THE DOLLAR AS THE RESERVE CURRENCY OF THE WORLD

May 13, 2010

THE DOLLAR AS THE RESERVE CURRENCY OF THE WORLD
In 1900, most of the world currencies were on the gold standard. Even the British “Pound Sterling” (meaning sterling silver) was defined as 0.25 ounces of gold. The U.S dollar and most currencies in the Americas and Europe were also defined as so many ounces of gold. At that time the US dollar was defined as 0.05 Troy ounces of gold ($20 per Troy ounce).
The gold standard meant that in theory, each dollar, pound, franc, and mark circulating as money substitutes: banknotes, checks, or bank balances, could be freely exchanged for the stated amount of gold. There was one little problem, however. There wasn’t enough gold reserve to redeem all these money substitutes in circulation. The world banking system and the gold standard, were based on fraud. This had already been standard banking practice for 300 years. This is called fractional reserve banking.
Nevertheless, the money substitutes could be redeemed freely, at least until gold reserves dropped enough to scare the banks and governments. Then governments would suspend payments, or re-define the money unit to a lesser weight of gold, or do something equally dishonest, to escape from their legal obligations. Anything a government does is, by definition, legal.
World War 1 (1914-1919), and World War 2 (1939-1946), were essentially European wars, although Japan and the USA were drawn into the fray in 1941. It all ended with most of Europe deeply in debt to the USA, essentially bankrupt, and most of the monetary gold from Europe was in Fort Knox- the U.S treasury.
After WW2, at the Breton Woods Conference, the monetary authorities of the countries involved worked out a sort of solution for the financial woes of Europe. They agreed that the U.S. dollar would be used as the reserve currency for all the European currencies. After all, all of the gold was in the USA to back the dollar, and the US dollar was the most stable and substantial currency in the world,
The dollar, then, became the most important and valuable currency in the world.
Since then, the supply of dollars has increased ten-fold. In the 1970s foreign countries, sensing the decline of the value of the dollar, started redeeming their dollars for gold. There was by then the age-old problem; there wasn’t enough gold to redeem them at their stated value, then 0.0286 Troy ounces of gold ($35 per ounce).
In desperation, we (the USA) reduced the value of the dollar by half to 0.0143 Troy ounces of gold ($70 per ounce). Dumping of dollars continued. So finally, in 1971 we stopped redeeming dollars for gold. We abandoned the gold standard altogether.
Yet the rest of the world continued to accept dollars in trade for goods and even to use the dollar as their reserve currency.
It may surprise you (It astounds me) that once a paper money system is established upon a commodity standard (such as a gold standard), it can continue to function even after the commodity (gold) is withdrawn. Yet it has happened many times in many countries. I would welcome a good explanation of that phenomenon.
So people everywhere are still willing and anxious to earn dollars, and essentially sell their goods cheaply to Americans. For 60 years Americans have been subsidized by foreign producers exporting goods to America. We have lived very well indeed at their expense.
The day of reckoning must come eventually. China and Japan, and many other countries, hold stacks of US government bonds. China, in particular, is essentially lending us the money (by buying US government bonds) to buy Chinese products and services so as to build up Chinese industry.
More recently, Chinese exports to other countries, and consumption of Chinese products by the Chinese people is now expanding rapidly. In time, China will become independent of the US market to support the growth of Chinese industry. They are already moving toward a basket of foreign currencies for their foreign reserves, as are many other countries worldwide.
I’m going to stick my neck out and make a prediction; within 10 years, a tipping point will be reached. People and banks and governments worldwide will start dumping dollars, devaluing the dollar to a fraction of its present value in foreign currencies. They will no longer subsidize American consumers.
We will no longer live like kings, subsidized by what we call “slave labor” abroad. Our living standards will drop shockingly. We will have to learn to get by without the gravy train that was the result of the Breton Woods agreement 60 years ago. And in time, our living standards will just be average for the civilized world. But the rest of the civilized world will be much richer than they are now.
We will then start rebuilding our own manufacturing and attain a more balanced economy. Perhaps we will move to a more free market economy. I hope so.

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