Today we’re at the end of another major era.
Let’s call it the ‘Columbian’ era – as in the Christopher Columbus era, where white European people can sail across the world and go places, do things and impose their will, whether they’re Spanish, Dutch, French, British, Danish, or whatever.
Of course, for the last 65 years of this period, America has been at the top. And what has kept America on top is the simple fact that the US dollar is the world’s reserve currency.
How did we get here? Let’s take a step back to World War I…
A Quick Tour of History
The British pound was pretty much the accepted currency all through the 19th century, you know since probably the Napoleonic Wars at least.
Then, World War I knocked the British on their tail in terms of spending lots of money and national prestige and kind of a European civil war, just a civil war in the sense that white Christian nations were fighting each other, even though they spoke different languages, had different culture, etc.
So in the historical sense you had the British pound linger on, but after World War I the US dollar was suddenly looking good, too.
Now fast forward to 1945. We were the victorious power after WWII, we had the monopoly on atom bombs, we had B-29 bombers to deliver them, we had a navy that crossed the whole world, our industrial base was uniquely intact, we had lots of money, and lots of gold in Fort Knox.
The rest of the world was blown up, destroyed or completely undeveloped. For instance, back then if you looked at the Middle East, it was just desert. If you looked at Latin America, it was predominantly an area of trees, jungles and mountains.
The US was on top and everyone accepted it.
Today, we’re nearing the end of that era. Where now there is real competition between, as Niall Ferguson puts it, ‘the West and the rest’. The rest of the world has decided that they like Western science, Western medicine, and certain aspects of Western business and accounting methods.
They don’t necessarily like Western culture. They’re not enamoured with democracy, with Hollywood; with the drug culture and the TV violence and Madonna and Lady Gaga kind of stuff. They don’t need that part of us, but they do like the science and the medicine and the technology and as they adopt these things the gap between the West and the rest is getting narrower and narrower.
Enter China
Okay, now if you are China, you are 1.3 billion people strong, you are highly nationalistic, and you have a very, very, very long historical memory of everything, every slight, every insult that China and the Chinese people have ever suffered going back 1,000 years. Naturally, you think strategically because all of your smart kids grow up reading Sun-tzu and talk about this stuff.
So if you are the Chinese and you’re looking at this world and you see yourself as a rising power, a power in ascendancy: now what?
Okay, we had the pound, we have the dollar, now what do we have? Is the world going to be run by Russian rubles? Not really. Russia can be run by Russian rubles, perhaps, but the system behind it is too weak to support the world’s reserve currency. How about the euro? Well, Europe speaks for itself. It’s a disaster.
Every day we wake up ready to read the EU’s obituary. It won’t be a Latin American currency that dominates the world. What, the Brazilian real? I doubt it. No African currencies, no Middle Eastern currencies.
So what’s left? The Chinese renminbi? Do you want the yuan to be the world’s reserve currency?
Well, think like a Chinese. If you’re China do you want to have your currency be the world’s reserve currency? It’s tempting, very tempting, but the Chinese are cautious people. So in terms of what system is out there, what would the Chinese like to use? All of this is prefatory to the point I want to make.
The New Global Currency Market
What the Chinese seem to like are these things called special drawing rights, or SDRs, created by the International Monetary Fund in 1969. Special drawing rights are basically a basket of monies, plural: the dollar, the euro, the yen, and the pound sterling.
One thing that hasn’t been part of an SDR in 40 years is gold, but international regulators are set to upgrade gold to what’s called a Tier 1 banking asset; gold will back bonds and loans and depending on the rules, be a basis for fractional banking.
Now in a sense it’s back to the future, because the world relied on the gold standard until the 20th century when they went off it to finance modern wars and stuff.
So anyhow, the IMF’s next major revision of the SDRs is scheduled for 2015, so if you are China – indeed, think like a Chinese – what are you doing for the next two years? You are accumulating as much gold as you possibly can in the Middle Kingdom, as many tons as you can import and mine.
You’re not bragging about it. You’ll publicly report the absolute minimum amount of information that you’re required to under international treaties and obligations. You’ll even go as far as to boldly deny any large accumulation. You’re not going to tell the world that you’re buying gold because then everybody will bid the price up and it’ll cost you more.
You’re going to buy as much gold as you can so that in 2015 when the IMF revises the SDR basket for accounting purposes, you can say, ‘We’ve got ‘XX’ thousand tons of gold, and by default or by de facto our Chinese currency is the strongest currency in the world.’
The yuan won’t be the reserve currency, but a major component of the SDR. And the SDR will now be the backing of the world’s reserve currency – along with a gold component that could come sooner than later.
By 2015 the global monetary system as we know it will be very different. The US, Europe, China will have the three dominant paper currencies in the SDR, and, more importantly everybody’s going be looking at everybody else’s gold holdings.
More tomorrow….
Byron King
Contributing Editor, Money Morning
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