Rumors are flying that secret meetings are taking place between Arab states, China, Russia, Japan and France, to dump the dollar and replace the U.S. currency’s role in the pricing of oil. The dollar fell against the euro, yen and Swiss franc, while gold hit new highs of $1,041 an ounce.
Is there any truth to the rumors that the dollar is being replaced by a basket of foreign currencies, and what will be the impact your investments and the U.S. economy?
The fact is that this rumor has been making the rounds for years. It has been repeatedly denied by officials, but that doesn’t mean foreigners are happy with the falling dollar.
But facts are a stubborn thing: The dollar is still the world’s currency. Oil, gold and other commodities have to be conveniently priced in some currency, and the dollar has traditionally been the currency of choice for a variety of reasons: The United States remains by far the world’s largest economy and trading partner. It remains the only military superpower. And the Federal Reserve is the most powerful central bank.
The Treasury securities market is the world’s largest liquid market. Where else is China going to keep its foreign exchange reserves of $2.1 trillion? As of July 2009, foreigners owned the following amounts in U.S. Treasuries:
China $800.5 billion
Japan $724.5 billion
United Kingdom $220.0 billion
Caribbean Banks $193.2 billion
Oil Exporters $189.2 billion
Brazil $138.1 billion
(Source: the United States Treasury)
In short, the United States is the 800-pound gorilla, and will continue to be the principal investment vehicle for foreign reserves.
Now of course the Chinese and other foreign countries will make every effort to diversify their holdings into euros, yen, Swiss francs, and British pounds, as well as stockholding gold and other commodities.
That’s just prudent diversification.
And that’s what’s happening. Last week, the IMF reported that the dollar’s share of total reserves has fallen to its lowest level since 1995.
Despite all the talk of pricing oil in another currency, the dollar reigns supreme. Russia has been talking about doing a oil contract in Rubbles for years, but it hasn’t happened. The Arabs lost out to the New York Mercantile Exchange in the early 1980s in setting the price of crude. Crude oil is the world’s most actively traded commodity, and the NYMEX light sweet crude oil futures contract is the world’s most liquid form for crude oil trading, as well as the world’s largest-volume futures contract trading on a physical commodity, and the pricing is in dollars. So far, changing the pricing to a basket of foreign currencies has proven unworkable.
The biggest risk is a massive crash or run on the dollar, and that’s always conceivable if the Federal Reserve engages in reckless irresponsible monetary policy.
The dollar has fallen sharply this year, losing over 20% against the euro, but so far it’s been an orderly decline.
In order for the dollar to rally, the Fed needs to abandon its “zero” interest rate policy, the Obama administration needs to reign in its deficit spending, and the US economy needs to recover sharply from the Great Recession. So far neither event has happened.
Until these three events occur, it would be wise for investors to keep buying gold and silver, especially silver. Gold has hit new highs, but silver at $17 an ounce is still way below its all time high of $50 an ounce set in 1980.
(I recommend the major chapter on gold in my book, EconoPower: How a New Generation of Economists is Transforming the World (Wiley, 2008).)