by Chris Hamilton, February 2015
Following WWII, a new monetary system for international commerce and finance was implemented. This agreement known as Bretton Woods gave the expected Allied victors the spoils and represented the World as of 1945.
CHIEF FEATURES OF THE BRETTON WOODS SYSTEM
- An obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar
- The ability of the IMF (created by the Bretton Woods agreement along with many other current day acronyms) to bridge temporary imbalances of payments (IMF would loan money to nations in trouble with strings attached to ideally resolve these imbalances and keep the system functioning).
- Address the lack of cooperation among other countries and to prevent competitive currency devaluations (in an attempt to avoid countries printing money to cheapen their exports and gain advantages in trading).
- To ensure the US did not abuse it’s privilege as the world’s de-facto currency, the US dollar would be freely convertible into gold (if the US printed an excess quantity of dollars, nations accumulating too many dollars from US trade/budget deficits could convert and retire these dollars into gold). Gold represented a relatively fixed quantity and storage of value.
WHAT ACTUALLY TOOK PLACE
- 1946-1959 US federal debt was flat ($269 B to $285 B)…Debt/GDP fell from 113% to 54%… the US essentially ran a balanced budget adding approximately $1 B annually to national debt over 13 years, (about a third of a % annually…all while conducting the Marshall plan, the Korean War, and huge US infrastructure projects).
- 1960-1975 US federal debt doubled ($285 B to $533 B) while GDP grew 3.3x’s ($525 B to $1.7 T)…in ’75 the US hit a Debt/GDP post Great Depression low of 31%. But great forces were already set in motion that would lead us to today’s trouble…including the initiation of the Great Society in ‘65 and LBJ’s four years later theft of these surplus’ meant to cover future tax shortfalls for these programs…all to hide the true cost of the Vietnam war…all under the “Unified Budget”. Unfunded liabilities had begun and the horse was out of the barn.
- The US had roughly 19,000 tons of gold as of the end of WWII and peaked in excess of 20,000 tons by 1958…but by 1971, the redemptions by nations concerned over US deficit spending and printing had reduced the US gold holdings to just over 8,200 tons and a run on the remaining gold looked likely.
- 1971 President Nixon closed the US dollars convertibility into gold…but to avoid the dollars demise, Nixon struck an agreement with Saudi Arabia (and soon after all of OPEC) that all future purchases of oil will need be conducted in US dollars (regardless the buyer or destination). In exchange, the US promised weapons and protection to these close “allies” of the US. Unfortunately, this policy rewarded some very un-democratic and very despotic leaders in the middle-East and elsewhere whom reaped the rewards with a tiny minority of their cohorts. These policies typically left the oil producing populaces poor and seething with anger at the US for supporting kings and dictators who ruled in complete contradiction to US founding principles and the interests of the citizens of those nations.
- Ultimately, this petro-dollar agreement allowed the US to run very large trade and budget deficits and export the excess dollars worldwide (through our trade/budget deficits) that would have otherwise created significant inflation within the United States.
- This Petro-dollar agreement compelled by force of necessity a gigantic supply of dollars to be accumulated by foreign nations worldwide.
- In fact, the estimate is that there are more than 4x’s the supply of all money in the US ($2.8T, M1) held abroad ($12T+). This includes nearly $6 T in foreign held US Treasury’s, $4 T to $6 T in formal Reserves, and the Federal Reserve estimated that 55% to 70% (and potentially in excess of 100% of domestic M1) was held abroad and increasing as of 2012* (80% of all US currency is $100 bills, but foreigners also hold lesser amounts in $50’s and $20’s). These formal and informal dollar and US Treasury reserves held by foreign nations allow trade in oil and other de-facto dollar denominated commodities (legal and/or illicit).
THEN AND NOW
- But global power has shifted a bit since 1945 and the US has balked on its Bretton Woods pledges, the Middle-East teams with “radicals” and “revolutionaries”, and now the BRICS (Brazil, Russia, India, China, South Africa) seem on the precipice of a new global currency regime.
- Today, the BRICS account for about 25 per cent of global GDP, 35 per cent of total international reserves (with China at over $4 trillion), 25 per cent of total land area and around 42 per cent of the world’s population…and BRICS affiliated nations increase these numbers significantly more.
- However, despite their economic weight, the BRICS’ representation, voting power, participation in management and staff in the Bretton Woods institutions (International Monetary Fund, World Bank, World Trade Organization, and International Finance Corporation) and others like the Bank of International Settlement, displays a major deficit of ‘voice’ and influence.
- As of July ‘14, the BRICS nations formally agreed on a BRICS bank funded w/ $100B to rival the influence and power of the IMF. This money is to be lent to nations in competition with the IMF $’s (typically with US directed strings attached). China, Brazil, Russia, and so many more are moving away from clearing their trade in dollars and instead utilizing the Yuan, the Real, the Ruble, etc. Please note that Russia and Saudi Arabia are now the largest exporters of oil – and at least Russia is moving rapidly to settle in anything but the dollar…and the troubles in Saudi Arabia, Iran, Iraq, Libya, Syria, Ukraine, etc. are all symptomatic of this potential shift.
