August 19, 2017 05:52 am CDT
Gold is Back!
By Geoffrey Pike, Wealth Daily

According to some, there was a turning point in American dominance this past week.

The Asian Infrastructure Investment Bank (AIIB) has officially taken off, with most Asian countries and other major countries joining, even to the surprise of Chinese officials.

The U.S., Japan, and Canada are not participants in the new bank, which was originally proposed by the government of China. It was alleged that the U.S. government attempted to keep Australia and South Korea from joining as founding members, but both countries ended up applying. Even Israel ended up submitting an application by the deadline to become a founding member.

While the purpose of the bank is to provide capital to finance infrastructure projects in the Asian region, it has not stopped many European countries or even Brazil from applying to join. It has also fueled speculation that this is an attempt by many to take the U.S. dollar off the center global stage.

Former U.S. Treasury Secretary Larry Summers has come out with an article stating that “this past month may be remembered as the moment the United States lost its role as the underwriter of the global economic system.” He mentions other events of the last century, such as in 1971 when Nixon ended the dollar’s international convertibility into gold and the Bretton Woods agreement near the end of World War II.

Summers was a top candidate for heading up the Federal Reserve, but Janet Yellen beat him out for the job. Perhaps Summers would have been better than Yellen, but we can be sure he would not have released such an article if he were currently head of the central bank.

In other words, he is an Establishment guy, and while his piece breaks ranks a little in that it is somewhat critical of U.S. policies, his solutions are still mostly that of a central planner.

Summers points out that U.S. officials need to adjust to this new economic era and realize that other countries are frustrated with U.S. policies. There is probably frustration both militarily and economically, and sometimes these tie together, but there is no question Americans have been given something of a subsidy by having the U.S. dollar as the world’s reserve currency.

1971: Nixon Closes the Gold Window

It is interesting that Summers mentions “the 1971 Nixon shock” at the beginning of his article, because it is quite relevant to the whole subject at hand.

Up until August 15, 1971, foreign governments could redeem their U.S. dollars for gold. There was still something of an international gold standard.

But the Federal Reserve had been on a money-printing spree since the 1960s, which coincided with the increased spending of the Vietnam War and Johnson’s welfare state policies. Other countries, particularly France, were rightly concerned about this inflation and started redeeming gold for the dollars they accumulated.

While Nixon certainly does not deserve any credit for being a free market guy (he instituted wage and price controls with his announcement about ending gold convertibility), we can guess that almost any politician in his position would have done the same thing.

The U.S. would have run out of gold. Too much money had been printed, and there was not nearly enough gold to back it up at $35 per ounce.

In 1971, it had been illegal for Americans to possess most gold for nearly four decades thanks to Franklin Roosevelt. But even though it was illegal at that time, the international gold standard was still an important part of the American economy.

The U.S. had been on top of the world economically since at least World War II, and the dollar had become the reserve currency for major trade. And while the dollar wasn’t backed by gold for Americans, it was still on something of an international gold standard, which helped keep a somewhat stable currency.

It is no coincidence that the double-digit price inflation of the 1970s came around the time the dollar became fully unbacked.

It is amazing that the U.S. dollar has been able to hold onto its status as the world’s reserve currency over the last 44 years, despite being a fiat currency with no gold backing. We can partly attribute this to the poor reliability of other fiat currencies.

We can also partly attribute it to the U.S. government’s military power and its sway over oil-producing countries that agree to use dollars in trading oil. We can also partly attribute this to Paul Volcker’s time as Fed chair, when he slammed on the monetary brakes and hiked interest rates.

Turning Points

It is rare that a turning point happens in one day. You could point to September 11, 2001 and say that things changed quite a bit with that event, both with foreign policy and the economy. But even that is debatable.

Nixon’s closing of the gold window in 1971 was certainly a significant event, but it really was inevitable at that point. If he hadn’t done it then, it would have been done sometime soon after that, with the U.S. having even less gold in its possession.

It is no different with the Asian Infrastructure Investment Bank. I don’t think — as Larry Summers does — that we are going to look back years from now and see April 2015 as some kind of turning point or even some kind of wakeup call for U.S. officials.

Is he really serious in saying it is time for U.S. leadership to wake up to our new economic era? He could have just as easily said that back in 2008 or 2001. He could have said it in 1971, and it would have been far more accurate.

Does he think the establishment of a new Asian bank, founded by China, is going to change U.S. policy in any significant way? Is Congress going to bring back the gold standard? Is the Fed going to stop creating money out of thin air? Is Congress going to balance the federal budget anytime soon?

The biggest joke in all of this is that the whole AIIB is a scheme of more central planning by a bunch of mercantilist politicians in China. Why do they need some international bank with worldwide participation to build infrastructure?

The Chinese have managed to build lots of infrastructure in China in the form of ghost cities. Maybe Chinese officials want to do to the rest of Asia what it did in its own country, which is simply misallocate capital on a grand scale.

If China wants to disrupt the dollar, as some are speculating, then why doesn’t it start by selling off a portion of its $1.2 trillion in holdings of U.S. debt? After that, it could make the yuan a freely floating currency.

Dollar Dominance

This isn’t to say the U.S. dollar will remain on top forever. There is no gold standard, international or otherwise, which was definitely evident in the fall of 2008.

Since that time, the Fed has quintupled the adjusted monetary base, which is unprecedented.

In our global and digital economy, there is no reason the dollar should remain the world’s reserve currency. In fact, there is no reason to have a reserve currency at all. Countries can trade with their own currencies using open exchange markets. If anything is to replace the dollar as the world’s reserve currency, it should be gold.

The dollar has not lost its status yet, but it has been in a slow decline. Ironically enough, China is one of the reasons the dollar has held onto its status as long as it has.

But let’s not fool ourselves that some international Asian welfare bank, set up by China, is going to change anything significantly for the American economy. And it sure isn’t going to be any wakeup call for any U.S. politicians or central bankers.

In the end, all central planning schemes fail — some more quickly than others. We should not view fiat currencies any differently. The story that began in 1971 is not over yet, as we should expect the unbacked dollar to eventually fail. But right now, it is the least bad of all of the major currencies.

The only answer is to make sure a portion of your investment portfolio is in gold and silver to hedge against the central planners of the world.

When the failures of central planning become more evident, including in China and the U.S., many people are going to return to gold as a safe haven. You don’t need an international bank to own gold.

Until next time,

Geoffrey Pike for Wealth Daily

Bookmark and Share