from Silver Doctors:
Here’s a jam packed analysis of the US dollar, from the birth of the dollar as the world reserve currency to the pressures the dollar faces today…
by Rick Mills via Streetwise Reports
Donald Trump will go down in history for many things, including a Justice Department investigation into U.S.-Russian collusion in the 2016 election, a guilty verdict for his former campaign chair, Paul Manafort, and a guilty plea by his personal lawyer, Michael Cohen, in relation to hush-money payments to women in violation of campaign finance laws. Then there was the Access Hollywood tape, the ban on Muslims, the implicit condoning of neo-Nazis, the plans to build a border wall to keep out illegal Mexicans, the separation of immigrant children from their parents (though some say that law was drafted under Obama), and Trump’s ban on global abortion funding to please the pro-life portion of his base. Could Trump’s legacy though be something few had ever predicted: The beginning of the end of the dollar?
On the economic front though, it appears that Trump is doing all the right things. The Dow was at its highest-ever level of 26,616.71 in January, just over a year after Trump took office. The U.S. dollar is strong, unemployment is at its lowest level in 20 years, the stock market is booming, and the Fed thinks things are going so well that it is ready to pass more interest rate hikes. Why has the U.S. dollar done well? Mostly because of high demand for U.S. Treasuries.
Read our Gold and the great stage of fools to learn more about why the dollar is so strong, at the expense of gold, but also why there are cracks in the U.S. economy.
Foreign investors purchased some $26 billion of T-bills in May, driven by fear of a trade war and the indecisive result of the Italian election. They were also attracted by higher bond yields, which hit a seven-year peak in May. The two largest Treasury holders, China and Japan, both increased their buying. Germany bought $12 billion more in April compared to March.
However Russia sold off 84% of its U.S. debt holdings between March and May, leaving just $14.9 billion in its U.S. reserve account. That compares to $102 billion in December 2017. (See graph below). The sell-off corresponded with tough U.S. sanctions imposed on Russian President Putin’s closest associates and Rusal, which produces 7% of the world’s aluminum.
The dumping of U.S. Treasuries by Russia caused barely a ripple among U.S. Treasury officials and politicians, who know that the country only holds about one-tenth of the T-bills owned by China, which has the most of any country, $1.2 trillion. But it begs the question, what would happen if China started selling U.S. Treasuries? The trade war with China is not going well and the evidence shows that China does not need the U.S. as much as it thinks. China is warming to Russia through energy deals and is buying Iranian oil despite U.S. sanctions. Its One Belt, One Road initiative is key to its plan to exert Chinese hegemony and create a trading bloc without the need to trade with its former enemies: the U.S. and Europe. Eventually China could stop buying U.S. Treasuries altogether.
How would that affect the U.S. dollar? And more significantly, how would the U.S. finance its $21.476 trillion debt if the anti-T-bill movement spread and the market for them dried up? Here we trace the origins of the dollar and its post-war pinnacle as the world’s reserve currency, to its current sickly state. Does the U.S. dollar deserve to be the reserve currency, or in the words of former French finance minister and future president Valéry Giscard d’Estaing, should it continue to enjoy its “exorbitant privilege”? We think not. This article will explain why.
Birth of the dollar as reserve currency
In July 1944, as Allied troops were racing across Normandy to liberate Paris, delegates from 44 nations met at Bretton Woods, New Hampshire, and agreed to “peg” their currencies to the U.S. dollar, the only currency strong enough to meet the rising demands for international currency transactions.
“At the closing banquet, the assembled delegates rose and sang ‘For He’s a Jolly Good Fellow.’ The fellow in question was John Maynard Keynes, leader of the British delegation and intellectual inspiration of the Bretton Woods design.” Robert Kuttner, Bretton Woods Revisited
What made the dollar so attractive to use as an international currency, the world’s reserve currency, was each U.S. dollar was based on 1/35th of an ounce of gold (35.20 U.S. dollars an ounce), and the gold was to be held in the U.S. Treasury.
There’s a lesson not learned that reverberates throughout monetary history: when government, any government, comes under financial pressure it cannot resist printing money and debasing its currency to pay for debts.
London Gold Pool
The US began to send larger and larger amounts of dollars overseas to fund its increasing trade deficits. The glut of U.S. dollars held abroad began to threaten U.S. gold reserves—remember U.S. dollars were redeemable for gold—and worldwide demand for gold was soaring. By the late 1950s U.S. gold reserves had began to dwindle rapidly.
“Nineteen fifty-eight marked the first year in which foreign central banks exercised their convertibility rights in significant amounts and returned their dollars for gold. U.S. gold reserves fell 10% from 20,312 metric tons to 18,290 that year, another 5% in 1959, and 9% in 1960.” John Paul Koning, Mises.org, The Losing Battle to Fix Gold at $35
In October of 1960 panic buying caused gold’s price to rise to over US$40 per ounce. A night-time emergency call was made by the U.S. Federal Reserve. The Bank of England was to immediately flood the gold market with enough supply to reduce and stabilize the price of gold. The U.S. had just made it abundantly clear that stopping the drain of its gold reserves, and the depreciation of its currency against gold, was a huge priority.
