13 Nov 2013

What A Confidential 1974 Memo To Paul Volcker Reveals About America's True Views On Gold, Reserve Currency And "PetroGold"

Just over four years ago, we highlighted a recently declassified top secret 1968 telegram to the Secretary of State from the American Embassy in Paris, in which the big picture thinking behind the creation of the IMF's Special Drawing Right (rolled out shortly thereafter in 1969), or SDRs, was laid out. In that memo it was revealed that despite what some may think, the fundamental driver behind the promotion of a supranational reserve paper currency had one goal in mind: allowing the US to "remain masters of gold."
Specifically, this is among the top secret paragraphs said on a cold night in March 1968:
If we want to have a chance to remain the masters of gold an international agreement on the rules of the game as outlined above seems to be a matter of urgency. We would fool ourselves in thinking that we have time enough to wait and see how the S.D.R.'s will develop. In fact, the challenge really seems to be to achieve by international agreement within a very short period of time what otherwise could only have been the outcome of a gradual development of many years.
This then puts into question just what the true purpose of the IMF is. Because while its stated role of preserving the stability in developing, and increasingly more so, developed, countries is a noble one, what appears to have been the real motive behind the monetary fund's creation, was to promote and encourage the development of a substitute reserve currency, the SDR, and to ultimately use it as the de facto buffer and intermediary, for conversion of all the outstanding "barbarous relic" hard currency, namely gold, into the fiat of the future: the soon to be newly created SDR. All the while, and increasingly more so as more countries converted their gold into SDR, such remaining hard currency would be almost exclusively under the control of the United States.
Well, in the intervening 44 years, the SDR never managed to take off, the reason being that the dollar's reserve currency status was exponentially cemented courtesy of both the great moderation of the 1980s and the derivative explosion of the 1990s and post Glass Steagall repeal 2000s, when the world was literally flooded with roughly $1 quadrillion in USD-denominated derivatives, inextricably tying the fate of the world to that of the dollar.
However, back in 1974, shortly after Nixon ended the Bretton Woods system, and cemented the dollar's fate as a fiat currency, no longer convertible into gold, the future of the SDR was still bright, especially at a time when the US seemed set to suffer a very unpleasant date with inflationary reality following the 1973 oil crisis, leading to a potential loss of faith in the US dollar.
Which brings us to the topic of today's article: the international monetary system, reserve currency status, SDRs, and, of course, gold... again.
Below is a memo written in 1974 by Sidney Weintraub, Deputy Assistant Secretary of State for International Finance and Development, to Paul Volcker, when he was still just Under Secretary of the Treasury for Monetary Affairs and not yet head of the Federal Reserve. The source of the memo was found in the National Archives, RG 56, Office of the Under Secretary of the Treasury, Files of Under Secretary Volcker, 1969–1974, Accession 56–79–15, Box 1, Gold—8/15/71–2/9/72. No classification marking. A stamped notation on the note reads: "Noted by Mr. Volcker." Another notation, dated March 8, indicates that copies were sent to Bennett and Cross. It currently resides in declassified form in Document 61, Foreign Relations Of The United States, 1973–1976, Volume XXXI Foreign Economic Policy, and is found at the Office of the Historian website.
The memo is a continuation of the US thinking on the issue of the then brand new SDR, the fate of paper currencies, and the preservation of US control over reserve currency status. Most importantly, it addresses several approaches to dominating gold as well as the US' interest of banning gold from monetary system and capping the free market price, contrasted by the opposing demands of various European deficit countries (sound familiar?) on what the fate of gold should be at a time when the common European currency did not exist, and some European countries were willing to fund their deficits with gold: something the US naturally was not happy about.
While we urge readers to read the full memo on their own, here the two punchlines.
First, here is what the S intentions vis-a-vis gold truly are when stripped away of all rhetoric:
