Toward a New World Monetary Orderby David McAlvany
Can you imagine a world that has rejected the dollar? The rest of the world can. What if the U.S. dollar lost its monopoly status in world trade?
The sons of Issachar were notable for two things: 1) Understanding the times and 2) Knowing what Israel should do. In essence these men were described as perspicacious. Just as wisdom is a step beyond knowledge, perspicacity is a step beyond wisdom. It is the application of wisdom.
While these men were learned, they were also men of action. What a powerful combination. These were men who could make an appraisal of current circumstance and put in motion a plan of action informed by the times in which they lived.
As you read the context of 1 Chronicles 11 and 12, you’ll see the gathering of loyal warriors to support David as king. Others were described as being the equal on the battlefield of 100 or even 1,000 men. The sons of Issachar were thoughtful and strategic. Analysis paralysis would not have been a problem for them. Nor were they merely information junkies.
The segue to our current economic challenges is not as rough at it seems on the surface. Do you understand the times? What knowledge do you possess that informs your course of action?
In order that we might think clearly and plan strategically, we divide the world into three spheres 1) the moral/spiritual, 2) the social/political and 3) the monetary/economic. We turn our attention to the latter because so much is presently at stake, and in this sphere there are many grand delusions among believers and non-believers alike.
Can you imagine a world that has rejected the dollar? The rest of the world can. What if the U.S. dollar lost its monopoly status in world trade? As you read this, a number of our trade partners are assuming that this outcome is inevitable. The storyline has been many decades in the making, but is now accelerating rapidly. If you live in the U.S., trade internationally in U.S. dollars, or have the majority of your assets denominated in dollars, you should pay careful attention. The money system we’ve known is being turned upside down. Do you understand the issues at stake? Are you ready for the painful implications of change?
Even after the failure in the early ’70s of the post-WWII Bretton Woods agreement, the U.S. dollar has remained the de facto currency of the world. Under Bretton Woods, foreign currencies were fixed in relation to the dollar, and the dollar was fixed to gold at $35 per ounce. The monetary system had a few disciplines that were holdovers from the pre-WWI gold standard. The disciplines were critical for global acceptance and the shoring up of confidence.
President Nixon removed the primary pillar of stability (gold) from the Bretton Woods monetary system less than 30 years after that system began. By March of 1973, European countries started striking out on their own, with six of them tying their currencies together and “floating” them against the dollar. In a matter of 24 months, the world had lost gold as a monetary stabilizer and the U.S. dollar had lost a control relationship with other currencies that were no longer pegged to it.
This was the birthing process for our current floating monetary (non) system. Today there are no absolute measures of value in this floating system—only relative relationships. In spite of these changes, world trade centers now, as then, insist on the settling of invoices in U.S. dollars. This forces financial institutions all over the world to hold dollars on account to facilitate business. But even this practice is changing, creating considerable downside risk for the dollar—the foundation of nearly every American’s assets.
With no substitute to take its place, dollar dominance has been presumed by financial experts and money managers. How much longer can we assume that the dollar will keep its monopoly status? The rest of the world has grown agitated and begun to reengineer its financial markets for a post-dollar world. Trade agreements that eliminate the dollar as the intermediary currency have proliferated in recent years. The factors involved in this monetary sea change are: 1) the rise of the euro, 2) the growth of emerging market players, and 3) the shift in behavior among some of our primary creditors. In concert, these factors portend a new global monetary system.
The European Union as a quasi-political and economic project was envisioned in the 1950s and ’60s, and finally emerged in the ’80s under the influence of Jacques Delors and a number of other European socialists. The monetary unit we call the euro was launched in 1999. After an initial bout of weakness, it climbed 30–40% as it gained in global acceptance (I well remember the appreciation in personally held euro-denominated German bonds).
Since its launch, the currency has been bought as a reserve asset by central banks all over the world. It now comprises 24% of all central bank holdings.
This development has progressed at the expense of the dollar, and has coincided with a 30% decline in the U.S. dollar’s purchasing power. In spite of the obstacles to, if not impossibility of, political and fiscal union, the European monetary unit has marched ahead with considerable stability and global support. The world is in search of dollar alternatives and is not being easily dissuaded from its choice of the euro as a viable alternative—the first in decades. Thus, we have a pivotal shift away from U.S. dollars by the central banks of the world.
Emerging markets have enjoyed considerable economic progress over the past 30 years. As the West has over-consumed, the rest of the world has over-produced, providing the goods we desire at cheaper and cheaper cost. Over several decades, this abundance of consumer goods has grown the bank accounts of emerging market entrepreneurs and governments via an increase in trade. The IMF now estimates that emerging markets will overtake advanced economies as a percentage of global GDP this year!
Why is this critical? The rest of the world has a more forceful presence than ever before. On a collective basis, the emerging markets are independently creating more efficient ways of trading with each other, including the direct settlement of transactions and invoices without U.S. dollars. The modern world is gaining autonomy from the U.S. that it hasn’t known in the post-WWII era.
This marginalizes the U.S. dollar, both as a reserve asset for central bankers and as a currency used for free trade settlement. In short, we have the makings of a currency coup d’état.
China figures into the equation on several counts. Not only have we witnessed the meteoric rise of the Chinese economy since Deng Xiaoping’s reforms in the late 1970s, we’ve also seen China become our number one creditor. China has our paper (U.S. Treasuries that it has purchased), Japan holds our paper, and the Middle East holds our paper—(strangely, the Federal Reserve is now an enormous holder of Treasury IOUs).
Our dependency on these creditors is critical. Not only must they remain content with current holdings of Treasuries, but we need them to continue purchasing to fund our budget deficit. Note that January Treasury data (TIC report) shows China liquidating close to $50 billion in Treasuries. That is a problem that will push the dollar lower and raise interest rates. The Japanese are now running trade deficits and lack the surplus dollars to purchase Treasuries.
And lastly, we have a decline in U.S. demand for Middle East oil as new fields have been exploited in North America. Our Middle East Treasury buyers are consequently receiving fewer petro dollars that can be fed back into the dollar recycling-Treasury purchasing pipeline.
From this evidence, we conclude that the monetary system we’ve lived with since the ’70s is rapidly falling apart. The dollar is vulnerable to rapid devaluation, and the Treasury market may be subject to a rapid rise in rates. The implications are very straightforward.
With a currency in decline, the price of goods and services moves up and potentially out of reach for the average consumer.
Not only is devaluation harmful to consumers, leading to a tremendous amount of civil unrest and social decay, but investors and savers are equally in harm’s way. Dollar-denominated assets, which may include bank deposits, stocks, bonds, and real estate, can dramatically drop in value. We witnessed Argentine assets selling for pennies on the dollar in 2001 during that nation’s currency crisis, and the process is repeating as I write.
The U.S. is very different than Argentina, but one of the critical distinctions between us—the U.S. dollar being the reserve currency of the world—is being dismantled in real time. It would not surprise us to witness an entire generation of U.S. savers wiped out over the next three to five years.
King David asks, “If the foundations be destroyed, what will the righteous do?” This represents a challenge to our generation and to those of like mind with the sons of Issachar. Not only must we appraise the times in which we live, but we must know what to do. I would encourage you to think strategically and act decisively.
The Lord commands us to “be strong and courageous.” To do so, we must step beyond knowledge and wisdom to strategic and wise action.
David McAlvany was a featured speaker at our recent Strategic Perspectives conference. His presentation, “Can America Endure the Coming Years?” is available on DVD. If you’d like more information, see David’s website at www.mcalvany.com.