Gold and the end of dollar hegemony, part II

METALS COMMENTARY

The following is the second of three parts of a speech delivered to the U.S. House of Representatives on Feb. 15, 2006. We printed the first part in our Feb. 24-March 2/06 issue.

In recent years, central banks and various financial institutions, all with vested interests in maintaining a workable fiat dollar standard, were not secretive about selling and loaning large amounts of gold to the market, even while decreasing gold prices raised serious questions about the wisdom of such a policy. They never admitted to gold price fixing, but the evidence is abundant that they believed if the gold price fell, it would convey a sense of confidence to the market — confidence that they, indeed, had achieved amazing success in turning paper into gold.

Increasing gold prices historically are viewed as an indicator of distrust in paper currency. This recent effort was not a whole lot different than the U.S. Treasury selling gold at US$35 per oz. in the 1960s, in an attempt to convince the world the dollar was sound and as good as gold. Even during the Depression, one of President Roosevelt’s first acts was to remove free market gold pricing as an indication of a flawed monetary system by making it illegal for American citizens to own gold. Economic law eventually limited that effort, as it did in the early 1970s when our Treasury and the International Monetary Fund (IMF) tried to fix the price of gold by dumping tons into the market. It was an attempt to dampen the enthusiasm of those seeking a safe haven from a falling dollar after gold ownership was legalized again.

Once again the effort between 1980 and 2000 to fool the market as to the true value of the dollar proved unsuccessful. In the past five years, the dollar has been devalued in terms of gold by more than 50%. You just can’t fool all the people all the time, even with the power of the mighty printing press and money creating system of the Federal Reserve.

Even with all the shortcomings of the fiat monetary system, dollar influence thrived. The results seemed beneficial, but gross distortions built into the system remained. And true to form, Washington politicians are only too anxious to solve the problems cropping up with window dressing, while failing to understand and deal with the underlying flawed policy. Protectionism, fixing exchange rates, punitive tariffs, politically motivated sanctions, corporate subsidies, international trade management, price controls, interest rate and wage controls, super-nationalist sentiments, threats of force, and even war are resorted to — all to solve the problems artificially created by deeply flawed monetary and economic systems.

Long-run threat

In the short run, the issuer of a fiat reserve currency can accrue great economic benefits. In the long run, it poses a threat to the country issuing the world currency. In this case, that’s the United States. As long as foreign countries take our dollars in return for real goods, we come out ahead. This is a benefit many in Congress fail to recognize, as they bash China for maintaining a positive trade balance with us. But this leads to a loss of manufacturing jobs to overseas markets, as we become more dependent on others. Foreign countries accumulate our dollars due to their high savings rates, and graciously loan them back to us at low interest rates to finance our excessive consumption.

It sounds like a great deal for everyone, except the time will come when our dollars — due to their depreciation — will be received less enthusiastically or may even be rejected by foreign countries. That could create a whole new ballgame and force us to pay a price for living beyond our means and our production. The shift in sentiment regarding the dollar has already started, but the worst is yet to come.

The agreement with OPEC in the 1970s to price oil in dollars has provided tremendous artificial strength to the dollar as the pre-eminent reserve currency. This has created a universal demand for the dollar, and soaks up the huge number of new dollars generated each year. Last year alone M3 increased over US$700 billion.

The artificial demand for our dollar, along with our military might, places us in the unique position to “rule” the world without productive work or savings, and without limits on consumer spending or deficits. The problem is, it can’t last.

Inflation is raising its ugly head, and the NASDAQ bubble — generated by easy money — has burst. The housing bubble, likewise created, is deflating. Gold prices have doubled, and federal spending is out of sight with zero political will to rein it in. The trade deficit last year was over US$728 billion. A US$2-trillion war is raging, and plans are being laid to expand the war into Iran and possibly Syria. The only restraining force will be the world’s rejection of the dollar. It’s bound to come and create conditions worse than 1979-1980, which required 21% interest rates to correct. But everything possible will be done to protect the dollar in the meantime. We have a shared interest with those who hold our dollars to keep the whole charade going.

Alan Greenspan, in his first speech after leaving the Fed, said that gold prices were up because of concern about terrorism, and not because of monetary concerns or because he created too many dollars during his tenure. Gold has to be discredited and the dollar propped up. Even when the dollar comes under serious attack by market forces, the central banks and the IMF surely will do everything conceivable to soak up the dollars in hope of restoring stability. Eventually they will fail.

Most importantly, the dollar/oil relationship has to be maintained to keep the dollar a pre-eminent currency. Any attack on this relationship will be forcefully challenged — as it already has been.

Euros for oil

In November 2000, Saddam Hussein demanded euros for his oil. His arrogance was a threat to the dollar — his lack of military might was never a threat. At the first cabinet meeting with the new administration in 2001, Treasury Secretary Paul O’Neill said the major topic was how to get rid of Saddam Hussein — though there was no evidence whatsoever that he posed a threat to us. This deep concern with Saddam Hussein surprised and shocked O’Neill.

It now is common knowledge that the immediate reaction of the administration after 9/11 revolved around how they could connect Saddam Hussein to the attacks, to justify an invasion and the overthrow of his government. Even without evidence of any connection to 9/11, or of weapons of mass destruction, public and congressional support was generated through distortions and flat out misrepresentation of the facts.

There was no public talk of removing Saddam Hussein because of his attack on the integrity of the dollar as a reserve currency by selling oil in euros. Many believe this was the real reason for our obsession with Iraq. I doubt it was the only reason, but it may well have played a significant role in our motivation to wage war. Within a very short period after the military victory, all Iraqi oil sales were carried out in dollars; the euro was abandoned.

In 2001, Venezuela’s ambassador to Russia spoke of Venezuela switching to the euro for all its oil sales. Within a year, there was a coup attempt against Venezuelan president Hugo Chavez, reportedly with assistance from our Central Intelligence Agency.

After these attempts to nudge the euro toward replacing the dollar as the world’s reserve currency were met with resistance, the sharp fall of the dollar against the euro was reversed. These events may have played a significant role in maintaining dollar dominance.

It’s become clear the U.S. administration was sympathetic to those who plotted the overthrow of Chavez, and was embarrassed by its failure. The fact that Chavez was democratically elected had little influence on which side we supported.