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Page added on October 14, 2013
How Much Longer Will the Dollar Be The Reserve Currency?
Nothing lasts forever… (especially in light of China’s earlier comments)
Submitted by Patrick Barron via The Ludwig von Mises Institute,
We use the term “reserve currency” when referring to the common use of the dollar by other countries when settling their international trade accounts. For example, if Canada buys goods from China, it may pay China in US dollars rather than Canadian dollars, and vice versa. However, the foundation from which the term originated no longer exists, and today the dollar is called a “reserve currency” simply because foreign countries hold it in great quantity to facilitate trade.
The first reserve currency was the British pound sterling. Because the pound was “good as gold,” many countries found it more convenient to hold pounds rather than gold itself during the age of the gold standard. The world’s great trading nations settled their trade in gold, but they might hold pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment. Toward the end of World War II the US dollar was given this status by international treaty following the Bretton Woods Agreement. The International Monetary Fund (IMF) was formed with the express purpose of monitoring the Federal Reserve’s commitment to Bretton Woods by ensuring that the Fed did not inflate the dollar and stood ready to exchange dollars for gold at $35 per ounce. Thusly, countries had confidence that their dollars held for trading purposes were as “good as gold,” as had been the Pound Sterling at one time.
However, the Fed did not maintain its commitment to the Bretton Woods Agreement and the IMF did not attempt to force it to hold enough gold to honor all its outstanding currency in gold at $35 per ounce. The Fed was called to account in the late 1960s, first by France and then by others, until its gold reserves were so low that it had no choice but to revalue the dollar at some higher exchange rate or abrogate its responsibilities to honor dollars for gold entirely. To it everlasting shame, the US chose the latter and “went off the gold standard” in September 1971.
Nevertheless, the dollar was still held by the great trading nations, because it still performed the useful function of settling international trading accounts. There was no other currency that could match the dollar, despite the fact that it was “delinked” from gold.
There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value vis-à-vis other commodities over time. These two factors create a demand for holding a currency in reserve. Although the dollar was being inflated by the Fed, thusly losing its value vis-à-vis other commodities over time, there was no real competition. The German Deutsche mark held its value better, but German trade was a fraction of US trade, meaning that holders of marks would find less to buy in Germany than holders of dollars would find in the US. So demand for the mark was lower than demand for the dollar. Of course, psychological factors entered the demand for dollars, too, since the US was seen as the military protector of all the Western nations against the communist countries for much of the post-war period.
Today we are seeing the beginnings of a change. The Fed has been inflating the dollar massively, reducing its purchasing power in relation to other commodities, causing many of the world’s great trading nations to use other monies upon occasion. I have it on good authority, for example, that DuPont settles many of its international accounts in Chinese yuan and European euros. There may be other currencies that are in demand for trade settlement by other international companies as well. In spite of all this, one factor that has helped the dollar retain its reserve currency demand is that the other currencies have been inflated, too. For example, Japan has inflated the yen to a greater extent than the dollar in its foolish attempt to revive its stagnant economy by cheapening its currency. So the monetary destruction disease is not limited to the US alone.
The dollar is very susceptible to losing its vaunted reserve currency position by the first major trading country that stops inflating its currency. There is evidence that China understands what is at stake; it has increased its gold holdings and has instituted controls to prevent gold from leaving China. Should the world’s second largest economy and one of the world’s greatest trading nations tie its currency to gold, demand for the yuan would increase and demand for the dollar would decrease. In practical terms this means that the world’s great trading nations would reduce their holdings of dollars, and dollars held overseas would flow back into the US economy, causing prices to increase. How much would they increase? It is hard to say, but keep in mind that there is an equal amount of dollars held outside the US as inside the US.
