Tuesday, September 15, 2009

U.S. Dollar in Trouble—Worse Ahead!

Even amid widespread talk that the recession is ending, ominous developments have been taking place on the monetary front, which are rarely reported. I explained the background for this in my 3-part series “Mortgage Crisis, the Dollar and its Future”, which I recommend you read if you have not already done so. It covers: 1) how inflation, recessions and depressions are caused by the government monetary policies; 2) the mechanism by which the Federal Reserve creates inflation; 3) specific government policies that created the bubble in the housing/mortgage industry; 4) why gold is essential as the basis of the monetary system; and 5) the extent to which the dollar's status as the world's reserve currency is imperiled, and how steps are inexorably being taken throughout the world toward returning to gold as a store of value.

What I predicted in that series of articles is now taking place. In July, French President Nicolas Sarkozy joined Russia, China and other emerging-market countries in calling for an end to the dollar's reign as the primary international currency of reference. Less than two weeks ago, he said the world “cannot count upon only one currency.” A new United Nations report last week endorsed moving away from the central role of the dollar in the world monetary system.

Last week the dollar fell to its lowest level against the euro since September 2008. It declined far more against some less prominent currencies. It has fallen 21% against Brazil's currency, 17.5% against the Australian dollar, and 14.9% against the Norwegian krone. It has also been declining, though less severely, against the six major currencies that comprise the InterContinental Exchange's U.S. dollar index.

China—which had not bought gold since 2003—has now turned to buying gold. Its gold reserves increased 76 percent so far this year as it bought 600 metric tonnes, according to the International Monetary Fund. Spokesman Cheng Siwei said Beijing is dismayed by the Fed's recourse to easy credit. He said China fears U.S. printing of money will lead to inflation and a hard fall of the dollar. A drastic decline in the dollar would seriously reduce the value of China's holdings. “Most of our foreign reserves are in U.S. bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,” said Siwei. “Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets.”

In addition to buying gold, euros and yen, the People's Bank of China called two months ago for a new international reserve currency based on Special Drawing Rights. SDRs were created in the 1960s based on a basket of major currencies. They were intended to serve as a shared currency for international reserves, but that didn't occur. Now they are used mainly in the IMF's accounting for its transactions with member nations. The difficulty is that they can't be used for transactions in the real world. When the IMF allocates SDRs, recipient countries exchange them at local central banks for local currencies, to be used to buy real assets and facilitate trade. That inflates the money supply of the country receiving the SDRs. Thus SDRs are just another way of creating a paper “asset” without an increase in real wealth. In other words, inflation. So that is not a satisfactory solution and merely leads back to gold again as the only real solution.

China is not the only buyer of U.S. bonds, though it is a very big. The Japanese are big buyers of U.S. debt, and many small Asian countries, taken together, buy a large amount. American institutional investors, e.g., insurance companies and pension funds, are big buyers; but 44% of U.S. Treasury debt is held by foreigners.

We are spending—and plan to continue spending—as much as we like for as long as we like, with the rest of the world funding our profligacy by buying our government's bonds. The creditor nations already own trillions of dollars, and the fear is that if they don't continually roll over our debt to keep the circus going, the dollar and the monetary system will collapse. Thus the creditor nations are stuck in a situation where, essentially, they can't use their bond money for anything but rolling over our debt. They will not put up with that situation indefinitely—especially as it continues to worsen—with our government undertaking spending plans that will result in trillion dollar deficits ten or twenty years from now. Nor will the U.S. citizens of the next generation be willing to undergo the ever-increasing costs of inflation and taxation for the benefit of the dead who lived beyond their means, courtesy of the politicians who promoted this intergenerational theft. The end will come as the dollar is dethroned, ending the inflationary binge, and the world turns increasingly to gold.

A decade ago members of the International Monetary Fund agreed to reduce their gold holdings in an orderly manner in the belief that these weren't needed because monetary paper was an adequate substitute. The IMF engaged in periodic gold sales, and a sale of another 403 tons of gold is already planned and may occur in the next year or two. China has already said it is willing to buy the entire 403 tons and—get this—has said it is willing to buy the entire 3,217 tons held by the IMF! The IMF has the third largest gold holding in the world, with the U.S. being first and Germany second.

