The same force that made the US dollar the world’s reserve currency is now working to dethrone it.
22 July 1944 marked the official conclusion of the Bretton Woods Conference in New Hampshire. There, 730 delegates from 44 nations met at the Mount Washington Hotel in the final days of the Second World War to devise a new international monetary system.
The delegates there were acutely aware that the failures of the international monetary system after the First World War had contributed to the outbreak of the Second World War. They were determined to create a more stable system that would avoid beggar-thy-neighbor currency wars, trade wars and other dysfunctions that could lead to shooting wars.
It was at Bretton Woods that the US dollar was officially designated the world’s leading reserve currency — a position that it still holds today. The Bretton Woods system pegged all major currencies to the dollar at a fixed exchange rate. The dollar itself was pegged to gold at the rate of US$35 per ounce. Indirectly, the other currencies had a fixed gold value because of their peg to the dollar.
Other currencies could devalue against the dollar, and therefore against gold, if they received permission from the International Monetary Fund (IMF). However, the dollar could not devalue, at least in theory. It was the keystone of the entire system — intended to be permanently anchored to gold.
In 1950, the US had about 20,000 tons of gold (imperial, not metric). By 1970, that amount had been reduced to about 9,000 tons. The 11,000-ton decline went to US trading partners, primarily Germany, France and Italy, who earned dollars and cashed them in for gold.
The UK pound sterling had previously held the dominant reserve currency role starting in 1816, following the end of the Napoleonic Wars and the official adoption of the gold standard by the UK. Many observers assume the 1944 Bretton Woods conference was the moment the US dollar replaced sterling as the world’s leading reserve currency. In fact, that replacement of sterling by the dollar as the world’s leading reserve currency was a process that took 30 years, from 1914 to 1944.
The real turning point was the period from July to November in 1914, when a financial panic caused by the start of the First World War led to the closures of the London and New York stock exchanges and a mad scramble around the world to obtain gold to meet financial obligations. At first, the United States was acutely short of gold. The New York Stock Exchange was closed so that Europeans could not sell US stocks and convert the dollar sales proceeds into gold.
But within a few months, massive US exports of cotton and other agricultural produce to the UK produced huge trade surpluses. Gold began to flow the other way, from Europe back to the US.
Wall Street banks began to underwrite massive war loans for the UK and France. By the end of the First World War, the US had emerged as a major creditor nation and a major gold power. The dollar’s percentage of total global reserves began to soar.
Finally, in 1939, England suspended gold shipments in order to fight the Second World War and the role of sterling as a reliable store of value was greatly diminished apart from the UK’s special trading zone of Australia, Canada and other Commonwealth nations. The 1944 Bretton Woods conference was merely recognition of a process of dollar reserve dominance that had started in 1914.
The significance of the process by which the dollar replaced sterling over a 30-year period has huge implications for you today. Slippage in the dollar’s role as the leading global reserve currency is not necessarily something that would happen overnight, but is more likely to be a slow, steady process…
It is equally obvious that a major creditor nation is emerging to challenge the US today just as the US emerged to challenge the UK in 1914. That power is China.
The US had massive gold inflows from 1914–1944. China has massive gold inflows today.
Officially, China reports that it has 1,054 metric tonnes of gold in its reserves. However, these figures were last updated in 2009, and China has acquired thousands of metric tonnes since without reporting these acquisitions to the IMF or World Gold Council.
Based on available data on imports and the output of Chinese mines, it is possible to estimate that actual Chinese government and private gold holdings exceed 8,500 metric tonnes, as you can see in the chart below.
Assuming half of this is government owned, with the other half in private hands, then the actual Chinese government gold position exceeds 4,250 metric tonnes, an increase of over 300%. Of course, these figures are only estimates, because China operates through secret channels and does not officially report its gold holdings except at rare intervals.
Source: Markets and Money US
Click to enlarge
China’s gold acquisition is not the result of a formal gold standard, but is happening through stealth acquisitions on the market. They’re using intelligence and military assets, covert operations and market manipulation. But the result is the same. Gold is flowing to China today, just as gold flowed to the US before Bretton Woods.
China is not alone in its efforts to achieve creditor status and to acquire gold…
Other countries, including BRICS members Brazil, India and South Africa, have joined Russia and China to build institutions that could replace the balance of payments lending of the International Monetary Fund (IMF) and the development lending of the World Bank. All of these countries are clear about their desire to break free of US dollar dominance.
Sterling faced a single rival in 1914, the US dollar. Today, the dollar faces a host of rivals — China, Russia, India, Brazil, South Africa, Iran and many others. In addition, there is the world super-money, the special drawing right (SDR), which I expect will also be used to diminish the role of the dollar. The US is playing into the hands of these rivals by running trade deficits, budget deficits and a huge external debt.
What are the implications for your portfolio? Once again, history is highly instructive…
Source: Markets and Money US
Click to enlarge
The index had a value of 5.1 in 1751. There were fluctuations due to the Napoleonic Wars and the First World War, but even as late as 1934, the index was at only 15.8, meaning that prices had only tripled in 185 years.
But once the sterling lost its lead reserve currency role to the dollar, inflation exploded. The index hit 757.3 by 2005.
In other words, during the 255 years of the index above, prices increased by 200% in the first 185 years while the sterling was the lead reserve currency…but went up 5,000% in the 70 years that followed.
Price stability seems to be the norm for money with reserve currency status — but once that status is lost, inflation is dominant.
The dollar’s decline is now being amplified by China’s emergence as a major creditor and gold power. Not to mention the actions of a new anti-dollar alliance consisting of the BRICS, Iran and others. If history is a guide, inflation in US and Australian dollar prices will come next.
In his 1925 poem The Hollow Men, T. S. Eliot writes:
‘This is the way the world ends / Not with a bang but a whimper.’
Those waiting for a sudden, spontaneous collapse of the dollar may be missing out on the dollar’s less dramatic, but equally important slow, steady decline.
The dollar collapse has already begun. The time to prepare is now.
Keep an eye on your inbox tomorrow, and we’ll show you how you can set yourself up to profit from these forces.
for Money Morning
James G. Rickards is the strategist for Strategic Intelligence, the newest newsletter from Port Phillip Publishing. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.