U.S. objectives for world monetary system—a durable, stable system, with the SDR [ZH: or USD] as a strong reserve asset at its center — are incompatible with a continued important role for gold as a reserve asset.... It is the U.S. concern that any substantial increase now in the price at which official gold transactions are made would strengthen the position of gold in the system, and cripple the SDR [ZH: or USD].
In other words: gold can not be allowed to dominated a "durable, stable system", and a rising gold price would cripple the reserve currency du jour: well known by most, but always better to see it admitted in official Top Secret correspondence.
We continue:
To encourage and facilitate the eventual demonetization of gold, our position is to keep the present gold price, maintain the present Bretton Woods agreement ban against official gold purchases at above the official price and encourage the gradual disposition of monetary gold through sales in the private market. An alternative route to demonetization could involve a substitution of SDRs for gold with the IMF, with the latter selling the gold gradually on the private market, and allocating the profits on such sales either to the original gold holders, or by other agreement.... Any redefinition of the role of gold must be based on the principle stated above: that SDR must become the center of the system and that there can be no question of introducing a new form of gold– paper and gold–metal bimetallism, in which the SDR and gold would be in competition.
And there, in three sentences, you have all the deep thinking behind the IMF's SDR: simply to use it as a vehicle through which a select few can accumulate gold (namely those who can create fiat SDRs d novo), while handing out paper "profits" to the happy sellers.
And just in case it was not quite clear, here it is again, point blank:
Option 3: Complete short-term demonetization of gold through an IMF substitution facility. Countries could give up their gold holdings to the IMF in exchange for SDRs. The gold could then be sold gradually, over time, by the IMF to the private market. Profits from the gold sales could be distributed in part to the original holders of the gold, allowing them to realize at least part of the capital gains, while part of the profits could be utilized for other purposes, such as aid to LDCs. AdvantagesThis would achieve our goal of demonetization and relieve the problem of gold immobility, since the SDRs received in exchange could be used for settlement with no fear of foregoing capital gains.Disadvantages: This might be a more rapid demonetization than several countries would accept. There would be no benefit from the viewpoint of financing oil imports with gold sales to Arabs (although it is not necessarily incompatible with such an arrangement).
One wonders just who in the "private market" would be stupid enough to convert their invaluable paper money into worthless, barbaric relics?
And finally, was there the tiniest hint of a proposed alternative system to the PetroDollar. Namely, PetroGold?
There is a belief among certain Europeans that a higher price of gold for settlement purposes would facilitate financing of oil imports... Although mobilization of gold for intra-EC settlement would help in the financing of imbalances among EC countries, it would not, of itself,provide resources for the financing of the anticipated deficit with the oil producers. For this purpose, it would be useful if the oil producers would invest some of their excess revenues in gold purchases from deficit EC countries at close to a market price. This would be an attractive proposal for European countries, and for the U.S., in that it would not involve future interest burdens and would avoid immediate problems arising from increased Arab ownership of European and American industry. (The Arabs could both sell the gold and use the proceeds for direct investment, so that the industry ownership problem would not be completely solved.) From the Arab point of view such an asset would have the advantages of being protected from exchange-rate changes and inflation, and subject to absolute national control
One wonders if the price of gold is "high enough" now for Arab purposes, and just where the Arabs are now in their thinking of converting oil into gold... or alternatively into a gold-backed renminbi. And if not now, soon, once the pent up inflation in the Fed's $4 trillion, and rising, balance sheet inevitably start to leak out?
The full Volcker memo can be found here.