Even central banks that agreed a decade ago to a series of gold sales are viewing the metal in a new light. France, the largest seller, says it will sell no more gold. The Austrian central bank said in a recent report that the rise in gold prices and “the concomitant depreciation of the U.S. dollar over the past few years have shown clearly how important gold is as an instrument for a central bank.” Germany's Bundesbank, the world's second largest official holder of gold with 3,417 tons (66.3% of its reserves) has indicated it is now more willing to hold and buy gold. The second quarter of 2009 was the first quarter since 1987 that central banks bought more gold than they sold.

In the first quarter, Russia's gold holdings rose by 29.8 percent, to 523.7 tons, raising to 4% the percentage of its reserves in gold. Then it bought 18.7 tons of gold in June and July and has now bought gold every month for over a year. Alexei Ulyukayev, first deputy chairman of the Bank of Russia said the bank intends to continue buying and increasing the percentage of its reserves in gold. Ecuador's gold holdings more than doubled in the first quarter, to 54.7 tons, and gold as a percentage of foreign reserves rose to 32%, from 9.8%. Venezuela's gold holding rose to 363.9 tons, to 36% from 23%. So small countries are buying gold too, and the percentage of their assets in the metal is in many cases higher than that of the larger countries. They want to stay ahead of the game and can buy in small amounts without driving the price up sharply in world markets.

Private investors, including small ones, are doing the same thing. The recent spike of gold above $1000 per ounce does not evidence a “footprint” of active buying by the Chinese, according to industry sources. Instead, it seems to be a reaction to weakness of the dollar and fears of future inflation, resulting in widespread interest in such things as gold ETFs (exchange traded funds), as well as traditional gold oriented investments. A new gold-oriented ETF is scheduled to open this week, marking the third such fund in the U.S. SPDR Gold Shares (formerly StreetTRACKSGoldShares), the largest ETF gold fund in the world, owns approximately $35 billion of gold, which is more than many nations have in their reserves. According to the World Gold Council, there are 163,000 metric tons of gold in human hands, with 51% in jewelry and 12% in industrial applications such as electronics and dentistry. Private investments account for 16%, while most of the rest is held by central banks.

Allan Greenspan, before he became chairman of the Federal Reserve, once wrote: “The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit....In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, government would have to make its holding illegal, as was done in the case of gold. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.”

It is to protect themselves that people around the world are now turning to gold rather than dollars and other paper currencies. The reign of the dollar will come to an end as the dollar is discredited by the colossal infusion of credit into the world monetary system resulting from the colossal spending the Obama Administration has heaped upon the excessive spending of previous administrations.

In my book MAKERS AND TAKERS, I wrote, “Inflation is a means of transferring wealth form the creditors to the debtors. And who is the biggest debtor of all? The federal government, of course. By acquiring anything it wants through its own debts, the government transfers purchasing power to itself from the people, whose money depreciates proportionally.

“The reason men of force loathe gold is that it is the perfect defense against inflation. It is the bastion which must be overcome if the invasion of monetary value is to succeed. But there is more at stake in the battle than material wealth. Gold represents value uncontrolled by government; it permits men to achieve economic self-determination, to live freely and independently, to work and save and use their wealth for themselves. Gold is the fortress defending every man's right to live his life for its own sake. It is this fortress which must be annihilated if men are to be forced to serve the government and made dependent upon it.”

The great economist Ludwig von Mises once said that sound money, such as gold, is as important to human freedom as constitutions and bills of rights. It is no coincidence that government monetary management, wealth redistribution, and welfarism which are destroying the value of the dollar are at the same time destroying the safeguards which the Founding Fathers built into the Constitution—as protections against government! The intent of the Founders is no longer honored as the Constitution has been “interpreted” to mean whatever the politicians and the courts want it to mean—not what the Founders intended it to mean. The result has been an expansion of the role of the federal government and a concomitant growth in federal debt and the loss of individual freedom. President Obama has said he will not nominate to the Supreme Court people such as Justices Antonin Scalia and Clarence Thomas, who are noted for interpreting the Constitution according to original intent. Thus the outlook for individual rights and liberty in America is pointing downward along with the future of the U.S. dollar.

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