US Dollar As Reserve Currency Not Working Very Well

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We read with interest earlier this week 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
for The Daily Reckoning Australia

Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.
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38 Comments on "US Dollar As Reserve Currency Not Working Very Well"

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Justin
Guest

Yeah, but Alan Kohler is pretty clueless.

And I disagree, the USD is not backed by nothing, it is still backed by gold, a progressively smaller amount as time goes by. The day it is no longer redeemable for even a variable amount of gold is the day it becomes ‘worthless’. Same goes for the AUD, Pound, Euro etc.

Large dollar holders are still able to redeem their millions, billions etc of USD for gold on the COMEX, but maybe not for much longer.

Dinakarananda
Guest

Nice article. I am totally sold about the necessity of a gold backed reserve currency. However, what puzzles me is the great depression that happened when the USD was backed by gold. Was it because of that 70% devaluation of USD done by FDR in 1934? Was it a recession from 1929-1934 that was made a monster depression by the then US president FDR? I am sure anyone in the distinguished panel of DR can enlighten me.

Rob
Guest

One thing not mentioned is that gold is still being dug up and this represents an ongoing reduction in its ‘store of value’ through greater supply, similar to printing money really, and through this mechanism, any country with more gold in the ground can print more money and have comparatively greater wealth.

John Smith
Guest

I agree there needs to be controls on a fiat money system. But Gold is worthless / essentially useless metal. Backing a currency with it encourages economies to waste physical resources to actually find, produce and best of all store it in expensive vaults for no purpose (more so than they waste now). Whilst paper money is also worthless / useless at least it doesn’t waste physical resources to produce. We should focus on laws to control the printing of money not bother backing it with gold.

dsylexic
Guest
John smith -totally and absurdly wrong. gold has value has jewelry and usage in hitech.this is apart from its monetary commodity value. getting people to spend resources on finding gold is not an exercise in futility unlike printing paper -since gold has lots of other uses as well. and Rob,sorry mate -your fears are unfounded.gold IS scarce .that is why no country can dig up gold and ‘inflate’ away to glory unlike paper. btw, the country with the largest amount of gold mines doesnt need to possess the largest amount of gold. the largest amount of private gold exists in… Read more »
Lachlan
Guest

Virtually everybody uses gold.

Lachlan
Guest

And dont forget silver….money,industry,medicinal uses (going bigtime) etc.
We need gold for our computers so we can chatter on the DR website.

Greg Atkinson
Guest

But don’t forget that despite what the PR machine pumps out there is plenty of gold around, it is just that investor demand has put a lot in vaults. Remember a lot of gold isn’t consumed as such and is sitting on peoples fingers, in electronics and can be recovered. As a percentage, little gold is actually lost, it isn’t like oil.

TC
Guest
The whole idea of a floating dollar/central bank manipulation is about control. Not money or wealth. We are simply witnessing a point in our history that those who know and understand the inner-workings of the FED are free to do what they like. It matters not who is in charge politically. Meet the new boss…same as the old boss. There are internal power manipulations behind the scenes. There is a delay in the results but they are displayed in the media. This new aristocracy wants to manufacture (craft as the politicians/aristocrats are fond of saying) events through the laws they… Read more »
John Smith
Guest
Thanks Greg. The whole point is gold has very little use practical use (other than Jewellery). Some much is stored in vaults! Brilliant what a complete waste of resources. Dig stuff out of the ground, refine it, mould it into nice bricks. Store it in a vault and make people think that it is useful and is doing something. Think fort Knox, Perth Mint etc. The high price then means other useful metals such as platinum get used for jewellery when they should be used for other things. Also, means people are paying more than necessary to have wedding bands,… Read more »
Dan
Guest

Very deep comment from TC, especially given the date today. Worth pondering and following up IMO.

Greg Atkinson
Guest

John Smith the World Gold Council provide details about how gold is used and the industrial use of gold (including dental) is not a major driver of demand. Yes gold is used in industry, but much of this gold can be recovered. I tried to pull together the bull and bear views of gold here: http://www.shareswatch.com.au/blog/commodities/investing-in-gold-a-basic-guide-for-investors/

Cheers!

