agreed upon rate.
A 1971 President Nixon decree repealed the Gold Standard keeping physical possession of gold against the physical currency (dollar); thus making the "real money" into "fiat currency". This paved the way of unbridled expansion of dollar without being backed by real asset. This may be construed as the root of Fall of the Dollar.
After President Nixon "closed the gold window", the US leadership worked feverishly to develop a new system of international monetary management. In December 1971, a meeting at the Smithsonian Institute by a group of 10 countries (G10), all industrialised, created the Smithsonian Agreement.
This Agreement effectively ended the fixed exchange rate system established under the Bretton Woods Agreement. The new agreement envisaged reestablished an international system of fixed exchange rates without the backing of gold or silver and allowed for the devaluation of the US dollar.
The Smithsonian Agreement, which President Nixon hailed as "the greatest monetary agreement in the history of the world", led to an approximately 8% devaluation of the US dollar and revised the price of gold from $35 to $38 per ounce. However, the Agreement failed to impose discipline on the US government and with no other mechanism in place, the pressure against the dollar on gold continued. The gold became a floating asset. Towards the end of 1971, it reached $70.30/ounce of gold and has kept on rising.
This is when the industrialised nations of the world started to abandon the devalued peg against the dollar. By February 1973, all resemblance to the Breton Woods currency exchange or the Smithsonian fixed rate of exchange markets was closed.
During late '60s and early '70s several crucial events occurred that substantially affected the dollar landscape.
l In 1967, occurred Arab-Israeli war where Israel took over the Gaza Strip, The West Bank, the Golan Heights and the Sinai Peninsula. Six years later in 1973, the Arab forces retaliated by reclaiming some lands.
l The Arab placed an "oil embargo" against the west to pressurize them to withdraw Israeli troops from Arab territory. That led to 1973 oil crisis.
l In US, high inflation from the '60s, staggering war expenditure in Vietnam, sky-high oil price, the gold reaching $800 an ounce nearly caused the dollar to collapse in the '70s.
l Before the Vietnam War, America had $30 billion in gold reserves. But it spent nearly $500 billion in the war alone. It ran a tremendous budget deficit.
l All the central banks tried to convert their dollars into gold. America could not honor its obligations. So America was forced to severe ties between the dollar and the gold.
l Also the Smithsonian Agreement failed miserably. It ultimately all the countries opted to adopt free-floating exchange rates.
These factors led to the loss of faith in dollar as world reserve currency and international exchange currency. So the US worked desperately to find a way to persuade the entire world to keep accepting dollars.
The then US foreign secretary, Henry Kissinger met with King Faisal of Saudi Arabia and convinced his government that OPEC denominates all oil sales in US dollar in exchange for its backing to monarchy. This paved the way to establish US Dollar as the only means for purchasing the indispensable energy source for the whole world. Subsequently, as the most prominent member of the OPEC, Saudi Arabia played the critical role of conniving with the US to establish US Dollar as the global currency for trade and means of exchange.
America has posted a trade deficit since the 1970s and it has been rapidly increasing since 1997. The Tread Deficit hit a record high of $763.6 billion dollars in 2006. In 2008, the total US trade deficit was $685.9 billion, which improved by $5.5 billion between 2007 and 2008, thanks to higher exports, a result of the declining dollar.
The dollar is the reserve currency of the world and many countries hold sizable dollar denominated debts like US treasury securities. Foreign countries literally hold trillions of dollar reserves with China alone holding $1 trillion.
U.S. has sunk into indebtedness to an unsustainable level. In tandem with this, the Budget Deficit is bulging like anything. Currently US budget deficit is 13% of its GDP, which is $1.5 trillion plus. The ever accumulating US debt now stands at more than 12 trillion dollar.
Rob McEwen, a legendary investor in gold, commented on Dollar succinctly, "Money supply has expanded so rapidly that there are a lot more dollars looking for a steady home. Governments cannot help themselves. They want to help the economy. They are printing money. They are going into debt on a horrific scale. And that will depreciate the value of the dollar."
The writer is assistant vice president in International Leasing and Finance services Limited. He can be
reached at shihab@ilfsl.com