America is now being humbled, just as Great Britain was in the last century (when we were relatively even more powerful at the beginning). In America’s case it is something that has taken 70 years to start to become apparent. The story needs to be told because events in the immediate future and for perhaps a year or two to come will be so profound that they will affect every person in the world (except perhaps the Andaman Islanders or some other hunter-gatherers in New Guinea or elsewhere who have not yet been discovered!).
America forced the superiority of the dollar on its Allies (except Soviet Russia) in 1944 when it was clear that America’s mighty military machine would inevitably defeat Germany and Japan — which it did in 1945. This was the famous ‘Agreement’ at the Bretton Woods Hotel, New Hampshire, US.
By this ‘Agreement’, 43 currencies were thenceforth tied at a particular rate to the dollar, and only the dollar was to be a ‘real’ currency backed up by gold—of which, by then, America had about 80% of the total world stock in its vaults. From then on, if the 43 nations were having problems with export prices, they could only devalue their currencies occasionally against the dollar with discrete adjustments and, in effect, with the permission of America. Meanwhile, America began printing more dollars whenever it wished, thus devaluing them and enabling its own exports to prevail over all others. Prosperity poured in. Americans were able to have a standard of living far beyond anything that Europeans could dream of. America was living off the rest of the world as effectively as if it were extracting rent from it or taxing it.
But, 20 years later, the European nations began getting their industrial act together and were beginning to earn dollars by exporting to America. They then started to get stroppy — the Germans and Ffrench more than others—and began to ask for their dollar earnings to be translated into gold. This, under the Bretton Woods Agreement was obligatory. America had to do so and gold began to shipped to Europe or moved into special vaults in the New York Fed bank with the country’s ownership label attached to it.
By the early 1970s America was losing so much of its precious gold that President Nixon broke the Bretton Woods Agreement unilaterally. He de-linked the America dollar from gold altogether. By the same act he also allowed all the other signatories to devalue their currencies flexibly. All currencies became freely exchanged against one another and started see-sawing about (and downards when compared with commodity prices). By this time, however, the American dollar had already accounted for as much as 80% of the world’s currency used in trade. This meant that America could devalue its dollar faster than other countries and still hang onto a great deal of the world’s trade. It led the world in a devaluation — inflationary—race. In effect it was exporting inflation to everywhere else—and still is.
Because, in the 1970s, America still had a mighty military machine arraigned against what were, by now, deadly enemies—communist Russia and China. Its tanks and missiles were stationed in Europe and its Sixth Fleet in the Pacific Ocean protected Europe and Japan respectively. It still had great power, and part of that power exercised against Europe and Japan was the excoriation and outlawing of gold as currency. European and Japanese central banks were pressured into selling their gold reserves in order to push the price down to levels only suitable for ornaments and tooth-fillings.
They yielded until 1999 when the worms started to turn. Some West European countries started a new currency, the euro, as a competitor to the dollar. European central banks started to buy gold again. The price of gold started to move upwards. Many gold mines which had previously been driven into bankruptcy started to revive again.
This had happened very briefly once before in 1979/80 when America was inflating the dollar faster than usual and investors started to rein back on buying US Treasury bonds. The gold price spiked up to $2,300/ounce. Volcker (then Chairman of the US Fed bank) raised interest rates to 20% and investors immediately sold their gold and bought dollar bonds instead. The gold price immediately collapsed. This time, however, gold has taken 11 years to rise and has done so steadily from about $300 to $1560/ounce. This time, Bernanke (the present Chairman of the US Fed bank), dare not raise the interest rate even by 0.25% for fear of plunging America into economic depression. Nor can the Bank of England do so. The European Central Bank has raised its low rate only very slightly in an effort to reduce inflation. It cannot raise it to normal levels because, like America and the UK the Eurozone stands on the edge of depression.
But it’s America—hitherto the central financial pivot of the world—that’s crucial. Its national debt, which was only 20% more than its annual GDP at the time of Bretton Woods is now almost four times higher. As both Europe’s and Japan’s debts, it is already higher than its taxpayers can possibly repay. Sooner or later it is going to have to pay some or all of its immense debts with gold—when the price of gold reaches high enough.
There are those commentators who still say that the present rise in gold price is a spike. But scores of central banks in the world, including China and Russia and the vastly prosperous Middle East oil and gas countries, don’t think so. Gold speculators have almost been driven out now, such is the heavyweight demand for the metal. Gold is now making its way back to its traditional role as the background currency which doesn’t inflate. You can be certain that although Bernanke of the US Fed and Geithner of the US Treasury are saying all sorts of brave things to the world, they are even now thinking seriously of how to bring about a gold standard world trading currency. This is what China and Russia have been asking for for years. This is what Zoellick, of the World Bank suggested last November.
Does this mean that America is going to eat dirt? No, of course not—no more than the UK did when lost is British Empire. America will become an ordinary country again over a period of decline of perhaps 50 years or so. It still has vast resources and entrepreneurial energy. Its scientific research and development still leads the world. But it is going to have to learn to share these assets because the rest of the world is catching up. And they’ll do so even quicker when there’s a level currency playing field.