A New Monetary System to Come. Will Gold Have a Role?


After raising the issue of a new global reserve currency and only finding some verbal support from France’s President Sarkozy, the issue of replacing the dollar with another or other currencies was put firmly on the table at the G-8 conference this week. The issue, while acknowledged, was not treated seriously, a major error on the part of the G-8 we believe!

The Reserve Currency crisis coming!

After raising the issue of a new global reserve currency and only finding some verbal support from France’s President Sarkozy the issue of replacing the dollar with another or other currencies was put firmly on the table at the G-8 conference this week. The issue, while acknowledged, was not treated seriously, we believe a major error on the part of the G-8!

China’s position was made clear, “To avoid the inherent deficiencies of using sovereign currencies for reserves, there's a need to create an international reserve currency that's delinked from sovereign nations," is the position of the People's Bank of China. The IMF should expand the functions of its unit of account, Special Drawing Rights it feels. The restatement of Governor Zhou Xiaochuan's proposal in March added great weight to the likelihood that China will diversify its currency reserves, the world's largest at dollar 2.0+ now. Zhou Xiaochuan sees the current international financial system as flawed, putting too much emphasis on the dollar as a reserve currency. They feel that the dollar should depreciate to address the global imbalance. But if this happens and because it’s a reserve currency it would give the rest of the world a monetary crisis too!

We are certain China will not wait for the West to accommodate their wishes but as you can see below will act in the short-term to adjust their own reserve policies for the benefit of China. With little cooperation from the West we can now look forward to the destabilization that attends global currency confrontation.

China, the biggest foreign holder of U.S. government, is already in the process of cutting its dollar holdings. In April it cut them by $4.4 billion to $763.5 billion in April, the first monthly reduction since February 2008. It is difficult for China to do this quickly, for such moves would cause the dollar to collapse, if seen as a departure from the U.S. dollar by the Chinese. The unhappiness with the dollar is not limited to China. Russia holds only Euros in its reserves now, in reaction to the dangers facing the dollar. Internationally, by the end of 2008 the dollar accounted for 64% of global central bank reserves, down from 73% in 2001, after the arrival of the € on the global monetary scene.

Dollar Problems

The U.S. dollar is being undermined by U.S. economic problems and its over-issuance by the Fed, despite comforting platitudes flowing from U.S. Monetary authorities over the last few years. The threats internal U.S. policies posed to the international monetary system are frightening. The virtually zero response from U.S. monetary authorities to international dollar problems has disturbed eastern central banks because the dollar holdings in the reserves of foreigners are huge and could well be diminished in value considerably in the years to come. It is also clear that the U.S. has a great deal to gain both from a depreciating dollar and from inflation, despite the impact on the U.S. economy. As a result confidence both in the U.S. economy and in the dollar has dropped considerably since the credit crunch impacted in August 2007. The problem is how to get away from the dollar’s grip without collapsing the global monetary system itself!

"The excessive reliance on the credit of several sovereign currencies has added to the risks and crises, the P.B.O.C. said adding, "A currency with stable value in the long term is required."

Actions Underway for Change

The biggest dollar reserve holders are taking small and uncertain steps already:

1. Russian President Dmitry Medvedev, Chinese President Hu Jintao, Indian Prime Minister Manmohan Singh and Brazilian President Luiz Inacio Lula da Silva called for a "more diversified" monetary system to reduce dependency on the U.S. dollar at a June 16th meeting.

2. In May, China and Brazil began studying a proposal to move away from the dollar and use Yuan and Reais to settle trade instead.

3. Group of 20 leaders on April 2 gave approval for the IMF to raise $250 billion by issuing Special Drawing Rights, or SDRs, the artificial currency that the agency uses to settle accounts among its member nations. It also agreed to put another $500 billion into the IMF's war chest.

4. This month, Russia and Brazil announced plans to buy $20 billion IMF bonds, while China said it is considering purchasing $50 billion.

5. IMF First Deputy Managing Director John Lipsky said on June 6th “it's possible to take the "revolutionary" step of making SDRs a reserve currency over time”. The U.S. and other developed nations will attempt to drag out such moves because this disturbs the present global balance of power.

S.D.R.’s in Place of Gold in the Seventies

Special Drawing Rights were created by the I.M.F. in 1969 to support the Bretton Woods exchange-rate system that collapsed in 1971 after the dollar was “floated” against gold. Gold sales followed thereafter, first from the U.S. [who saw few nations were convinced and snapped up the U.S. gold], then by the I.M.F. seen by many as an act in support of the dollar, which was rapidly moving to its position as the world’s reserve currency. The I.M.F. also saw that gold sales were a failure and stopped them. The discrediting of gold as money was part and parcel of these moves. It was hoped that the S.D.R. act as a currency, but few nations were willing to trust it, as the I.M.F. was considered [and still is to some extent] an arm of the U.S. Treasury. Now S.D.R.s act as a unit of account rather than a currency. The S.D.R. is issued against cash provided by each member and is then disbursed as S.D.R.’s in proportion to the money each member nation pays into the fund. China will be most keen to hand over its dollar reserves in exchange for S.D.R.’s and partially escape the collapse of the dollar that may happen then.

S.D.R.s and the Noughties

With no other globally linked organization available, the I.M.F. is the only one able to provide an alternative to the dollar through the S.D.R. A “basket of currencies” is the only sound way to counter the flaws in the dollar at present hence the push towards the S.D.R. The value of S.D.R.’s are based on a ‘basket of currencies’, shielding them from swings in any single currency [we foresee the Pound being dropped and the Yuan taking a major role in the basket as the U.S. dollar portion is considerably reduced over time]. One SDR is currently valued at $1.54. China is proposing the basket be broadened. The current weighting is: 44% for the U.S. dollar, 34% for the € and 11% each for the Yen and the Pound Sterling. It doesn't include the Yuan, yet. Neither does it include gold! The four currencies in the SDR, which must be convertible, are those issued by Fund members with the largest share of global trade. The weights assigned by the I.M.F. are based on the value of exports and the amount of reserves denominated in those currencies. The composition of the basket is reviewed every five years. The next review is due in 2010. We fully expect the Yuan to become a major constituent of this basket [20%+?]. Before then, it has to make the Yuan available freely for international trade at least. As the Chinese are already pressing for a change the implication is that they will be ready and happy to see this happen by then. 2009 and 2010 will therefore prove to be watershed years in the world’s monetary system. This has to mean a rising degree of currency volatility this year through next.

I.M.F. Rules to Change?

The I.M.F. itself will have to change its rules too. The U.S. 16.83% of votes and a need for 85% of votes to pass any resolution will have to change for the I.M.F. to be a truly international body. The U.S. will have to step back to a role of just another member or no S.D.R. role will be plausible. It is even possible that in time its headquarters will move away from U.S. shores? No national or nationally controlled currency will be allowed to rule the roost.

Is there to be a Role for Gold in the S.D.R.? Will China and Russia [and developed nations] want this?

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If this does happen, there will be a rising chance globally, that governments will attempt to confiscate locally owned gold! This may well not be restricted to the U.S.A.!

This is a snippet from a recent issue of the Gold Forecaster with Subscriber-only parts excluded. Gold Forecaster regularly covers all fundamental and Technical aspects of the gold price in the weekly newsletter. To subscribe, please visit www.GoldForecaster.com

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