Biker Pete, Ottawa, Ontario, Canada
Guest
Biker Pete, Ottawa, Ontario, Canada
Anything, including gold, is ‘worth’ any amount anyone will pay. Having said that, I recall Greg advising us that gold costs around $560(?) per oz to produce, so I guess gold IS worth at least that much. As a decent house in a good location costs a minimum of $380K to build (including land), we’d expect that to also be a base rate. I confess I was intrigued by Bill’s comment that: “The price of gold today, adjusted for inflation, is about where it was 26 years ago.” Some properties we owned twenty six years ago are worth well over… Read more »
Ross
Guest

Physical gold is a logistics nightmare. It must be secured, it must be carried to be exchanged, and the person you exchange it with must have the same capabilities. Gold markets are subject to the same liquidity induced value issues as all the other equity, securitised, and commodity markets.
Nobody knows if the marketing of gold, or “diamonds are a girl’s best friend” or anything else will prevail value upon it in a severe downturn. People will certainly reach for a promissory valued something and gold is a chance but it has only odds and not certainty.

Greg Atkinson
Guest
Some time ago Pete posted this graph during a discussion regarding gold we were having. Also if anyone is interested this is where some of us were rambling on about gold prices: http://www.shareswatch.com.au/blog/commodities/are-we-in-a-gold-bubble-could-gold-prices-fall/ Last time I checked gold production costs were in the range of $500-600 USD an ounce but this varies a lot from mine to mine. Some operations are pretty high costs (i.e. in remote areas) The fact is that demand is being driven by investors at present. This means we are simply putting tonnes of the stuff into vaults for? Maybe that trend will keep going, but… Read more »
William
Guest

If paper money is worth nothing then why do gold producers readily exchange their yellow stuff for worthless paper ? Surely they would be better off holding on to their real money..

Lachlan
Guest

William because their share holders and creditors demand paper/electronic profits. However there are many miners who keep their personal fortunes in metal.

Lachlan
Guest
Since year 2000 gold has increased in value in AUD terms by a multiple of approx 3.9 ….working on approximates $400 to $1550 (Jan 09) or say a 280% gain. So Aussie gold outperforms US gold to this point. Maybe the benefits of having a reserve currency (ie stronger than it should be against metal). Whats the USD going to look like post reserve status? Soon their will be little reason to prop it (or slow its devaluation). For interest/arguments sake I have calculated that to buy a $3,000 000 farm (my dream) in AUD gold you would need 81kg… Read more »
Lachlan
Guest

Re above: Latter calculations based on Au @ $1150 current price.

Pete
Guest
Biker Pete: “As a decent house in a good location costs a minimum of $380K to build (including land), we’d expect that to also be a base rate.” Land is the variable. What if land price halves? Gold production price factors in: – the costs of mining the gold, not something you can change without technological advances, and totally affected by depth of the mining – costs of processing the ore, totally affected by the grade of the deposit (or ‘vein’ or lode or whatever you want to call it), and is affected by cost of leeching or whatever method… Read more »
Biker Pete, Ottawa, Ontario, Canada
Guest
Biker Pete, Ottawa, Ontario, Canada
“…land prices…they vary based on demand. Demand is a huge variable.” Pete, 11/09/09 Thanks for your comments, Pete. Looking at land development costs over the years, with a view to entering that minefield (albeit on a small scale) we’ve been put off by the immense costs of development. At one stage, we calculated a gain of around $4K per block, certainly too little to warrant the expenditure and effort. I also appreciate that many older, deteriorating dwellings in sought-after locations may be overpriced. We’ve also steered away from that arena… for the reasons you’ve offered. While buyers are prepared to… Read more »
Justin
Guest

Yes Lachlan, I’ll be asking for my dividends from the gold mine, in gold!

Lachlan
Guest

Sure Biker wont mind the property diversion Pete.

My 3Mill worth gold (99.99) would weigh 81kg, but in terms of bulk…it would fit into a cube with sides barely exceeding 16cm. Think of two people trying to lift such a small object, and yet it still twice exceeds health and safety standards for each person.

Lachlan
Guest

Will they accomodate you Justin?

Ross
Guest

Today from Breakingviews.com
quote
Geithner exaggerates US government retreat

When is a lapsed guarantee really an extended guarantee? When the US Treasury secretary says Uncle Sam’s commitment to backstop money market funds is about to expire. The formal guarantees end next week. But it will be a while yet before the Feds let a big fund “break the buck”.

