The Greenback, as good as gold?



Roshan Madawela – Research Intelligence Unit – www.riunit.com



Short history

Historically, gold and silver coins have been in use since pre-Christian times. During the reign of Caliph Umar (AD 632) the gold dinar was used throughout the Islamic world and continued circulation until the fall of the Ottoman Empire in 1924. In the twentieth century, there has been a gradual shift away from gold and gold backed currency which culminated in its final abandonment when the Bretton Woods system collapsed in the 1970s.

Up until 1971 the dollar was fully convertible to gold for any foreign government. Dr. Krassimir Petrov from the American University in Bulgaria says that by August 1971 the US government had defaulted on its payments when foreigners demanded payment for their dollars in gold. The popular ‘spin’ at the time claimed that the US government was severing its link with gold but the reality was closer to an act of bankruptcy.

Essentially, Dr. Petrov shows that the gigantic hordes of goods the US imported from the rest of the world with printed money was un-threatened by a world that was powerless to assert it’s self with any meaning. Moreover, before the world could recover from being ‘bamboozled’, a policy to rationalize the holding of a depreciating dollar was being secured with the use of ‘black gold’.

Washington entered into an ironclad agreement with Saudi Arabia to support the House of Saud in return for accepting only US dollars for its oil. Subsequently, other Gulf States and the rest of OPEC followed to secure the dollar with a monopoly position in any oil transaction. With the spread of these interlocking agreements and the world’s growing thirst for more and more oil, the global demand for dollars only rose.

The view point is supported by recent history that proves how if any single nation dared to demand any other forms of payment for oil, it was dealt with either politically of militarily. In 2000, Iraq decided to shun away from the dollar under its UN oil for food program and switch to Euro as its oil exporting currency. A decisive military strike followed swiftly and with little time lost, the dollar was restored as Iraq’s oil export currency.

Today some 70 per cent of the world’s oil is denominated in dollars with even Russia using the greenback for oil transactions until last year. This is the status quo that the Whitehouse is fighting to maintain as it allows the leadership a free hand in expanding the public budget. It is the most significant factor as to why the US Federal Reserve was able to raise money supply last year by a massive 15 per cent. Conversely, a massive current account deficit of some $800 billion per annum has prevented hyperinflation as the Asian giants together with the oil exporters soak up the US debt.

Bush’s plans for 2007-2008 include an unprecedented $700 billion for foreign wars. The fact that he can raise such funds sans the conventional means of doing so via export growth, tax increases and / or economic expansion is a testament to the power of the petro-dollar. By forcing foreign central banks to hold increasing reserves of the dollar, he can shift the US debt on to trading partners in foreign lands. According to sources at The International Forecaster, US debt was up 10.1 per cent to 4.085 trillion last year and now accounts for over 58.8 per cent of total 2006 globally issued credit.

Bubble economics

Commentators have long argued that the recent US equity bubble that spurred the continuation of artificially low interest rates and a reckless expansion of the money supply has served to further deteriorate the income and wealth disparities in the US. The recent phenomenon has effectively shifted billions of dollars from the poor to the rich and if it continues unabated, may even threaten democracy in the long run.

Internationally, each and every time the dollar is traded, a check is drawn against an account that is overdrawn by $8.6 trillion, the estimated size of the US national debt. Mike Whiteny describes it as the biggest swindle in history. He argues that the only reason why the world continues to engage in dollar denominated trade is due to the glutinous US consumerism that is commonly referred to as the engine of global growth, sucking in exports from all corners of the globe.

The US love for consumer spending is unparalleled and the world marvels at its obsession with electronic gadgetry and craving for the latest fashions and other consumer goods according to Whiteny. The shopping mall is at the center of the US consumer culture that drives the economy. Consumer spending is estimated to account for 70 per cent of GDP. However, recent data indicates that the US consumer’s pockets are thinning out under the strain of personal debt. The AP reported that US saving are at the lowest rate since the Great Depression. The Commerce Department has confirmed this, reporting that the nation’s personal savings rate for 2006 was a negative one per cent, the worst in 73 years.

Skyrocketing credit card debt is also another feature of the phenomenon that analysts say is an indication that home owners are no longer able to leverage easy money from their home equity. Moreover, rumblings of a real estate crash in parts of the continent have served to reduce the mortgage value of many properties. Last year an estimated $825 billion worth of loans were extracted from real estate equity. The signs are that the housing bubble is on a downward roll.

