Gold and Silver Performed Just as Expected
With so much focus on inflation over the past several months, or worsening economic productivity, or mounting job losses in the tech sector, who would have thought that the most acute problems in our...
For nearly 80 years the US dollar has been the world’s reserve currency. That status was born out of victory in World War II, but was threatened only a few decades later as foreign nations began to redeem their dollars for gold, upsetting the international financial system and exposing how the US had taken advantage of the dollar’s status to create billions of unbacked dollars.
In response, President Nixon closed the gold window in 1971, ushering in a new era of floating fiat currencies. But rather than being the start of actual currency competition, the dollar still maintained its reserve currency status. The key to this has been the petrodollar system, a system that is now possibly on the verge of ending.
The petrodollar system is a system in which the dollar’s strength and status is directly tied to world oil markets. In exchange for providing Saudi Arabia and other key Arab oil producers with military hardware and helping keep their governments secure, those oil producers agreed to accept only US dollars when selling their oil.
Because of the vast worldwide demand for oil, that agreement fostered massive demand for dollars from around the world, guaranteeing a steady demand for the US dollar. This allowed the US to once again take advantage of the dollar’s reserve currency status to create trillions of dollars out of thin air. In essence, the US government has the distinct advantage of being able to export its own debt and inflation, something most governments can’t do. Here’s how it works.
One of the original deals the US had with Saudi Arabia required the Saudi government to recycle the proceeds of its oil sales into US Treasury bonds. So the Saudis would only accept dollars for oil sales. Foreign countries would exchange their currencies on world markets to get dollars, which would then be used to buy oil. The Saudis would then use the dollars they received to buy Treasuries (and eventually US weaponry, but that’s another story.)
How do Treasury bonds come into existence? The federal government has to run a budget deficit, i.e. it has to spend more money than it actually has. It issues Treasury bonds to cover the difference. And those bonds are now being propped up by Saudi petrodollars. In essence, the dollar’s continued dominance as the currency used in oil markets has allowed the US government to run its massive deficits for over half a century.
A similar situation existed with respect to China and Japan, with US consumers importing huge amounts of Chinese and Japanese goods. Chinese and Japanese exporters would receive dollars for their goods, convert those into their own currencies, and their governments would then use those dollars to buy US Treasury bonds.
All of this enabled the US government to continue running massive budget deficits, and all of it was enabled by the US dollar’s status as the world’s reserve currency. But just as the rest of the world got tired of the US creating dollars out of thin air in the 1960s and decided to start cashing in their dollars for gold, countries today are also getting tired of the status quo and are starting to push back on the dollar’s dominance.
Russia and China have been among the foremost nations attempting to reduce their reliance on the dollar, with both countries strengthening their ties, boosting their gold reserves, and trying to avoid both the US banking system and US-linked financial intermediaries. China is trying to internationalize the yuan, although it’s going to take some time to do so.
What is most concerning, however, is Saudi Arabia’s recent announcement that it might consider accepting other currencies besides the dollar in payment for oil. If major oil consumers are able to start using other currencies besides the dollar to pay for their oil, it could end up dethroning the dollar’s status as the world’s reserve currency. But what would replace the dollar?
The euro seems an unlikely choice, although it’s certainly possible. Nor do the ruble or the rupee seem like alternatives. The yuan is still not fully internationalized either. But the projection in some quarters is that some sort of gold-backed currency tradable on international markets could end up being the alternative that topples the dollar on oil markets.
Whether that would be Chinese alone or the result of a Russian-Chinese or BRICS consortium is still under speculation. But the fact that the Saudis are even floating the possibility of accepting non-dollar currencies has many fearing that the dollar’s best days are behind it.
So what, you may think. How does this affect me? Well, if international dollar demand drops as a result of Saudi Arabia and other major oil producers and exporters accepting non-dollar currencies, it would also result in fewer dollars flowing to the Middle East, and fewer dollars coming back to purchase Treasury bonds.
The government’s ability to finance trillion-dollar deficits each year would be called into question, and interest rates might have to rise in order for the government to finance its deficits. Or taxes might end up having to be raised to cover the shortfall, or perhaps a combination of both.
American citizens have lived large for decades, being the recipients of being the domestic users of the world’s most demanded currency. But if demand for that currency falls, it could have a domino effect.
Dollar-denominated debt of all types could find itself in less demand, both corporate debt as well as government debt. US stocks might also no longer be quite as in demand, as there wouldn’t be nearly as many dollars overseas since they wouldn’t be needed for oil transactions anymore. Just how far down the dollar’s demise as the world’s reserve currency could drive the US economy is conjecture at this point, but the results might not be pretty.
That’s why many people are starting to turn to gold to help diversify their portfolios and help protect themselves against the dollar’s demise. If the dollar’s replacement ends up being a gold-backed international currency, gold’s return to the international monetary system could end up being a boon for gold owners.
At the very least, owning an asset that is known for maintaining its purchasing power over the long run and for being a hedge against inflation can be a smart move any time there’s the possibility of economic turmoil or financial crisis. In the short term, with high inflation and the possibility of recession looking likelier, buying gold is certainly becoming more popular.
But the long term effects of owning gold shouldn’t be overlooked either. While the dollar won’t be replaced anytime soon, who’s to say that in 10-20 years it couldn’t face a significant challenge? And certainly within 30 years it’s not out of the question that the dollar could be on its way out.
Of course, everything could also come crashing down sooner than that. As they say about bankruptcies, they happen gradually, then all at once. Is it time for you to start thinking about owning gold to protect your hard-earned savings and investments? Call the experts at Goldco to learn more about how you can benefit from gold.
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