unquote

Lachlan
Guest
Sorry for incessant pro gold posts but Im stuck at home for a period until I have a new work vehicle. Pete I sold my property for a profit last year and put a substantial part of the profit into gold. My viewpoint was that (a) Currency/political instability unfolding (b)productive land best buy ( long term appreciation or survivalist strategies apply). However I cant afford that right now. However… (c) gold undervalued (d) property overvalued (devaluation or zero growth for a period likely) (e)money supply certain to expand with increasing reliance on deficit spending It follows then that if my… Read more »
Biker Pete, Ottawa, Ontario, Canada
Guest
Biker Pete, Ottawa, Ontario, Canada
From today’s NY Times, a year after the collapse of Lehman Bros: “Pay is already returning to precrash levels, topped by the 30,000 employees of Goldman Sachs, who are on track to earn an average of $700,000 this year.” Lachlan, the more things change, the more they stay the same… and the ‘location’ rule of property remains the Golden Rule. Your prediction: ” …property overvalued (devaluation or zero growth for a period likely)…” appears improbable, given the continuing ‘growth’ in prices in those areas with high employment and good prospects (if you’ll excuse the pun… .) I’ll concede that it’s… Read more »
Lachlan
Guest

What!
30,000 x 700,000 =210 Billion dollars….. oh wait, thats USD isnt it. Poor buggers ;)

Biker Pete, Ottawa, Ontario, Canada
Guest
Biker Pete, Ottawa, Ontario, Canada

Very good article on the ‘next page’ of the NYT:

http://www.nytimes.com/2009/09/12/your-money/mortgages/12money.html?em

Spells out the pros&cons of property for FHBs… an abridged ‘Property for Dummies’ if you like… . :)

The tax reference isn’t applicable (yet) but who knows* what The Henry Report may bring in November… ??!

* I sometimes wonder if Ned isn’t Ken himself…. . Seems pretty close to the pulse…!!! ;)

Bargeass
Guest

The sun is already setting on the US empire but unfortunately things will get much worse under our new black hearted chinese communist masters. Don’t be fooled or blinded by the trinket money they use to bribe because you will be on the losing end of the ledger. Try enforcing a contract, agreement or other legal obligation against a chinese communist.

John
Guest

Re: production cost of gold
I watched a 60 Minutes program last night where we were told that in the Congo miners are digging for gold with hand-held tools in very dangerous conditions, using mercury to dissolve the gold and then producing little nuggets to sell in town, all for a pittance. How many thousand times is that gold marked up, I wonder, when it is sold on the international market? We were urged not to buy gold from the Congo, but how would we know it is from the Congo?

Unpopular Truth
Guest

The USD is not based on anything tangible in the sense of a metal or bit of paper, but rather has been based around the threat of violence (which is very tangible, just ask the 2 nations they crushed in weeks in the last 8 years).

The promise of violence has worked wonders

NickW
Guest
As usual it is always about basics. What is money? It can of course be almost anything, specially printed bits of paper, lumps of metal or even cowrie shells but whatever it is it must be capable of fulfilling three functions. It functions as “A medium of exchange”. People must be prepared to accept it in exchange for goods or services. It functions as “A measurement of relative value” at any given time. In this function money acts as a weighting to decide the relative value of individual items of purchase – from a money point of view a diamond… Read more »
I TOLD YOU SO!
Guest

You’ll call me crazy but Maize is the way to go!! Those who knows world history specially when for the first time Europeans stepped on AMERICA SOIL, the INDIGENOUS PEOPLE used a currency known as MAIZE and not GOLD!! although the Europeans were puzzled by their thought procesing this becomes more likely to happen nowadays. Also check the BIBLE! it says so as well =>when the world no longer will value treasures and MAIZE will have a superior value! (not the exact words but the idea is the same)

Justin
Guest

Maize might be good but sugar is better!!!

I TOLD YOU SO!
Guest

You can make fun now of the concept I just postulated JUSTIN; but when
I get my sack of grains of maize and you have your gold and try to purchase some food from me
or someone else, I’m going to tell you to eat your gold because gold on its own has no “VALUE”.
It’s you and I who gives the value because of our sense of vanity. In fact if you set your mind on survival mode, then it’s
food and water what people will desire the most in times of crisis. AND BELIEVE ME “A CRISIS WE SHALL SEE”! (http://www.wnponline.org/wnp/wnp0712/)

Justin
Guest

No, no, I wasn’t making fun of the concept. I’m sure maize is potentially a currency in times of crisis.

Sugar however is a form of currency, NOW! It always has been. It has by far the largest open interest on the commodities futures exchanges, out of all the agricultural products.

It is one of the most hoardable, most marketable commodities.

Harry
Guest
The comment below is right. This is hard for people to understand. But since you can’t eat gold it has limited uses in a soon to be hungry world. “Comment by John Smith on 10 September 2009: I agree there needs to be controls on a fiat money system. But Gold is worthless / essentially useless metal. Backing a currency with it encourages economies to waste physical resources to actually find, produce and best of all store it in expensive vaults for no purpose (more so than they waste now). Whilst paper money is also worthless / useless at least… Read more »
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