The US, the Bank of England and the central banks of West Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg then set up a gold sales consortium to prevent the market price of gold rising above US$35.20 per ounce.
This consortium was known as the London Gold Pool. Member banks were to provide a quota of gold into a central pool; the U.S. Federal Reserve would match their combined contributions ounce to ounce. This meant that the dollar would now be backed not only by the gold in Fort Knox but all the other pool members’ gold as well.
By early 1962, the Bank of England, the consortium’s buy/sell agent, through the London Gold Exchange, was buying gold on the dips and selling on the rise to cap its price. Until 1968 nearly 80% of newly mined gold passed through the London Gold Exchange, London being the world’s premier gold market. The London Gold Fix had been a daily morning ritual since September 1919—the 3 pm Gold Fix was introduced in 1968 to coincide with the opening of the U.S. markets.
Despite the Cuban Missile Crisis and escalating tensions between Moscow and the U.S., gold prices remained fairly stable; the London Gold Pool was a success.
End of the gold standard
With the Gulf of Tonkin incident in late 1964 and the acceleration of the Vietnam War in 1965, U.S. military spending exploded. This was compounded by President Lyndon B. Johnson’s Great Society project spending and not raising taxes.
By 1965 the London Gold Pool was selling more gold, suppressing the rise, than it was buying back on the increasingly fewer, and shallower, dips. Britain devalued the pound sterling in late 1967.
The ramping up, in early 1968, of the Vietnam War—because of the Tet offensive and President Johnson’s agreeing to General Westmoreland’s proposed troop surge—brought renewed pressure on the dollar.
Since Johnson refused to raise taxes to pay for the social welfare reforms undertaken earlier and the war in Vietnam, the U.S. was now running massive balance of payment deficits with the world.
In a little over a month London sold close to 20 times its usual amount of gold, over 1,000 tons. France dropped out of the pool to send its dollars back to the U.S.—for gold rather than Treasury debt.
Gold demand was skyrocketing. London sold 100 tons of gold in one day, 20 times the average. The consortium said “the London Gold Pool re-affirm their determination to support the pool at a fixed price of $35 per oz.”
Fed chairman William McChesney-Martin said the U.S. would defend the US$35 per ounce gold price “down to the last ingot.” Several planeloads of gold were emergency airlifted from the U.S. to London. Gold demand continued to escalate with the London Gold Pool selling 175 tons one day and the very next day selling an additional 225 tons.
This broke the back of the London Gold Pool. Members were tired of draining their countries’ gold reserves to pay for the U.S.’ Vietnam War and social reform policies. At the request of London Gold Pool members the Queen of England declared Friday, March 15 a bank holiday. The London gold market remained closed for two weeks and the London Gold Pool was disbanded.
Johnson was forced to reverse his decision to send hundreds of thousands more U.S. troops to crush the Vietnamese resistance—instead he opened up peace talks.
An official “two-tiered” price for gold was announced to the world—the official price of US$35.20 would remain for central banks dealings, the free market could find its own price.
“…there came the March 1968 run on gold, which led to the collapse of the London Gold Pool. The U.S. government and Federal Reserve System, seeking to stave off the complete collapse of the dollar-gold exchange standard, felt obliged to take deflationary measures. The fed funds rate, which on October 25, 1967, had fallen to as low as 2.00 percent, rose to 5.13 percent on March 15, 1968, the day the gold pool collapsed.
As the Federal Reserve System’s deflationary measures took effect, the fed funds rate rose to as high as 10.50 percent during the summer of 1969. Long-term interest rose too, if to a lesser extent. On September 6, 1967, the rate on U.S. government 10-year bonds fell to 5.20, still well above the level of around 4 percent that prevailed during the first half of the 1960s…
On December 29, 1969, the yield on the long-term government bond hit 8.05 percent. With interest rates, both long term and short term, at such high levels, the demand for gold bullion was finally broken, and the dollar price of gold fell to around $35 an ounce by 1970. For the moment, the dollar-gold exchange standard had been saved.” The Industrial Cycle and the Collapse of the Gold Pool in March 1968, critiqueofcrisistheory.wordpress.com
In February 1970 the closing gold price on the London market averaged US$34.99. On August 15, 1971, U.S. President Nixon ended the convertibility of the dollar into gold. With gold finally demonetized, the Fed and the world’s central banks were now free from having to defend their gold reserves and a fixed dollar price of gold. The era of Bretton Woods was over.
For more economic history, read our Demise of London Gold Pool ends Vietnam War.