What is the best gift someone could give you? Cash? Money is power. It fosters a sense of security. It opens doors and makes friends. It can enable a life of ease.
But what if one day all your money wasn’t worth anything? What would you have then?
The world’s biggest, most powerful banks may be gearing up for just that possibility.
For decades, central banks in Europe, North America and elsewhere have agreed on one thing: The dollar is as good as gold. This faith was built on America’s sporting the biggest, and one of the strongest, most dynamic and productive economies in the world. And even when the economy struggled, as Federal Reserve Chairman Paul Volcker clearly illustrated, America would do what it took—even risk pushing the country further into recession—to protect the reputation and value of the dollar.
This system worked because even though America stopped backing its currency with gold, confidence in America was high and getting higher. Because they were confident in America, central banks with large dollar holdings decided dollars were still valuable assets and did not dump them wholesale when President Nixon repudiated the gold standard. Prior to that announcement, the dollar was literally as good as gold. After that announcement, the dollar was as good as confidence in America.
Prior to the Nixon administration, if a German accepted a certain amount of dollars for a Mercedes Benz vehicle, he knew he could always go to the U.S. central bank and exchange those dollars for gold if he needed to. So it came as a bit of a shock to the world when Nixon changed the terms of the deal. But back in 1971 you either stuck with now-goldless America, or you joined the Soviet system. That unsavory choice worked in America’s favor.
When America and its allies began to win the Cold War, the new fiat dollar also began to win the battle for legitimacy. Confidence in America increased, and so did confidence in the dollar. Central banks around the world began taking the unprecedented steps of purposefully exchanging their gold reserves for dollars, which earned interest. For example, the Bank of England aggressively obtained and covetously guarded gold for more than 300 years. In the late 1990s, it disposed of virtually all its gold reserves. Canada, Australia and New Zealand followed suit.
Instead of gold, these countries chose to hold dollars or their equivalent, U.S. treasury bonds. After the Cold War ended and the Russians had exhausted their gold supplies, even former Soviet bloc countries accumulated dollars to prop up confidence in their economies. Thus the dollar replaced gold as the world’s unchallenged reserve currency.
Why did the world’s sharpest bankers and pragmatic economists give up the ancient and historic golden reserve currency for a currency that can be produced ad infinitum with the click of a button? How could seemingly logical professionals choose something that is theoretically limitless in supply, over a proven 6,000-year store of value?
The dollar being as good as gold may go down as one of the biggest mass hallucinations of history.
But that trip may have come to an end last year—even if America is still entranced. The world seems to be waking up to a sobering reality.
For the first time in close to a generation, last year central banks around the world on average dumped dollars. And bought gold instead.
From 1989 to 2007, central banks averaged net sales of 400 to 500 tons of gold per year, according to Kitco News. By 2009 the total had plummeted to only 30 tons. Then in 2010, for the first time in 21 years, central banks bought gold on average—87 metric tons worth. And it looks like 2011 balance sheets will see more dollars going up in smoke in favor of real, hard gold. Earlier this month, Mexico made the surprise announcement that its central bank had purchased almost 100 tons of gold in February and March. That single purchase snapped up 3.5 percent of estimated global gold production for the year.
But Mexico isn’t alone. The Bank of Thailand purchased nearly 100 tons in March, continuing its new accumulation strategy. China, India, Russia and Saudi Arabia have all also announced significant gold purchases in recent years.
And it is not just central banks waking up from the mass dollar delusion. Just as significantly, the global investment community is showing the first signs of waking up too. The University of Texas Investment Management Co., the second-largest university endowment in the U.S., has announced that for the first time it has purchased and taken delivery of almost $1 billion worth of physical gold as a way to protect its investments.
Pimco, the biggest private bond investors in the world, which made headlines earlier this year for selling virtually its whole horde of U.S. dollar treasuries from its flagship fund, has now announced that it is buying gold too—and it is already in the largest position in its equities fund.
But why is the dollar suddenly going out of style? Why is non-interest-bearing gold beginning to attract attention again after 40 years of being sold and disparaged by central banks? What does it mean for you? Is there a warning in the rising price of gold? If central banks are dumping dollars for gold, should you too?
Kyle Bass, the investment analyst working with the University of Texas endowment fund, says one reason for the dollar’s ills is that “central banks are printing more money than they ever have,” which, he says, is wrecking the value of money. Gold is simply a “currency that they can’t print any more of.”
Former presidential candidate and publisher Steve Forbes agrees. According to him, unstoppable government spending and the Federal Reserve’s new proclivity for money printing are destroying the dollar. “People know that something is wrong with the dollar,” he said. “You cannot trash your money without repercussions.”
Yes, reckless government spending, fiat money creation, a deteriorating economic outlook, political gridlock, an aging population, debt-burdened consumers—all these factors are working against the dollar.
But the biggest factor of all is something else: broken trust.
Central banks are the institutions that create dollars, euros and yen. But if the paper-pushers themselves are dumping their own paper to get gold—what does that tell you about their confidence in their own product? How many times have you heard a Ben Bernanke, Alan Greenspan or Timothy Giethner say that he believes in a strong dollar—and then take actions that devalue it? Are these the headlines of a world where the dollar is strong?
Is the dollar a savvy investment or a defunct delusion? Central banks are dumping. The world’s biggest bond fund is dumping. Universities are dumping. And soon even everyday Americans may be dumping. A 40-year monetary experiment may be about to come to a disillusioning and tragic end.
Today’s dollar is just a piece of worthless paper if there is no confidence in it. That is reality.
The whole system is starting to crumble, and now it is dying due to broken faith, broken trust and broken confidence. If a dollar crash comes some day soon, will you be prepared? ▪