As we reported here on March 13, it was only two weeks ago that the Chinese Premier confessed to being "a little bit worried" about the safety of China's huge holding of US Dollar denominated assets and asked for guarantees from the US government that they retain their "value". Since then, we have seen the Fed's decision to begin to actively monetise Treasury debt (by actively buying Treasury debt paper) on March 18 and a further series of bailout packages to be implemented by the Fed/Treasury/FDIC troika. Since March 13, the Chinese have made many further "requests" that the US government refrain from any more programs to print more US Dollars into existence. And then this week came the proposals from China for a NEW RESERVE CURRENCY.
China's proposal is that the IMF increase the role of their "Special Drawing Rights" (SDR) - a basket of currencies which include the Dollar, the Euro, the Yen and the British Pound - to fill such a role. The SDR was invented by the IMF in 1969, in the waning days of the fixed currency era when the US Dollar could still be redeemed in Gold (by foreign governments and central banks only) at $US 35 per ounce. The SDR was set up as a contingency to be utilised if the US Dollar was to end that redeemability and leave the monetary world with no fixed anchor. At its inception, the SDR was defined in terms of Gold, but that didn't last long.
The US did end its Dollar's redeemability in Gold in August 1971 but the SDR did not step up as a new reserve. Instead, the world went to floating fiat currency regime in 1973 - a regime that remains to this day. The SDR had, in the meantime, been redefined as a basket of currencies, a basket which is "reviewed" every few years. The next revision is scheduled for 2010. But the SDR has never become anything but an internal bookkeeping entry inside the IMF, its function being to settle balances betweeen individual central banks. The SDR was invented as "paper gold" but never performed that function in the real world. Instead, the US Dollar took on that mantle, and retained its function as the world's reserve currency even though it was no longer redeemable in Gold or anything else.
There are two major reasons why the SDR has never been taken seriously as a "reserve currency". First, it is simply a beaureaucratic creation of the IMF. It has never been used in the real economy of any nation and it has certainly never circulated as cash in any nation. It would not be acceptable. The other reason is that the US controls the world's reserve currency and also the IMF. Passage of any IMF "resolution" elevating the SDR to even quasi reserve currency status would require an 85 percent approval from IMF members. The US, today, controls 16.75 percent of total IMF votes. It has always controlled more than the necessary 15.01 percent of votes necessary to veto ANY IMF proposal. The US cannot always necessarily get its way in IMF deliberations. But it CAN always veto any proposal of which it does not approve, even if all the other nations in the IMF do approve.
Here's an example. In 1997, the Board of Governors of the IMF tabled a proposal to double the amount of outstanding SDRs to 42.8 Billion (at present, an SDR is "worth" about $US 1.50). 131 IMF members with 77.7 percent of the voting power of the IMF have approved this proposal. The US has not.
The significance of China's proposal is not in its "suggestion" that the SDR might be a useful alternative to the US Dollar as world reserve currency. China is well aware that such an idea is fatuous. What IS noteworthy is the increasing insistence from China (backed by Russia and many other "developing" nations) that measures must be taken to establish a global monetary system which is NOT based on US Dollars. Remember late last year when the G-7 Summit was being billed in many quarters as the first step towards a new "Bretton Woods"? That fizzled, of course. But will the same demands fizzle at the upcoming G-20 Summit in London on April 2. Perhaps, in public. But definitely NOT behind closed doors.
The growing insistence that the world needs a new "anchor" for its monetary system is not going to go away. With every new $US TRILLION stimulus and/or bailout program that the White House or the Treasury or the Fed or the FDIC proposes, the drumbeat will become more insistent. The rest of the world cannot, even if they wanted to, "finance" the insatiable debt demands now pouring out of the Obama Administration.
The BIG problem is that so far, every proposal to "replace" the US Dollar wants to replace it with another fiat paper currency, a currency at the mercy of whichever government issues it and redeemable in NOTHING. It is true that the US government has abused the responsibility given to them in 1944 when their currency became the sole underpinning for the global system. But no fiat paper currency can step into the breach in any more than a temporary fashion because the same fundamental flaw remains. Whatever money or group of moneys is chosen, it can be created out of thin air with the consequences passed from the present generation to those yet to come. The days when that process could function with any credibility are almost over. What is needed now is a SOUND money, not a promise to pay.
Gold waits patiently to resume that role, a role it has held for thousands of years. In reality, the Heads of State to be meeting in London are united in one resolve. With the loss of control over the issuance of money comes the loss of control over the political power they wield. Consider once more the quotation from Ludwig von Mises with which we end the "Global Report" section in the current issue of The Privateer (Late March - Number 625 - Published on March 22).
Let us repeat the first sentence of that quote:
"It is impossible to grasp the meaning of the idea of sound money if one does not realise that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments."
It is not possible to have individual liberty and political freedom (FROM government) without a sound money. A cursory glance at the role of government before WWI in comparison to today is all the proof anyone could need. The problem is that the abuse of political power made possible by UNSOUND money has now reached a level which threatens to destroy the global economic and financial system based upon it. A return to Gold is inevitable - somewhere. The longer it takes, the worse the "interim" is going to be.
Oh, and one final point. The world doesn't need a "reserve currency". It simply needs a sound money.
(Chart appears here in original analysis)
A new low was hit on the chart when spot future Gold closed in New York at $US 705 on November 13 last year. This pushed the chart two "Xs" below the $US 715 support level established in late October and equalled early in November. Then came the first big turnaround - and upturn on the chart - of November 14. The region between $US 700-720 firmed as SOLID support for Gold. That support "zone" was emphatically confirmed as Gold rose by just over $US 110 between November 13 and November 28 last year.
On February 20, as you know, Gold made it all the way back to its previous all time highs. But it did NOT break through the $US 1000 barrier. Since then, Gold has retreated to just below the $Us 900 level in two moves down. What is now beginning to be traced out on this chart is a gigantic "reverse" head and shoulders formation. The trading range between $US 900 and $US 1000 is now firm. We will see how long it lasts.
We began the table below in 2007 and have extended it into 2009, even though Gold in all four currencies in the table remain well above their 2006 highs. The all time highs for Gold which occurred in 2008 have remained intact in US Dollars and in Yen.
But in terms of the Euro and especially the Aussie Dollar, the situation is very different. Gold hit new all time highs in both currencies on January 30 with situation being duplicated by Gold in terms of MANY other currencies. A month a go on February 20, those highs were taken out when Gold hit $US 1000. The only thing we still await is for that $US 1000 level to be broken through on the upside.
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