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The US dollar has been long respected as a “reserve currency,” or a currency that other nations opt to hold in their foreign reserves because of its universal acceptance and stability in pricing. However, as Congress and the Federal Reserve drive up massive debts and continue to inflate the money supply, many nations are leading the charge to remove the dollar's reserve currency status.
Why the Dollar?
Following the economic calamity of World War II, countries came together to rebuild and rejuvenate the global economy. During the war, entire factories had been destroyed by incessant bombing campaigns, and Europe’s infrastructure suffered dramatically. In addition, many currencies, including the German Mark, had been inflated beyond recognition to pay for costly munitions to fight the war.
In 1945, nations from around the world met in Bretton Woods, New Hampshire to discuss an economic system that would improve the current state of the global economy, as well as provide some stability to a politically and economically volatile world. This is where the reserve currency of the dollar was born; nations saw value in the gold standard of the US dollar, and many chose to switch their foreign holdings to the US dollar. Subsequently, the US emerged as a superpower, having won a global war and exiting World War II in the best shape of any country.
Fast Forward through History
Today, the US dollar still reigns supreme in the reserves of nations. However, unlike the economic situation in 1945, the United States is deeply in debt and has since inflated its currency several times over after breaking the gold standard in 1971.
Post financial crisis and $1000 per ounce gold prices, countries around the world are beginning to wonder whether placing such large bets on the value of the US dollar was in fact a wise financial decision. Since the year 2001, gold has nearly quadrupled in value, a sign that the US dollar is quickly losing value.
The Dollar and Oil
One of the primary reasons the US dollar is kept as a reserve currency is its ties to oil. In the 1970s, Saudi Arabia and the United States inked an agreement that would provide the Saudis with US military protection in exchange for the dollar being the only currency accepted for oil. As such, with the market for oil only denominated in dollars, nations still have a reason to hold US dollars.
This scenario is quickly changing, however, as many Middle Eastern OPEC nations have fought tooth and nail to allow other currencies in the oil trade. In 2002, Iraq sought to allow all currencies, but most prominently the Euro, to be traded for oil. More recently, Iran has challenged OPEC to accept Euros for oil, and the country has taken steps to move its oil bourse from dollar-denominated to Euro-denominated pricing.
Oil, Silver and the Dollar
Should nations be able to purchase oil in other currencies, it is expected that demand for the dollar will drop, nations will shed dollars from their reserves, and the price of the dollar will drop instantaneously. However, the value of gold and silver should continue to rise, as they trade with a negative correlation to the dollar. When the world can buy one less commodity with dollars, the best investment is made in others: silver and gold.
Hard Assets Are the Fading Dollar's Replacement
Foreign nations are shedding US dollars quickly, increasing the price of alternative hedges, such as silver and gold. The astute investor can generate a better return by pinpointing not only what nations are selling, but also what they are buying. Thus far, the Japanese yen and the Euro have been the largest replacements for the US dollar, but there are other assets that are hiding in the shadows, waiting for their bull run.
Hard Assets Reign King
Of all the dollar pessimists, Russia and China have been the most vocal, even though both of these nations currently hold a large position in dollars. China has its large dollar reserves because of its financing of US debt through the Treasury market, as well as from the US-China trade imbalance, which runs in the hundreds of billions each year. Russia's vast dollar reserves are generated from the sale of oil, which is only denominated in dollars around the world.
China is acting quickly to sell its dollars by the process of buying hard assets. Recent purchases include mineral and precious metal mines, steel producing companies in neighboring nations, and even more recently, gold and silver.
Why Metals?
World governments recognize that it is not the price of metals that changes, but instead the value of the currency against those metals. Throughout the ages, gold and silver have been used as a medium of exchange, and they are universally recognized as currency and units of exchange in barter.
Knowing this, large dollar owners, such as China, have an even greater interest in owning metals. As they convert their positions into gold or silver, they negate the risk that their dollar holdings lose value. At present, China owns very little gold, although analysts believe that recent spikes in the Tokyo financial markets may be China stocking up on both gold and silver. This presents a lucrative opportunity for investors to get in early and buy before China and other countries begin to trade their US dollars for hard assets.
History Repeats Itself
When the world convened to make the US dollar the original reserve currency, most members were sold on the idea that the dollar was as good as gold, as it was backed by gold reserves stored deep in the vaults of Fort Knox. At the time, the US was adamant about the gold standard, tying the value of the dollar to the amount of ounces the United States had in its vaults. Member countries felt safe keeping their reserves in the US dollar, knowing full well that they could always exchange their dollars for hard metals at any time in the future.
This thinking has hardly changed from many years ago; nations and their people still want a stable currency, and through the ages, no other currency has performed to the task as gold and silver have.
Silver Shines
One of the biggest differences between silver in 1945 and today is the thousands of modern applications for silver that have developed in the last six decades. This helps lower the amount of silver entering the market, as millions of ounces are consumed each year to create electronics and wiring for consumer goods. Once silver is melted, smelted, and used in circuit boards, it is lost forever, helping to preserve the value of silver held by investors.
Subsequently, each unit of physical silver (such as coins, bars, bricks) owned by investors appreciates as rarity increases, and with the industrial world using more and more of the metal, it is assured that the price of silver can only go higher. Dr. Jeff Lewis
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Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com
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