President Obama’s imminent appointment of career bureaucrat Janet Yellen as Chairman of the Federal Reserve Board is evidence that the US policy of continuing to cheapen the dollar via Quantitative Easing will continue. Her appointment increases the likelihood that demand for dollars will decline even further, raising the likelihood of much higher prices in America as demand by trading nations to hold other currencies as reserves for trade settlement increase. Perhaps only such non-coercive pressure from a sovereign country like China can wake up the Fed to the consequences of its actions and force it to end its Quantitative Easing policy.
16 Comments on "How Much Longer Will the Dollar Be The Reserve Currency?"
Ghung on Mon, 14th Oct 2013 1:22 pm
“To its everlasting shame, the US chose the latter and ‘went off the gold standard’ in September 1971.”…
…about the time US oil production peaks, and why the Dollar is unlikely to maintain its reserve status much longer. Debt becomes a proxy for real growth:
Ghung on Mon, 14th Oct 2013 1:25 pm
See it here: http://i1001.photobucket.com/albums/af140/Ghung/US-debt-1791-2010v01_zps1a5e697b.jpg
bobinget on Mon, 14th Oct 2013 2:31 pm
You all are ignoring US oil and more to the point, gas production that consistently pulls our marshmallows
from the fire… just in time.
China has been importing two commodities in record numbers; oil and gold. For good reasons.
Most US centric investors underestimate China and India’s oil thirst. Instead, pay close attention instead to gold markets, minuscule by comparison.
Most pure propaganda articles, (impostor educational) like the one above fail to point out how vital our tech sector is to oil and gas production.
The facts are clear. One US political party was taken over by know nothings radicals before the center right
of that party understood what they unleashed.
Expect that party to break apart as this attempted (party) coup is uncovered.
Solarity on Mon, 14th Oct 2013 3:29 pm
How Much Longer Will the Dollar Be The Reserve Currency?
As long as OPEC prices their oil (about 1/3 world supply) in dollars.
Since 1971 (end of gold standard) the world has been on the petro-standard and hence uses the petro-dollar as its reserve currency. OPEC determines its price of oil based on a market-basket of commodities all delineated in dollars. If they did not use dollars, they would use some other commonly available exchange medium. Until a broad spectrum of tangible items can be easily evaluated in some other currency, OPEC will continue to use the dollar.
Jerry McManus on Mon, 14th Oct 2013 5:41 pm
My understanding, and I may be wrong, is that money is just a token. Whether that token is paper or precious metal is really beside the point.
History shows that other societies have used stones, shells, and knotted ropes to good effect in terms of stimulating trade.
It is who controls the money that we are really talking about here. For 80 years in the US, and by extension the world, a cabal of private bankers has controlled our money via the Fed and other central banks.
Should the people one day decide to reclaim that control we would live in a world where banks are public and not private, where the government spends money directly into the economy to the benefit of production and other useful work, and where the people are not enslaved by debt and interest payments to an obscenely wealthy and powerful elite.
Simple, really. No?
DC on Mon, 14th Oct 2013 5:48 pm
Saddam Hussein’s government made the switch to Euros.Remember what happened to him?
Mr Ghaddifi went even further and *proposed* a common gold-backed currency for Africa. Remember what happened to him?
The US is openly murdering heads of state now that try implement alternatives to the IMF, WB, Oil, corporate control system.
What do you think the ‘China pivot’ is all about? Its to force China into a ruinous arms race with a nation that can print infinite IOU’s to cover it(for now).
Both Europe and certainly Iraq itself, paid a heavy price for that brief window where oil was openly traded in something other than amerikan IoUs. Hopefully that dollar collapse comes soon. Its the only thing that will end amerikas ability to export terror to the world at the scale it currently does.
LT on Mon, 14th Oct 2013 6:43 pm
Ones cannot eat gold, diamond, or gem stones during a famine or war times. And you have a higher chance to get killed by mob if they know you have gold. Therefore, gold/diamond/money are not the ultimate currency.
What America has compared to the rest of the world is the VAST amount of food they are able to produce with or without the help of oil. This ability comes from the VAST amount of arable land and fresh water resources in the continental US. This is the US real and ultimate currency to back up for those green-backs.
