Gold and the Demise of the Dollar
The days of the dollar as a reserve currency are numbered — and gold could be the biggest beneficiary of its demise.
Since the U.S. separated from the gold standard, the two assets have traded in a powerful inverse correlation: As the dollar sinks, gold pushes up, and vice versa.
Now, changing geopolitical tides are threatening to topple the dollar’s global dominance and send the yellow metal to new highs.
💸 Soaring U.S. Debt
“I am not worried about the deficit. It is big enough to take care of itself.”Ronald Reagan, joke at the Gridiron Club annual dinner, March 24, 1984
Common sense dictates that you can’t borrow money forever, but the U.S. is certainly trying.
The suspension of the gold standard and the status of the dollar as the world’s reserve currency has helped America to borrow cheaply from the rest of the world for decades and live well beyond its means by simply printing money to meet obligations. But as the dollar is not backed by physical gold, it represents only a promise of the government to accept it for payment. And with national debt ballooning beyond $23 trillion, it is becoming increasingly doubtful that the U.S. is actually capable of paying any debts.
Economists are divided over whether this debt is harmless, or a dangerous burden on the country, but the implications for the dollar could be catastrophic.
By simply printing money to inflate its way out of debt, the U.S. is devaluing the purchasing power of the dollar and effectively digging straight into the pockets of citizens with cash savings.
And as the recent tidal wave of economic stimulus shows, every new pandemic and global disaster can be an excuse to turn on the money printer…
🛢️The Dying Petrodollar
“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. The sooner the better.”Former U.S. Representative Ron Paul to Congress, 2006
The petrodollar is so rarely discussed that most think it is a myth, but a group of Wall Street analysts strongly believe that the dollar derives most of its value from a complex geopolitical structure based on black gold — Oil.
This has its roots in a deal struck between Saudi Arabia and the United States in 1973 that agreed all oil purchased from Saudi Arabia was to be denominated in dollars. In return, the U.S. offered protection of Saudi oil fields from neighboring nations.
The idea caught on, and by 1975 all OPEC countries were pricing oil in dollars in exchange for military protection.
This cunning power grab pinned the value of the dollar on the key commodity powering civilization, creating consistent demand for U.S. dollars around the globe and putting the U.S. in the enviable position of being able to buy oil with a currency it can print at will.
But today, the petrodollar is under threat.
Iran began pricing oil exports in euros in 2003, and other U.S. adversaries including Venezuela, China and North Korea have also moved off the Petrodollar. At the same time, demand for oil is waning as renewable energy sources like wind and solar become more viable.
Without the need to hold the currency to buy oil, foreign nations could turn around and return a massive amount of dollars to America — leading to unprecedented inflationary pressure.
💴 The Rise of the Yuan
“Ultimately, we will have reserve currencies other than the US dollar.”Bank of England Governor Mark Carney, January 2019
As escalating debt and the fall of the petrodollar chip away at the dollar’s dominance, China has been boosting the international circulation of its own currency.
In 2016, the IMF decided to include the yuan in the basket of currencies that make up the Special Drawing Right, an alternative reserve asset to the dollar. Since then, more central banks have shown an interest in increasing their foreign reserves of Chinese yuan.
And with the digital yuan expected to launch in 2020, China could outpace the dollar through technological innovation.
Analysts expect China to ask countries involved in its quasi-colonial One Belt One Road Initiative to pay for services in the new digital currency, which would create demand for the yuan in countries from Kazakhstan to Italy.
While this doesn’t mean the yuan is likely to displace the greenback in the near future, it could put the two currencies on a more equal footing.
💵 A slow bleed, not a sudden collapse
Just as the Roman denarius was eventually debased and pound sterling was toppled in 1945, dominant global currencies come and go.
Some collapse suddenly—like in Venezuela, Argentina and Zimbabwe where citizens stopped believing in the local currency almost overnight—and others are subject to a slow loss of faith, like the decline of sterling which stretched from the end of WWI to Harold Wilson’s devaluation in 1967.
As central banks hoard gold at unprecedented rates, many analysts suggest we are already in the early stages of the collapse of the dollar.
And when it comes, the implications are likely to be far-reaching, plunging other currencies into turmoil; causing interest rates to rise; and sparking inflation.
But those same headwinds pushing the dollar down are likely to be tailwinds for gold.
Gold’s inverse relationship with the dollar makes it a perfect hedge against loss of value, and the metal is likely to retain value long after the dollar has become just a memory.
Through the changing tides of civilization and every crisis imaginable, physical gold has persisted as the ultimate form of wealth insurance.