The True Gold Standard (Second Edition)
The U.S dollar is shrinking as a percentage of the world's currency supply, raising concerns that the greenback is about to see its long run as the world's premier denomination come to an end.
When compared to its peers, the dollar has drifted to a 15-year low, according to the International Monetary Fund, indicating that more countries are willing to use other currencies to do business.
While the American currency still reigns supreme -- it constitutes $3.72 trillion, or 62 percent, of the $6 trillion in allocated foreign exchange holdings by the world's central banks -- the Japanese yen, Swiss franc and what the IMF classifies as "other currencies" such as the Chinese yuan are gaining.
"Generally speaking, it is not believed by the vast majority that the American dollar will be overthrown," Dick Bove, vice president of equity research at Rafferty Capital Markets, said in a note. "But it will be, and this defrocking may occur in as short a period as five to 10 years."
Bove uses several metrics to make his point, focusing on the dollar as a percentage of total world money supply.That total has plunged from nearly 90 percent in 1952 to closer to 15 percent now. He also notes that the Chinese yuan, the yen and the euro each have a greater share of that total.
Faced with a stubbornly slow and uneven global economic recovery, more countries are likely to resort to cutting the value of their currencies in order to gain a competitive edge.
Japan has set the stage for a potential global currency war, announcing plans to create money and buy bonds as the government of Prime Minister Shinzo Abe looks to stimulate the moribund growth pace. (Read More: Japan PM Says BOJ Must Set 2% Medium-Term Inflation Goal)
Economists in turn are expecting others to follow that lead, setting off a battle that would benefit those that get out of the gate quickest but likely hamper the nascent global recovery and the relatively robust stock market.
While respective countries would have their own versions, the moves would follow three years of aggressive bond buying from the Federal Reserve as part of its $3 trillion quantitative easing program.
Though critics worry about the long-term consequences, the three rounds of QE have managed to keep the U.S. economy afloat and have boosted risk assets such as stocks and commodities.
"Ever since the Fed launched QE2 in August 2010, we have been in the currency-war regime," said Alessio de Longis, portfolio manager of the Oppenheimer Currency Opportunities Fund. "It will continue to be this."
In a late-2012 announcement, outgoing Bank of Japan leader Masaaki Shirakawa indicated an aggressive easing program that would total 50 trillion yen over the next year or so.
A German federal court has said that country’s central bank should conduct annual audits and physically inspect its gold reserves worldwide, including gold in the custody of the Federal Reserve Bank of New York. In addition to the FRBNY, Bundesbank gold is stored in London, Paris and Frankfurt.
For decades, the Bundesbank has relied on written confirmation of its gold holdings in London, Paris and New York. According to the report from the German audit court, the last time Bundesbank officials physically inspected the central banks gold holdings was, well, never.
(It should be stated that the folks at FT Alphaville quote a report saying an inspection took place in 1979/1980.)
Interestingly enough, the Bundesbank is apparently quite happy with taking the word of other central bankers about the existence, location and size of its gold reserves. It put out the word that it disagrees with the Audit Court, which only has advisory power and cannot force the Bundesbank to follow its recommendations, about the need for inspections. Nonetheless, the Bundesbank is actually going to follow the recommendation that it verify the gold stocks. It also has plans to ship some 150 tons of gold back to Germany for a more “thorough examination.”
Bretton Woods is a resort in the mountains of New Hampshire that was made famous by a series of meetings of world leaders and economists in 1944.
Nine months before the last of Hitler’s V-2 rockets struck Britain, 730 delegates from the 44 Allied Nations congregated in Bretton Woods to create a new world order, including a monetary system that could resolve the festering economic consequences of the First World War and the Great Depression.
Under the Bretton Woods Agreement, which lasted from 1944-1971, the world’s currencies would be pegged to the U.S. dollar and central banks would be able to exchange their dollars for gold at a set price of $35 per ounce. It was this arrangement that firmly established the U.S. dollar as the global reserve currency. During the early years of Bretton Woods, member states achieved increasing economic cooperation.
The trouble with the system was that global central banks had pegged their currencies at low levels to support exports to the U.S. This led to the accumulation of massive dollar reserves in the hands of foreign central banks. These dollars were used to buy interest-bearing U.S. Treasuries. This structural imbalance created problems that would ultimately compromise the existence of Bretton Woods. Today, global central banks are once again managing the exchange values of their currencies relative to the dollar to ensure export competitiveness
For the first time since the age of Reagan, the Republican Party is considering the gold standard. The platform adopted last week at the GOP convention includes a plank in favor of a commission to study the way back to a fixed value for the dollar. Such a commission would jumpstart a national debate on monetary reform, something needed now more than ever. But instead of participating in this, critics have objected with myth after myth about the gold standard.
Here are four of the most popular:
Myth 1: The gold standard leaves no discretion in the economy over the money supply.
This is a common refrain from Federal Reserve officials, including Chairman Ben Bernanke. The truth is that the gold standard does not make the money supply static; it simply shifts control over it from the central bank to the people. When the economy demands more money, people exchange gold for new dollars; when it needs less, they redeem excess dollars for gold. This is the market-guided alternative to the system we have now where the Fed controls the money supply through market intervention based on its interpretation of the economy.