Therefore, whether the US dollars continue to be world reserve currency or not is still solely under the US control/decision, not someone else; unless someone can defeat the US military and make a change to the current world order.
J-Gav on Mon, 14th Oct 2013 7:30 pm
Jerry – Exactly! Whether it’s fiat money or gold, it’s still a question of confidence. Say we go back to some sort of gold standard … Are the U.S. (ha-ha), China (tee-hee), Russia, Germany, Great Britain etc going to allow independent auditors to assess what they actually hold? Hardy-har-har. Though a yearly audit is required by law in the U.S., the last one took place in 1953!
LT – What you say is far from being all wrong but I can’t say I agree with your conclusion. I believe the world has understood it doesn’t have to defeat the U.S. militarily in order to gradually shift into a different monetary configuration. I don’t pretend to know exactly what that will look like but with every passing year more and more international trade is conducted without using dollars.
LT on Mon, 14th Oct 2013 8:22 pm
“I don’t pretend to know exactly what that will look like but with every passing year more and more international trade is conducted without using dollars.”
>> Mr. J-Gav:
What you said above is true. But that is mainly due to resentment toward US governments/policies. And US government/administration come and go every four years (I mean the American people always have a chance to vote in or out of office those officials they like or don’t like.)
And policies, after all, is like a piece of cloth, if it is perceived as unfit, it will be changed or replaced with what is more attractive.
Look at the US great depression in the 1930s. The US had lots of food, lots of farm, lots of factories, and yet millions of people out of work. It was the financial scheme/policy that was crashed, that put people out of work, not wars, not famines. Then, all of the sudden, the American people (leading by FDR) became smart and invented the GREAT NEW DEALS. It solved the great depression problem. It put America leap forward for several decades.
There are still many American who still have good common sense and know exactly what to do to revive the country. What you and me have been seeing, I guess, is a grand political/economic games: “It’s done on purpose, not unintentional.”
So if the current financial scheme is old and out of date, those in power may shred it and replace it with better ones. They have the power and the means to do it. The marshal project after WW2 proves US capability.
Lastly, although we live in a civilized world with law and order, but this is only true at local level, national level. The ultimate law that governs the world today is still the “law of the jungle”: The rights belong to the strongest, just like lions and tigers on prairies and forests.
J-Gav on Mon, 14th Oct 2013 9:34 pm
LT – You have an interesting voice. I wonder where it comes from, if that’s not indiscrete. You are correct when you state that a lot of what happens is not unintentional. That doesn’t mean by any stretch of the imagination that somebody, somewhere controls ‘everything.’ In fact, on certain key points regarding humanity’s future, the elites are at least as clueless as the average American citizen (I mean those who think they’re somehow going to carry on the race in bunker-land).
Ah! Lions and tigers and bears! Have you seen the footage of lionesses adopting their prey’s youngsters (Oryx)? There is much to be said about animal ‘instincts’ and also about their intelligence. But the upshot is: there is not one law in ‘the jungle.’ Things are more flexible than most people imagine. The biggest,strongest,fastest etc don’t always ‘win.’ The fastest for example, cheetahs, will likely be among the first largish felines to disappear. They have to run so fast for so long that their hearts give out.
Once again though, I question your conclusion: ” … those in power may shred it and replace it with better ones.” I don’t believe they want ‘better’ ones, I believe they want to continue to rape the planet as they have been doing for quite some time , as long as they can derive wealth and power from that process. By the way, the Marshall Plan was far from being the philanthropical enterprise it was made out to be – European countries paid a very high price in terms of their cultural sovereignty there.
Secondly, “We live in a civilized … etc.” Really?
If that were the case then why would the U.S. lead the world in mathematics (euh, no!); geographic and historical knowledge? (Yikes!); incarceration rates? Bingo! Executive powers that allow U.S. leaders to imprison for life anyone they choose without due process (or even to terminate lives). So, though civilization trundles on, mainly at the local level as you mention, it no longer necessarily applies at a national level.
