Russia and the Return of the Gold Standard
The #1 Reason to Own Gold
Wednesday, August 13th, 2014
Based on the events in Ukraine, the U.S. and a number of European countries are imposing further sanctions against Russia, supposedly for the Russian government’s support of Ukrainian insurgents.
And while the U.S. government is not explicitly citing the downing of the commercial plane over Ukraine as part of its official reason for the sanctions, it is still implied — despite a lack of evidence that Russia was involved in any way.
As a result, many believe the further sanctions are threatening a move away from the U.S. dollar as the world’s reserve currency.
Few are suggesting that the U.S. dollar will lose its reserve currency status anytime soon, however, and I believe this is correct. It will happen slowly over time, with more countries choosing not to use the dollar as a middleman.
Russian Revenge?
Some might see a move away from the dollar as Putin and Russian officials seeking revenge. This may be correct, and it would certainly seem logical that Putin would want some revenge against Obama and U.S. officials.
But there is a larger point here: Even if Putin is not trying to seek revenge at all, the sanctions will still likely result in a move away from the use of U.S. dollars, even if marginally. Russian officials are really left with no other choice.
In other words, U.S. politicians are shooting themselves in the foot. U.S. politicians and U.S. consumers both benefit in the short run from having the world use dollars.
Consumers benefit through subsidized prices. It makes consumer goods cheaper than they otherwise would be.
Politicians benefit because they can get away with more inflation and more deficit spending, particularly in the short run. When you have the central banks of China and Japan buying trillions in U.S. Treasuries, the federal government is able to spend more money without interest rates going up as far or as fast as they might otherwise.
So while U.S. politicians are posturing, trying to appear to take a strong stand against Putin, they are actually going to hurt themselves in the long run. If other countries start trading less with dollars and also slow down purchases of U.S. government debt, then the game of low interest rates and massive deficits may not last as long as they think it can.
Mercantilist Mindset
While I think the dollar will be used less in the future, I don’t see it happening suddenly, unless the Asian central bankers get some kind of a free market education in economics.
I have read stories about how the Chinese are going to slow their use of dollars and stop buying U.S. Treasuries. But this has not been the case at all.
The Chinese central bank continues to roll over the maturing debt it holds and has even recently added to its holdings.
As long as China and Japan each have over $1 trillion in holdings of U.S. government debt, I can’t take these stories seriously.
This is a mercantilist mindset, and it is somewhat Keynesian. Chinese and Japanese officials think they have to buy U.S. government debt so their currencies don’t appreciate against the U.S. dollar.
After all, they believe currency appreciation might hurt their export sector.
They may be right on this point in the short run. Unfortunately, they are missing a major piece of the puzzle in that depreciating their own currencies only hurts consumers — or just about everyone living in the country. It makes consumer goods and services more expensive and less available.
The Chinese and Japanese could put an end to dollar dominance in a very short amount of time by simply announcing that they will not worry if their currencies appreciate against the dollar or any other currency, so they will stop inflating and buying U.S. government debt.
But the mercantilists will not do this. They either don’t understand economics or simply don’t care.
Therefore, the dollar may remain as the reserve currency for a while longer — just because all the other major currencies are just as bad or worse.
Other Alternatives?
There are other alternatives to a U.S. dollar reserve currency that don't require another currency to take its place.
Since 2001, it is reported that the dollar’s share of global reserves has shrunk from 72% to under 61%.
This does not mean another currency is gaining traction against the dollar. It just means that in today’s global world, more people and governments are realizing they don’t necessarily have to deal with U.S. dollars for their trade, particularly if the trade doesn’t involve the United States.
This realization may become clearer with the latest round of sanctions against Russia. If Russia wants to sell natural gas to or import food from another country, then there is no reason to use U.S. dollars. The buying and selling can be done with rubles or any other currency.
If one of the parties really wants U.S. dollars, they can always do business with Russia and then convert the currency. This takes a matter of seconds in our world today, as long as the currency is freely floating and can easily be traded on an open exchange.
I believe more and more people are going to realize that all fiat currencies are trouble. You simply can’t trust individuals in power with a grand monopoly over the money supply. It is a race to the bottom between all of the major economic powers of the world, each trying to depreciate their currency faster than the next.
This may eventually pave the way for gold to become relevant once again in world trade.
Gold has mostly been irrelevant since 1971, when the U.S. finally reneged on its promise to convert U.S. dollars into gold for foreign countries. Nixon put a final end to the international gold standard, which was almost inevitable at that point.
In terms of economics and finance, since 1971, gold has only been used by a minority of investors to hedge against inflation and global turmoil. It has barely been used at all in international trade.
But gold is still held by the major central banks, even if it is a relatively small amount in comparison to the amount of fiat money they have created out of thin air.
I believe we will see a return to something of a gold standard eventually. It may take time for this to develop.
But when it finally replaces the dollar, many more people will wish they had invested in gold.
Until next time,
Geoffrey Pike for Energy and Capital