Posted on 10/13/2013 12:31:40 PM PDT by SeeSharp
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.
Keep in mind we’re really in the realm of hypotheticals here. If the dollar goes down with a THUD, then I don’t think any fiat currency will be all that popular for a few decades. Precious metals or other hard assets will be used for savings. But for short term transactions, the yuan is a fair bet to be a currency of choice.
I prefer your plan B as well. I just don’t thinks it’s going to be on the list of menu choices. In which case plan C: doing what’s necessary to protect you and yours is probably the most prudent avenue to pursue.
I can’t remember who said it , but I think the adage “the best way to help the poor is not to become poor” is operative here.
More seriously, BTW, the USD will continue to inflate as long as the manufacturing base on U.S. soil (different from “U.S.-based” manufacturing) is inadequate. The current economic problem is a result of the debt problem, and the debt problem is partly a result of trade imbalances (and in other part, a result of excessive government spending). The lack of manufacturing is a result of mostly zoning laws/ordinances against new, small manufacturing starts in rural areas (lack of new blood in the business).
Well I can say that American conservatives will decide what will happen about America.
For too long, we have been outsourcing everything.
For an entire generation in fact. Entire factories, upon factories, upon factories have been built in communist China, which the Chinese own by the way, for an (interest) in the resulting goods.
America has been getting shafted bigtime in this, and we have done nothing.
Now we’re at a point of saying enough.
I say bring back American factories.
We tried this mess. All it did was made China very very powerful. And a few Americans wealthy.
Bring back American factories to America.
Now.
Many months ago, fund managers released some word in e-mails to clients about the yuan trading in the Chicago Exchange.
I disagree with this.
We need to even out our trade balance, and we need to start with our (huge) and growing inbalance with China.
Trade with China made sense 20 years ago. Made sense to a point even 10 years ago.
Now we need to bring factories back here.
Now.
The worldly folks behind manufacturing now will bring more of it back here, when working conditions can be like those in China, Bangladesh, etc. Much larger numbers of other Americans will start new, small manufacturing operations, when it is legal for slaves to do so (re. local commie zoning laws/ordinances, etc.).
Thanks.
We need, we really need, to enact defensive trade tariffs.
Just saying.
True, so true.
God help us.
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