J-Gav on Mon, 14th Oct 2013 9:55 pm
Returning to Jerry’s comment. The ONLY way to move forward is to make the issuance of currency and the decisions regarding its terms of credit a public service. That probably means bye-bye Fed. But the whole world central banking system hangs in the balance here too. No little tweaking around the edges will get this job done. Whether or not it comes to massive civil unrest and/or grand scale international violence remains to be seen but isn’t it a shame that we find ourselves on the cusp of this crap when we had the means to make a different future work? Do we still have those means?
James on Tue, 15th Oct 2013 12:58 am
Ummm, The U.S. does have a lot of food resources. But, take away the oil and fertilizer, and it all goes down the drain. Also, most of our food is grown out in the Midwest and the West, were they use water from the Ogallala Aquifer which is in the state of severe draw down. Soon, they won’t be able to use the aquifer for water to grow these crops. So, there are large limiting factors that could bring all that food to nothing.
BillT on Tue, 15th Oct 2013 1:59 am
I pity all of you who still believe that America and tech is the greatest things on earth. Both are false. The US is struggling to keep some semblance of power in the world and to keep the dollar from turning into a useless form of toilet paper.
Have you ever considered that the ‘powers that be’ may want the US to crash and burn? Or at least the money system? Factions may want the dollar to reign, but others may side with gold or a basket of currencies. China is taking that side and will bring down the US one way or another.
As for the US being an exporter of food. Not for much longer. The Midwest is drying up. Climate change can make the US another North Africa in a few years. Did you know that the US imports 20% of it’s food? Read the labels. Where does your coffee come from? Chocolate?
Tech is not going to save the human species. It is too busy trying to kill it off.
RICHARD RALPH ROEHL on Tue, 15th Oct 2013 5:08 am
A Federal Reserve Bank note has no INTRINSIC value beyond the foolish FAITH that some people put into it. Hell! You can’t even use a Federal Reserve Bank note to wipe clean your anus. The paper is too stiff and none absorbant. And newspaper burns better and more efficiently for lighting the barbecue.
Bankster currency is an $ocio/economic invention, an abstraction of mind. Money dies when people lose faith in it… and when the CEREMONY of barter becomes an electronic digit used to buy a widget.
Arthur on Tue, 15th Oct 2013 6:00 am
A dollar may have no intrinsic value and you can loose faith in it, nevertheless ordinary Americans have no choice but use it for their daily transactions. There is no alternative. The only freedom of choice they have is to either decide to save it or spend it. In international trade things are different. Oil must still be paid for in dollar, courtesy US army/navy, stationed in the Gulf. But for the rest countries have the freedom to arrange bilateral trade agreements and they do.
William Godwin on Tue, 15th Oct 2013 8:32 am
Gold is a poor investment simply because it does not produce. In fact, it costs. Add up costs of mining, smelting, assaying, storing, guard’s salaries. Then Fort Knox needs a new roof or someone to cut the grass. Then perhaps the greatest cost is the environmental one. Look what Peru is doing to their true productive capacity (food and water) to mine gold. Gold is sucking wealth out of your pocket. Count the opportunity cost of just worrying about it. Why even mine it in the first place! This just puts it in danger of theft. It is safest right there in the ground.
I say let’s go back to the gold backed dollar. just don’t mine it and store it in vaults. Estimate the reserve in an ore body. Fence it off and walk away. Ok guys we have a reserve here of so many thousands of oz on the books. We will back the dollar with this reserve. We will discount the costs of mining to guarding and be that much farther ahead. You want to transfer the gold to your account, sure thing buddy. That will be x of your paper money for y tons of ore transferred to your account. Oh you want to mine, smelt, assay and store it. Sure, knock yourself out buddy. Shut the gate when you are done and mail us a copy of the scale receipt.