12 Nov 2013

The Death of the USD

The death of the dollar is coming, and it will probably be China that pulls the trigger.  What you are about to read is understood by only a very small fraction of all Americans.  Right now, the U.S. dollar is the de facto reserve currency of the planet.  Most global trade is conducted in U.S. dollars, and almost all oil is sold for U.S. dollars.  More than 60 percent of all global foreign exchange reserves are held in U.S. dollars, and far more U.S. dollars are actually used outside of the United States than inside of it.  As will be described below, this has given the United States some tremendous economic advantages, and most Americans have no idea how much their current standard of living depends on the dollar remaining the reserve currency of the world.  Unfortunately, thanks to reckless money printing by the Federal Reserve and the reckless accumulation of debt by the federal government, the status of the dollar as the reserve currency of the world is now in great jeopardy.
As I mentioned above, nations all over the globe use U.S. dollars to trade with one another.  This has created tremendous demand for U.S. dollars and has kept the value of the dollar up.  It also means that Americans can import things that they need much more inexpensively than they otherwise would be able to.
The largest exporting nations such as Saudi Arabia (oil) and China (cheap plastic trinkets at Wal-Mart) end up with massive piles of U.S. dollars...
Are You Ready For The Death Of The Petrodollar - Photo By Revisorweb
Instead of just sitting on all of that cash, these exporting nations often reinvest much of that cash into low risk securities that can be rapidly turned back into dollars if necessary.  For a very long time, U.S. Treasury bonds have been considered to be the perfect way to do this.  This has created tremendous demand for U.S. government debt and has helped keep interest rates super low.  So every year, massive amounts of money that gets sent out of the country ends up being loaned back to the U.S. Treasury at super low interest rates...
United States Treasury Building - Photo by Rchuon24
And it has been a very good thing for the U.S. economy that the federal government has been able to borrow money so cheaply, because the interest rate on 10 year U.S. Treasuries affects thousands upon thousands of other interest rates throughout our financial system.  For example, as the rate on 10 year U.S. Treasuries has risen in recent months, so have the rates on U.S. home mortgages.
Our entire way of life in the United States depends upon this game continuing.  We must have the rest of the world use our currency and loan it back to us at ultra low interest rates.  At this point we have painted ourselves into a corner by accumulating so much debt.  We simply cannot afford to have rates rise significantly.
For example, if the average rate of interest on U.S. government debt rose to just 6 percent (and it has been much higher than that at various times in the past), we would be paying more than a trillion dollars a year just in interest on the national debt.
But it wouldn't be just the federal government that would suffer.  Just consider what higher rates would do to the real estate market.
About a year ago, the rate on 30 year mortgages was sitting at 3.31 percent.  The monthly payment on a 30 year, $300,000 mortgage at that rate is $1315.52.
If the 30 year rate rises to 8 percent, the monthly payment on a 30 year, $300,000 mortgage would be $2201.29.
Does 8 percent sound crazy to you?
It shouldn't.  8 percent was considered to be normal back in the year 2000.
Are you starting to get the picture?
We need other countries to use our dollars and buy our debt so that we can have super low interest rates and so that we can afford to buy lots of cheap stuff from them.
Unfortunately, the truly bizarre behavior of the Federal Reserve and the U.S. government over the past several years is causing the rest of the world to lose faith in our currency.  In particular, China is leading the call for a "de-Americanized" world.  The following is from a recent article posted on the website of France 24...
For decades the US has benefited to the tune of trillions of dollars-worth of free credit from the greenback's role as the default global reserve unit.
But as the global economy trembled before the prospect of a US default last month, only averted when Washington reached a deal to raise its debt ceiling, China's official Xinhua news agency called for a "de-Americanised" world.
It also urged the creation of a "new international reserve currency... to replace the dominant US dollar".
So why should the rest of the planet listen to China?
Well, China now accounts for more global trade than anyone else does, including the United States.
China is also now the number one importer of oil in the world.
At this point, China is even importing more oil from Saudi Arabia than the United States is.
China now has an enormous amount of economic power globally, and the Chinese want the rest of the planet to start using less U.S. dollars and to start using more of their own currency.  The following is from a recent article in the Vancouver Sun...
Three years after China allowed the yuan to start trading in Hong Kong’s offshore market, banks and investors around the world are positioning themselves to get involved in what Nomura Holdings Inc. calls the biggest revolution in the $5.3 trillion currency market since the creation of the euro in 1999.
And over the past few years we have seen the global use of the yuanrise dramatically...
International use of the yuan is increasing as the world’s second-largest economy opens up its capital markets. In the first nine months of this year, about 17 percent of China’s global trade was settled in the currency, compared with less than one percent in 2009, according to Deutsche Bank AG.
Of course the U.S. dollar is still king for now, but thanks to a whole host of recent international currency agreements this status is slipping.  For example, China just recently signed a major currency agreement with the European Central Bank...
The swap deal will allow more trade and investment between the regions to be conducted in euros and yuan, without having to convert into another currency such as the U.S. dollar first, said Kathleen Brooks, a research director at FOREX.com.
"It's a way of promoting European and Chinese trade, but not doing it with the U.S. dollar," said Brooks. "It's a bit like cutting out the middleman, all of a sudden there's potentially no U.S. dollar risk."
And as I have written about previously, we have seen a bunch of other similar agreements being signed all over the planet in recent years...
1. China and Germany (See Here)
2. China and Russia (See Here)
3. China and Brazil (See Here)
4. China and Australia (See Here)
5. China and Japan (See Here)
6. India and Japan (See Here)
7. Iran and Russia (See Here)
8. China and Chile (See Here)
9. China and the United Arab Emirates (See Here)
10. China, Brazil, Russia, India and South Africa (See Here)
But do you hear about any of this on the mainstream news?
Of course not.
They would rather focus on the latest celebrity scandal.
Right now, the global move away from the U.S. dollar is slow but steady.
At some point, some trigger event will likely cause it to become a stampede.
When that happens, demand for U.S. dollars and U.S. debt will disintegrate and interest rates will absolutely skyrocket.
And if interest rates skyrocket that will throw the entire U.S. financial system into chaos.  At the moment, there are about 441 trillion dollars worth of interest rate derivatives sitting out there.  It is a financial time bomb unlike anything the world has ever seen before.
There are four "too big to fail" banks in the United States that each have more than 40 trillion dollars worth of total exposure to derivatives.   The largest chunk of those derivatives is made up of interest rate derivatives.  In case you were wondering , those four banks are JPMorgan Chase, Citibank, Bank of America and Goldman Sachs.
A huge upward surge in interest rates would absolutely devastate those banks and cause a financial crisis that would make 2008 look like a Sunday picnic.
Right now, the leader in global trade seems content to use U.S. dollars for most of their international transactions.  China also seems content to hold more than a trillion dollars of U.S. government debt.
If that suddenly changes someday, the consequences for the U.S. economy will be absolutely catastrophic and every single American will feel the pain.
The standard of living that all of us are enjoying today depends largely upon China.  They can bring down the hammer at any moment and they know it.