- China is organizing itself and its trade partners in at least 24 separate agreements to transact in the Yuan rather than the dollar. As of 2009, less than 1% of China’s global trade was settled in Yuan but by mid-2013, 17% of Chinese trade was being cleared in Yuan…almost entirely at the expense of the dollar. And the trend and structure to allow far more has only accelerated throughout the BRICS.
- It should be very clear where this trend is going and the implications to the United States – the Congressional Budget Office and like prognosticators have acknowledged the US will soon need to run larger budget deficits in excess of $1 T (again) due to large debt loads, growing social programs, and large unfunded liabilities. Of course the situation will only get worse because:
- We consistently spend more than we take in as tax revenue but due to Cash-Based accounting the true nature of the deficit spending is concealed.
- We continue adding new participants to existing entitlement programs increasing present and future unfunded liabilities…while the tax payers per social program recipient is collapsing.
- We add new entitlement programs (i.e. the Prescription Drug Act in 2003 and the Affordable Care Act in 2010) therefore increasing our future liabilities.
All this will necessitate the world accept and utilize these greater quantities of dollars. HOWEVER, the existing dollar system is not in the favor of most of the new powers of the world…and they are rapidly moving to reduce their dependence on the dollar…just as the US will need foreigners to embrace it more than ever. Rock meet hard place.
If $12+ trillion (plus the continuing growth in available dollars) is no longer needed as reserves for international settlement – where does that money go? Well, a relatively small reduction (say 5%-10% over a period, say 2014) would free up $600 B to $1.2 T to move where dollars are still readily accepted…the US of A. Typically, these dollars would be levered up (say conservatively up to 5x’s)…and voila, $3 T to $6 T of asset purchasing power is introduced to America in 2014. Things like stocks, bonds, and Real Estate would be pushed higher and higher (rents, insurance, etc. would also be unwelcomingly pushed higher as wages remain flat due to structural unemployment issues…in other words, asset owners are rewarded, wage earners are punished). As the Fed’s Z1 Household Survey displays, asset prices skyrocketed without wage gains, with a reduction in total US household liability, and a flat total US workforce. The data shows from Q1 2009 the Z1 household net worth bottomed at $55 trillion but by Q3 2014 had rebounded by 50% (+$26.3 trillion) to $81.3 trillion total…all while household liabilities (mortgages, all loans, etc.) fell (-$300 B) despite a $500 billion increase in student loan debt over this period, wages remained flat, and the full time US workforce declined by 1 million. So, where did all the money come from?
Let’s say in 2015 the pace of BRICS, etc. non-dollar trade continues expanding and international settlement in non-dollars grows by 20%...and 20% of dollars are no longer needed as reserves to buy oil, wheat, etc. etc. This is about $2.4 T formerly held reserves cleared to go looking for a home…the US of A. $2.4 T levered again very conservatively @ 5x’s (or 20% cash down) is $12 T in “hot” money looking for assets. With just a fraction of all the inflation the US exported over the 43 year period of ’71-present…this creates what amounts to a potential hyperinflationary dollar overdose for America. Foreign holders of US money chasing assets in America where dollars are readily accepted. And of course, once these things start, they create a momentum of their own and a likely counter by the administration to freeze out these dollars and the likely panic this ensues both domestically and internationally.
THE PETRO DOLLAR ON IT'S DEATH BED?
As of July ‘14, the BRICS nations formally agreed on a BRICS bank funded w/ $100 billion to rival the influence and power of the IMF. This money is to be lent to nations in need, as an alternative to the IMF (typically with US directed strings attached). China, Brazil, Russia, and so many more are moving away from clearing their trade in dollars and instead utilizing the Yuan, the Real, the Ruble, etc. Please note that Russia and Saudi Arabia are now the largest exporters of oil – and at least Russia is moving rapidly to settle in anything but the dollar…and the troubles in Saudi Arabia, Iran, Iraq, Libya, Syria, Ukraine, etc. are all symptomatic of this conflict for which currency(s) will be used to settle trade...particularly for energy.
China, now officially the world’s largest economy, is organizing itself and its trade partners in at least 24 separate agreements to transact in the Yuan rather than the dollar. As of 2009, less than 1% of China’s global trade was settled in Yuan but by mid-2013, 17% of Chinese trade was being cleared in Yuan…almost entirely at the expense of the dollar. And the trend and structure to allow for far more has only accelerated throughout the BRICS. As the below chart highlights, dollar reserves as a % of foreign creditors holdings are declining…and if Iran, Russia, and potentially others determine to clear trade, and particularly trade for oil, in non-dollar currencies…the need for global dollar reserves could accelerate its already declining role rapidly.
Source: IMF, Data Template on International Reserves and Foreign Currency Liquidity
Source: IMF, Data Template on International Reserves and Foreign Currency Liquidity
And just one chart to put today’s strong dollar in perspective vs. previous periods of appreciation…and previous periods of strength led to weakening US exports and weak dollar policies to counteract this. Will this time be any different?