Friday, October 23, 2009

“US Dollar As Reserve Currency Not Working Very Well” – Sayce [updated]

As Ben  Bernanke keeps  running the printing  presses to buy up the toxic assets of tomorrow, people keep talking about the death of the US dollar, and the possibilities of a new global reserve currency.  Australian financial commentator Kris Sayce, who writes at the Money Morning site, has a few thoughts on that and on how the UN – the UN! – are planning to take advantage of that. ANd on what a real “reserve currency” would look like.

US Dollar As Reserve Currency Not Working Very Well

We read with interest [a few weeks back] a call by the United Nations Conference on Trade and Development for a new global reserve currency.

Apparently the current set-up of having the US dollar as a reserve currency isn't working very well.

They're quick learners at the UN obviously!

Their report makes some of the right noises, "The dollar-based reserve system is increasingly challenged." Hmm, a slight understatement there. If "increasingly challenged" is a euphemism for "dead" then we'd agree.

But we don't think that's what they mean.

So, what do they plan replacing it with?

Special Drawing Rights, or SDRs. If you've got no idea what that means, it's simple.

An SDR is something made up by the boffins at the International Monetary Fund (IMF) to act as an "international reserve asset."

The rationale for the creation of the SDR was that "the international supply of two key reserve assets - gold and the US dollar - proved inadequate for supporting the expansion of world trade and financial development that was taking place."

Look, your editor won't pretend to be a grade 'A' student of monetary theory, but to us the creation of the SDR is part of the reason the global economy is in the current mess.

That gold was deemed to be inadequate for "supporting the expansion of world trade and financial development" tells you that's when the Western world begun its massive spending spree.

Back in 1969 with the creation of the SDR.

A spending spree that couldn't be achieved just through stealing money from citizens through the tax system, but one which could only be kept going by the creation of more money.

It was, you could argue, the beginning of the 'consume, don't produce' Western economies.

The problem that SDRs 'solved' was the ability to crank up the printing press. Of course that didn't happen straight away. There's always a transition with these things.

First, as it happens, like the US dollar, the SDR was backed by gold. But if you're creating a new reserve that you want to be more flexible than gold (ie. You want to print more money and spend it), then backing it with gold isn't going to work.

Because backing a currency with gold helps to maintain the value of the paper currency. If you know that your $1 note is redeemable for a set quantity of gold then it will maintain value.

It means the banks can't - or shouldn't - create more paper money than the reserves they have in gold to back it up.

Simply put, it creates and requires discipline. Something that bankers and governments in the 1960s weren't happy with. The 'inflexibility' of gold makes it harder to for governments to spend and makes it harder for banks to lend.

Therefore the creation of the SDR was a stepping stone to abandoning the reserve status of gold. And sure enough, four years after the SDR was invented, US President Richard Nixon closed the gold window at the Federal Reserve and there was no longer any obligation for US dollars to be exchanged for a fixed weight of gold.

Instead the US dollar was backed by nothing, and so the SDR was backed by the US dollar and other currencies which were also backed by nothing.

Yet it is this 'worthless' SDR which is being touted as the new reserve currency.

But why should the SDR make any difference? It won't. An SDR is just a weighted basket of other currencies. Unless it is backed by something tangible, such as gold, then it will prove to be equally as worthless as the US dollar it is replacing.

Perhaps, bankers and governments will see the error of their ways and make a call for these new SDRs to be back by gold...

Not a chance.

There are several reasons for that. One, as I mentioned above, is that gold forces a government and its central bank to be disciplined. It cannot circulate more money without having a corresponding increase in its gold reserves.

If it were to do so then the paper money - or certificates - would not be fully backed by gold. This would cause the value of the paper to decrease - the greater supply of one thing relative to another devalues it.

If people got wind that the central bank was printing more money without increasing its reserve of gold, there would be an increased demand for physical gold. There would be a run on the banks.

The other problem gold has is an image problem. Take this comment from a recent article by Alan Kohler over at Business Spectator:

"But while there's no doubt the gold will continue to be underpinned by the demise of the dollar, it is not a currency. I can't go into JB Hi-Fi with a lump of it and buy a TV."

"Central banks around the world own about 26,000 tonnes of it, which represents 8.5 per cent of total reserves, but it's not legal tender. It's just a commodity they got stuck with because it used to be a currency a long time ago and will never be again."

It's fairly common of the attitude the mainstream press has to gold. They don't understand that it is a store of value.

Kohler claims you can't go into JB Hi-Fi and buy a TV with a lump of gold. He's quite correct on that score. But it wasn't so long ago that is effectively what consumers did. Maybe not for TVs but for other items.

