Divorcing the Dollar and Marrying Gold
By Michael S. Rozeff
October 8th, 2009
With their money and banking system having presented them with a case of system failure by disintegrating before their eyes and taking the economy with it, America's economic experts who support and run the FED's central banking-inconvertible paper dollar system cannot place the blame for this where it belongs, which is on the system itself, its supporters, and those who make its policies. They cannot bring themselves to diagnose the system's ills and rectify them because they are at the center of them. They cannot stare the failure of inconvertible paper money squarely in the face and move to eliminate it. If they did, they'd be out of jobs and out of power.
American central bankers, manned by expert economists, have in vain dealt with the crumbling banking system and dollar by manufacturing massive new credits infused into the players with the most leverage and the weakest balance sheets. In the not-too-distant future, this promises to unleash a second and greater credit debacle that may unravel the entire system and bring down the government with it.
A good many foreign central bankers are no better at the inflation game than the FED, as they too have presided over banks swollen with overpriced real estate and other loans. Many of these central banks, sharing the aversion to non-income-producing gold, have elected to hold U.S. Treasury securities as assets and to issue their individual currencies against these assets, thereby producing a derivative currency whose value depends on the value of U.S. Treasuries and the dollar in which they are denominated.
Suppose a foreign central bank holds U.S. t-bills as its main asset. Against this it issues its main liability, which is its own currency. Now suppose that the U.S. dollar falls in value by depreciating against gold. The reserve asset, t-bills, is now worth less against gold. Hence, its currency must be worth less against gold too.
Suppose that the central bank held ruble bills, and Russia drove the ruble to much lower worth, then the bank's derivative currency would also fall in worth. But this might not happen right away because the people who use the currency cannot redeem it in anything of value. People will continue to use the overvalued currency as money for a period, until they recognize that it has no backing. At that point, they will attempt to rid themselves of their low-worth currency. They will shift to currencies, goods, and assets, such as gold, that have known values. Prices in terms of the low-worth currency will rise.
Foreign central banks have often ignored or sold off gold. The central banking experts have not understood the central position of gold as a reserve asset of unquestioned liquidity, acceptability, and value. Instead they have fallen into the trap of holding securities as reserves. They have taken on a counterparty risk that gold does not present, that counterparty being the central bank that issues the currency in which the securities are denominated. For what happens to the values of these foreign currencies when these securities held as assets decline in value, which they do when the dollar declines against gold? Since these dollar assets stand behind the foreign currencies, these currencies must also decline in value against gold. U.S. inflation in this way, through central bank holdings of U.S. securities as reserve assets, is exported to the world.
The fateful step away from gold occurred on August 15, 1971 when President Nixon closed the gold window and stopped redeeming the claims of foreign central banks in gold. Now, 38 years later, some of these banks are in the most halting fashion taking steps to get off their self-chosen hook, which is the connection of their currencies to a watered-down dollar whose own link to gold grows weaker with every FED purchase of mortgage-backed securities.
If one or more foreign central bankers, such as those in China, Russia, Brazil, and the Middle East, have finally decided that they no longer wish to accept dollars that are inconvertible into gold, they have no choice but to establish their monetary systems with gold as a reserve asset. Press reports suggest that they do not yet acknowledge such a move in the full totality of its meaning or in their own actions. We read of replacing the dollar by the SDRs of the IMF. We read of replacing the dollar by a basket of currencies, such as the yen, the euro, and the yuan. These are less-than-halfway measures and they cannot succeed in producing a sound and stable international monetary system.
Replacing one currency that is inconvertible into gold with a mix of several other currencies that are also inconvertible into gold won't produce sound currencies and sound banking systems. The central bankers want freedom from the dollar and FED slavery. This they have made clear, but they still want to maintain the discretion to inflate their own currencies. The statements of central bank experts and officials do not remotely acknowledge that they wish to produce a fully gold-based system.
Their actions, however, can only go in one direction: toward holding more gold as a reserve asset. There is no other way to sever the link to the dollar. If securities denominated in yen, yuan, and euro become major reserve assets, what is to stop the respective central banks that produce these currencies from inflating them? Only if they hold gold in a respectable proportion to their currency liabilities (at least 40 to 50 percent) can a degree of stability in exchange rates be produced. Foreign central banks cannot obtain a final divorce from the dollar without marrying gold. If they seek the mistress of a basket of currencies that is not firmly linked to gold, they substitute one unstable partner for another.
Intellectual experts turn dangerous when they acquire a degree of unchecked power. Central bankers have this now, and they are dangerous now. They are not anxious to give up this power. Divorce from the dollar is a means of acquiring more power. This will not solve the people's problem, which is to have a stable money and a stable banking system, not unless the system moves toward gold as the reserve asset.
The last thing that an expert with a high degree of unchecked power wants to do is publically admit deep error on his part or that of the system of which he is a part. This is tantamount to admitting his responsibility to the public. It means that his power is in some degree not unchecked but conditional on public approval and confirmation. It means that his expertise is questionable and/or the system of expert rule is itself questionable. The rightness of one's power does not inspire confidence when one admits that one is continually misusing it.
One cannot expect Ben Bernanke or Alan Greenspan to defrock themselves as priests of the order of central bankers. What they do in the face of difficulties for which they are responsible is blame someone or something else. They obfuscate and cloud the issues. They use complex language. They fabricate stories and make up history so as to extract benefit from their own errors. They paint themselves as essential saviors for any problems that have arisen. According to their self-promotion, they are working tirelessly to come up with remedies for these unforeseen problems. They are quick to devise and advertise new solutions. These always involve the further use of even more experts, not to mention themselves. Their remedies always involve more power to the experts, never less, except as a tactical maneuver. Nevertheless, the day is approaching when these experts will be forced into a position of uttering a syllable that they now are reluctant to acknowledge. That syllable is - GOLD.
On the first day of 1975, gold became legal for U.S. citizens to own. This was an enormously important step toward reinstating gold as a reserve asset. As foreign central banks move out of dollars into currencies with greater gold backing than the U.S. dollar, and as people in their own wisdom move out of U.S. Treasury securities and into gold, for the sake of safety and wealth preservation, the gold window closed by Nixon will be, for all practical purposes, reopened.
It is of the utmost importance that the private market in gold be kept open so that its discipline, brought about by those who seek gold out, can act, albeit indirectly, upon the FED and the other central banks. Stressing the economic importance of having this market open does not mean that I now see a substantial risk of the market for gold being closed to U.S. citizens. I do not. There is some risk, however. Desperate officials can take desperate actions in desperate circumstances. I can imagine scenarios in which powerful experts and officials blame a rise in the price of gold for inflation that they have caused or in which they take action against gold because of severe economic problems that they have brought about. Such moves would, in conjunction with other such controls, tend to isolate the U.S. from the world economy, which would drastically undermine the U.S. economy. I certainly hope that nothing like this transpires, and I don't think it's the most likely possibility. I believe that, rather than going the way of Argentina, currency reform is a more likely outcome if the economic problems mount up to an unmanageable level.
© 2009 Michael S. Rozeff - is a retired Professor of Finance living in East Amherst, New York.
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