Real Estate, traditionally a driving force of the US economy is also weakening at multifarious rates across the states. Some sources estimate the a decline of 3.6 per cent during January in sales of new homes. According to Standard & Poor’s Case-Shiller price index, the value of US homes dipped 0.7 per cent during the fourth quarter of 2006, the lowest rate since 1992.

Breeze of change

With the writing on the wall for the US economy, how can the world at large safeguard their own economic interest sans facing the ire of US military might. Outright rebellion with regard to dollar abandonment has resulted in the severest of consequences as the recent experience of Iraq bares witness.

However, if rebellion is not on, quite transition is nevertheless taking place as more and more central banks start to diversify into the euro or a mixed basket at the expense of the greenback. Analysts note that the central banks around the world are now watching for any further signs of cracks in US consumer confidence and other critical parameters. As soon as that happens, bank managers everywhere will swing into action, ditch their U.S. dollars and head for the exits. As one commentator put it, “when the global engine sputters to a halt; it could be curtains for the greenback.’

During the recent Davos World Economic Forum meeting in Switzerland, Malaysian Prime Minister Ahmad Badawi said in an interview that his country had shifted $82 billion of currency reserves away from the dollar as measure to protect Malaysian exporters. Malaysia un-pegged from the dollar in July 2005 and switched to an undisclosed basket of currencies. The ringgit has gained 0.7 per cent on the dollar this year and is the world second best performing currency next to Iceland. The Malaysian Central Bank has on occasion declined to comment on the issue of diversification of currencies and foreign exchange policy. In the recent interview, the Prim Minister also admitted that they have cut their dollar holding and will watch the situation in order to take further measures as required.

He is not alone. Kuwait’s Finance Minister has also said this year that the Arab state, the world’s third largest oil producer, may abandon the dinar’s peg against the dollar in favor of a basket of currencies. This follows similar statements made by other Gulf states who have been increasingly disillusioned by US foreign policy that has spilled over to sour economic relations with the GCC. The Dubai Ports World deal failure is a case in point. Others also complain of the additional hassle’s involved in travel when dealing with US firms.

A Royal Bank of Scotland survey showing that 19 of 47 Central Banks surveyed cut their share of dollar reserves and 21 have raised their holdings of euros. A recent survey by the Central Banks Publications also showed that the euro made small gains as a reserve currency at the dollars expense during the fourth quarter of 2006. The survey also found that gold will reassert it’s self as a reserve asset. Of the 47 central banks surveyed, 21 claimed to have raised their share of Euro and 15 had done so at the expense of the dollar.

Currency markets

The currency revolution will not be televised, it will be fought out in the markets. End of February witnessed a new two month low in the US dollar against the Euro as analysts speculated on the dawning of a state-wide housing slump following the release of fresh data. Further, the greenback weakened against 13 of the world’s 16 most active currencies amidst speculation of a lower growth forecast for the fourth quarter. The U.S. currency has dropped six percent against the euro in the past year.

In London the dollar is trading at $2.02 against the UK pound and has moved from $1.3184 per Euro earlier this year to $1.37 and is expected to fall further in 2007 due to key financial parameters. For instance, the Federal Reserve’s target overnight lending rate between banks of 5.25 per cent is 1.75 per cent higher than the European Central Bank’s rate whilst the yield premium that investors earn on ten year US Treasuries compared with similar maturity German bonds reached 0.613 per cent, chipping-away at the comparative lure of the US as a low risk high yield destination.

However, some traders believe that the dollar is not likely to free-fall due to vested interests that will intervene in order to protect options. It is expected that buying will be triggered at around $1.32 per euro thereby serving to stem the decline. Options give holders the right to buy or sell a currency at a set price at a fixed future date. Furthermore, the dollar is likely to strengthen by up to four per cent against the Japanese yen by mid-year due to the expectation that Japan’s Central Bank will not raise rates before the fourth quarter, according to sources at the world’s largest currency trader, Deutsch Bank AG.





Main sources: Information Clearing House, Asia Times, Lanka Business Online, The Research Intelligence Unit, Associated Press, Bloomberg, BBC.