Food and fuel costs exploded. Banks urged their customers to convert Austrian kronen into a more stable currency…even though it was against the law.
A law-abiding widow is wiped out on the day of a bank run. Her diary entry is reproduced in Adam Fergusson’s book When Money Dies…
“Why don’t you think the krone will recover again?” [I asked my banker.]
“Recover!” [he] said with a laugh… “just test the promise made on this 20 kronen note and try to get, say, 20 silver kronen in exchange.”
“Yes, but mine are government securities: Surely, there can’t be anything safer than that?”
“My dear lady, where is the state that guaranteed these securities to you? It is dead.”
We’ve recounted the tale before. We tell it again now for two reasons. First as a reminder that most of the imbalances that caused the Panic of 2008 remain woefully out of balance. But you already knew that.
There’s extra urgency to our telling now: The one ‘X factor’ the pundit class touts as the US dollar’s saviour? It might prove the dollar’s final undoing. Bank runs, capital controls, an effective default on the national debt — and all because of the ‘prosperity’ we’re enjoying now.
Our suspicions were first raised in January…when two ‘opposing’ politicos held hands and sang in sweet harmony about America’s energy boom.
‘Cheap natural gas is going to allow us to basically reshore manufacturing,’ says Chicago Mayor and former Obama chief of staff Rahm Emanuel. As a result, manufacturing will be ‘coming back in ways we can barely anticipate,’ says former Republican presidential contender Steve Forbes. Together they were on CNBC to pitch an event called the ‘Reinventing America Summit’.
Not that we disagree: It all sounds very familiar if you were following the ‘Re-Made in America’ thesis of our own Byron King more than two years ago. Then it was radical. Now it’s conventional wisdom.
Leave it to us to throw a cat among the pigeons: For as much prosperity as the US energy boom is creating now…it will ultimately set off the next major economic crisis. Indeed, it will tank the US dollar’s status as the world’s ‘reserve currency’ once and for all.
We say this knowing we court the wrath of conventional wisdom…
- ‘The U.S. shale oil revolution which has been quietly unfolding behind the scenes has now begun to exert a direct influence on foreign exchange markets — to the benefit of the U.S. dollar,’ says a report from UBS
- ‘Global reserve currency status allied with less dependence on foreign investors will boost the currency on a five-year view,’ says a strategist at Société Générale
- Because of ‘the technological advances that enable oil and gas to be extracted from shale,’ says fund manager David Donora at Threadneedle Investments, ‘the dollar will likely enjoy a period of sustained strength.’
Right. Until it doesn’t.
The very thing helping to prop up the US dollar now will ultimately kick out all those props and topple the greenback from its status as the world’s reserve currency. Not tomorrow or even next year. But the destination is set…and our arrival is certain. It won’t look exactly like Vienna in 1921…but it will feel just as awful.
So strap in: Some of the ground we’re about to cover might sound like old hat to you…but we promise you’ve never seen the dots connected in this way before.
US oil production averaged 7.5 million barrels per day during 2013. The increase over 2012 marked the biggest in US history. Indeed, it’s the fourth-biggest annual increase by any country ever…and Saudi Arabia holds the top three spots.
And it only gets better from here. The peak year for US crude production was 1970 — a little shy of 10 million barrels per day. As you see from the ‘Back to the Future’ chart, the US Energy Department projects the nation will once again equal that number by 2019.
In 2005 — only nine years ago — the United States imported 60% of its oil needs. By 2012, that number collapsed to 40%. Check out the chart nearby and you’ll see the percentage is set to shrink even more over the next quarter-century. And make a mental note — we’ll be coming back to this chart later.
As we go to press, a barrel of oil fetches $100, give or take. So every 1 million barrels per day of new supply means $100 million less imported oil every year. Lower import costs, a lower trade deficit, fewer dollars flowing overseas — great news for the dollar, huh? It’s all good, right?
Well, yes…except that now the entire structure that’s supported the global financial system for 40 years is starting to come unglued.
Since 1974, the world has run on ‘petrodollars’.
The petrodollar arose from the ashes of the Bretton Woods system after President Nixon cut the dollar’s last tie to gold in 1971.
In the immediate post-World War II years, Bretton Woods made the dollar the world’s reserve currency — the go-to currency for cross-border transactions. If you were a foreign government or central bank, the dollar was as good as gold — for every $35 you turned in to the US Treasury, you received one ounce of gold.
Chances are you know the rest of the story: Foreigners recognized Washington was printing too many dollars, the French wanted more gold than Washington was willing to give up and Nixon ‘closed the gold window’. But without gold, what would continue to cement the dollar’s position as the world’s reserve currency?
After the ‘oil shock’ of 1973—74, in which oil prices shot up from $3 a barrel to $12, Nixon’s Secretary of State Henry Kissinger got an idea and convinced the Saudi royal family to buy in.
The deal went like this: Saudi Arabia would price oil in U.S. dollars and use its clout to get other OPEC nations to do the same. In return, the U.S. government agreed to protect Saudi Arabia and its allies against foreign invaders and domestic rebellions.
The appeal for the House of Saud was obvious — the weight of the US military would keep the family’s 7,000 princes living in the style to which they’d become accustomed.
The appeal for Washington was more subtle — but no less important. Anyone who wanted to buy oil now needed dollars to do so. That meant perpetual demand for dollars and a cycle that goes like this…
Dollars used to buy oil are deposited in the banking system to support international lending by the major banks. That lending supports the purchase of American goods — everything from Boeing airplanes to Archer Daniels Midland corn. Oh, and US Treasury debt. Can’t forget that.
‘This gave the dollar a special place among world currencies, and in essence ‘backed’ the dollar with oil,’ explained Rep. Ron Paul in a prescient speech on the floor of the US House in 2006. ‘The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.’
Then came his forecast: ‘The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil, rather than dollars or euros.’
Strange as it might be to imagine…the great American energy boom is hastening that day’s arrival.
More to come…
for Markets and Money
Ed Note: The US Energy Boom Will End the Dollar’s World Reserve Status originally appeared in Markets and Money USA.
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