Today I want to take a running jump through history. I’d like to guide you through some very bloody episodes to arrive at a truly massive event that I see shaping up..
I’m talking about the dollar losing its status as the world’s reserve currency.
For ten years now the dollar has been in terminal decline. But having had a respite during the 2007 meltdown, the dollar looks set to resume its death spiral.
In fact, something that happened this week tells me that we have already entered the endgame for the dollar. This could have a massive bearing on your wealth over the next few years.
Let’s start by looking at how we got into this mess…
How America took over the casino
The financial system as we know it grew up on international trade. As the merchant fleets took to the seas in search of spices, tobacco and all manner of exotic stuff, they needed currency to trade with. Something that everyone had faith in. And that was generally precious metals.
Of course there was a fair bit of gun-boat diplomacy too, but let’s focus on the economics…
Rather than trudge around with chests full of gold, traders embraced an international banking fraternity. One that stretched across the globe and had gold and silver at its heart. If the UK imported more than she exported, she’d have to send over some metal (or an IOU for it) to balance the books.
Everything worked swimmingly. At least it did until a couple of world wars upset the apple cart.
By the end of WWII the IOUs were massive. The Europeans and Japanese ended up owing way too much debt to the US. It was decided that these debts could be ‘dollarised’ and the world could move to a new reserve currency. Everyone could now trade and pay back debt in dollars.
And the agreement was that you could always cash in your dollars for gold from Fort Knox. It was like a giant casino. The Fed was the cashier and traded real money for their dollar chips…
This was a dollar/gold reserve currency. One that could be used for international trade as well as for saving. The 50s and 60s were tremendous years. But then the rot set in…
End game for the dollar
Unfortunately by 1971 the States reneged on its promise. No more gold for dollars. So what could you do with your dollar chips? Well, you could buy US treasury debt. And that’s been the jig for the last 40 odd years. Central banks have saved up an awful lot of these dollar chips issued by the Fed.
In fact the States has issued so much debt that many influential investors say they’ll never be able to pay it back. And I agree.
This debt based, dollar chip reserve system is starting to unravel…
On Monday, ratings agency Standard & Poor’s issued its first negative outlook for US bonds. This is serious stuff. The overseers smell a rat and if these guys say something is wrong, things must be really bad! This could be the endgame for the dollar.
The following chart measures the US dollar against a basket of currencies: EUR, JPY, GBP, CAD, CHF and SEK
The dollar’s trajectory has been pretty well marked out for ten years now. Ever since Alan Greenspan slashed rates to guide markets out of the dotcom malaise, the dollar has been ebbing away.
At least it was until the credit crunch, Point A.
The US dollar over the last ten years
Source: fxstreet.com
During the 2007/8 crisis investors ran scared, looking for a place to stash cash. They decided that dollars were the best bet. The dollar bounced back – a kind of knee-jerk reaction.
But the Fed’s QE frenzy was about to change perceptions. Greenspan’s low rates gave way to Bernanke’s money printing. And within a year, the dollar was back on its downbeat track.
But what happened in 2010 you may ask… the dollar rallied to Point B. What caused that?
Well, the world cottoned on to the fact that a weak dollar wasn’t great for them. Suddenly everyone wanted a weak currency. The pound, the yen and even the euro – all the major currencies found new ways of showing their uselessness. It was the classic race to the bottom.
But it seems the rest of the world simply can’t compete with dollar uselessness. Now the dollar is sliding again. And there’s a good reason for it. We should all be very wary…
The hunt is on for a new reserve
You see, all the time that the dollar is the de facto reserve it has an inbuilt advantage. People need it for trade. There will always be buyers of dollars and her debt.
But now the world is on the hunt for a new reserve. They’re fed up with this useless dollar.
BRICs have started to deal with each other in local currencies. Just last month China announced that “it hopes all exporters and importers to settle cross-border trades in the yuan by this year”.
Both China and Russia have been muttering about some sort of asset and currency backed reserve. And before the euro hit its own wall of debt, oil-producing nations were vocal about using it for international trade. The euro remains a viable alternative to the dollar long term.
The point is that creditor nations (the guys sitting on reserves of questionable value) want something that is backed by something tangible. Just like it used to be before 1971. They want a currency that doesn’t keep deflating.
And they’ve had enough. As my colleague John Stepek pointed out, “even amid the chaos in the Middle East and the fear of further sovereign debt problems in Europe, the dollar has been resolutely left to drift lower”.
Buy gold while the dollar burns
Nobody knows how this will turn out – or what could back a new reserve currency. But I think these new fears about the dollar will help gold regain its lustre. Maybe it won’t form part of the new reserve, but it’ll certainly do as a store of value in the meantime.
And so for anyone that says gold is over-valued, my response is the same… Against what? Against a consistently falling dollar? One that’s almost set up to fail?
People also keep telling me: ‘You can’t value gold’. But that’s rubbish too – it’s worth what it costs to get it out of the ground at the very least.
The point is you can’t value the dollar. You can’t value fiat currencies. They are only worth anything so long as investors/speculators/businesspeople have faith in them.
So if you want something to ponder on, then why not consider how long international trade can continue pegged to an ever-faltering debt-laden dollar – a casino chip of extremely questionable value.
And while you are wondering, make sure you buy some gold. If you haven’t done so yet, my favoured option for the traditional investor remains the PHGP Physical Gold ETF (LSE:PHGP).
• This article was first published in the free investment email The Right side. Sign up to The Right Side here.
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