Under a gold standard where your dollar was backed by gold, consumers were exchanging a gold backed dollar for goods. It was an exchange of gold for goods, only that a paper note was used as a proxy.

What's so crazy about that? Nothing.

But if you look at Kohler's other comment about 26,000 tonnes of gold being only 8.5% of total reserves it gives the game away for the real reason bankers and governments don't want a gold backed currency.

Inflation.

It's no coincidence that since the early 1970s global paper currencies have lost about 90% of their value. Virtually every currency you name is worth significantly less today than it was thirty-odd years ago.

That's not because prices have risen, it's because currencies have become devalued.

As Kohler, perhaps unwittingly admits, central banks and governments have embarked on a massive money printing exercise.

If paper money still had the backing of gold then global economies would not have one-tenth of the current problems we are currently facing.

The fact that the UN and other government organizations are proposing to replace one currency backed by nothing with another currency backed by nothing signals they are either ignorant or are intentionally pursuing policies guaranteed to deliver economic destruction.

And more importantly to you, to guarantee the continued devaluation of your money and wealth.

Kris Sayce

UPDATE: On a related note, today’s FEG Newsletter reckons you should “read what the Wall Street Journal has to say as the paper currencies of the world vie for the lowest position on the world markets. The race is picking up speed!”  I did read the summary, and was brought up short by this ridiculous sotto voce comment: “For its part, the U.S., publicly favors a strong-dollar policy . . . “  Given the Fed’s overheated printing press and an Administration enthusiastically cheering as the paper money pours off them, one wonders what the Wall Street Journal’s reporters think the Fed would be doing differently if they favoured a weak-dollar policy?!

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5 Comments:

Anonymous Anonymous said...

PC - Interesting read (or quick browse from me).
I would be interested in your thoughts is we can fast forward a bit to potentially when there is no currency but credits.
It is close already. Many people work, get paid by direct credit and make most of their payments by eftpos, credit cards. They don't actually handle any paper money. Their bank balance is just numbers going up and down.
Consider soon a world economy with no sovereign currencies, just people, business, governments carrying around cards that tell them how much XXX they have. All stored ??? All meaningless and important at the same time

David

10/23/2009 11:48:00 am  
Blogger Opinionated Mummy said...

I believe the calls for the new global reserve currency initially came from China and Russia, reflecting Beijing’s and Moscow’s concerns about a potential decline in the US dollar, and by extension, the value of their own substantial dollar holdings. China has previously expressed concerns about the safety of its investments in US government securities.

But it’s difficult to see a viable alternative to the dollar. The alternatives are still tenuous, or not used widely enough (the carry trade notwithstanding), or are losing significance due to long-term economic decline. Investing in, say, Japanese Government Bonds (JGBs) instead of US Treasuries is hardly appealing, given the low yields on offer for such a high debt pile (170% of GDP). Or, in the case of the SDR, would take an extraordinarily long time to develop, implement, and will be fraught forever on the fairness of the calculations and by countries wanting to exert their sovereign strength by stepping outside the SDR system, thereby undermining any value that the SDR has as a fair calculation.

While I think it is natural for countries such as China and Russia to want to diversify their reserves, I’d say that their calls for a new reserve currency also have a strong political whiff to them. Not coincidentally, both countries would like to see the end of US hegemony, and one way of achieving this might be to erode the dollar’s dominance – although not quickly, obviously, lest a dollar collapse hurt their own economies.

The UN should never be the key player in global economics (no small point that China and Russia have a loud voice in the UN).

10/23/2009 12:09:00 pm  
Anonymous Sinner said...

It's pretty simple. The new reserve currency will be the yuan. Russia might not like it but there's fuck-all they can do about it - or anyone else.

10/23/2009 12:36:00 pm  
Blogger PC said...

@Sinner: You know, Sinner, I've never yet see you make an argument. Just bald statements. "This will happen." "This won't." "We should do this." "We should stop that."

Reasons why? Blank out.

Is it, perhaps, that you just have opinions instead of ideas?

Whatever the reason, if you're going to make a statement, then why not show your working?

10/23/2009 12:50:00 pm  
Anonymous Brian Barker said...

A recent CNN television broadcast gave the impression that Esperanto aims to be a single global language. The comparison was with a global reserve currency, instead of the US dollar.

See http://www.youtube.com/watch?v=ZpC8mPk4QBM

May I put the record straight? Esperanto intends to be an auxiliary language, or a second language for all.

Please see http://www.lernu.net for confirmation.

10/23/2009 03:09:00 pm  

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