What will kill the dollar?

Kish Island in Iran is famous for two reasons: it’s the place where FBI agent Robert Levinson, the longest-held hostage in American history, was kidnapped in 2007; and it’s the free trade zone Iran picked for its new Iranian Oil Bourse. But don’t expect to find prices quoted in USD per barrel there. Mahmoud Ahmadinejad, the last president of Iran, officially excluded dollar payments for Iran’s large oil reserves.

Tensions between Iran and the US are hardly news, but other emerging markets are now starting to turn their back on the American currency.

The US dollar has been the world’s ‘petrocurrency’ since the Opec agreements of 1971 and 1973. It has also become the world’s de facto reserve currency. But faced with increasing currency turmoil, some emerging markets are starting to look at other options.

The Turkish lira is in freefall and the Russian rouble is plumbing new depths. Yet both Turkey and Russia  were among the select few central banks piling into gold over the last year. And more and more countries are now trading in Chinese yuan or Russian roubles. So has the tide turned for the American currency? The short answer is: not yet. But until that day comes, I’d recommend holding some gold in your portfolio, 10% at the very least.

How empires end

No currency remains the world’s number one forever. Here’s a handy little infographic courtesy of JP Morgan for some historical context…

Reserve currency status does not last for ever

Historical world reserve currencies

Source: JP Morgan Chase

On average, no currency has dominated world exchanges for more than a century. And it’s certainly true that both the Russian rouble and the Chinese yuan have become increasingly important in international trade. Brazil, South Africa and countless other ‘rogue’ nations have formed new trading blocs with Russia and China, with countless deals denominated in both roubles and yuan. Cutting out New York in currency transfers is a growing phenomenon. In fact, Iran (barred from US dollar transactions) has exchanged oil in lieu of gold.

Trade can and will increasingly be done without the blessing of the world’s biggest banker, the USA.

But that’s not to say the US loses its reserve status. At least not yet.

Bitcoin, roubles, or yuan?

Though many in the web-o-sphere will tell you that the Chinese, Russians and, perhaps, many more, are hatching up a grand plan to depose the dollar’s reserve status, it’s not strictly true.

You see, establishing a trade currency – or  any sort of barter – is but the first step.

International trade can be done in any currency. Yes, it’s true that the dollar is the preeminent currency, but it is by no means the only currency. I mean, you can use bitcoin if you prefer.

But a trading currency isn’t the same thing as a reserve currency. In fact, it’s one reason I’ve never really quite come to terms with bitcoin. Sure, as a trading entity, it’s fine. But then what do you do with it? Sit on it? Well, maybe, but heck – it’s a volatile beast. I wouldn’t want to run my business in bitcoin alone!

But maybe this is an avenue for further discussion on another day. Let’s stick to the difference between a trading currency and a reserve currency. A reserve currency offers deep markets in which to invest your spoils. For the moment, neither the rouble, nor the yuan offer a global solution for investor needs.

The Chinese government isn’t a borrower (at least not to the extent of the West) so there’s no significant bond market to stash your yuan. The Russian bond market is thin and still suffers dire investor sentiment following the painful 1998 default.

Become your own central bank

For the moment, we’re all stuck with the US dollar reserve system. For all its ills, it provides the global liquidity and investability that’s required of a reserve system. Other trading currencies have and will continue to proliferate, though that’s more to do with avoiding the banking system.

But for countries, or individuals, wishing to extricate themselves from the dollar reserve system, the only global alternative is gold, a currency that fits very neatly with reserve status. The emerging world sees this, and that’s why they’re buying. Forget all about the fact that other trading currencies are proliferating – that’s a red herring.

Gold may not be the world’s next reserve currency, but during the transition period, I suspect it will provide a pivotal role. It’ll probably form part of the mechanism that spans the chasm between the dollar and the new ‘thing’.

Just remember, the dollar is not dead, even as new forms of trading currency appear. But the day will come when the world needs to move on to the next reserve currency. And whatever that is, to my mind, it’ll probably have the price of gold ingrained in its value.

I’ve said it before, and I’ll say it again: the safest thing to do is to become your own central bank and hold your own reserves. And the only way to do that is to hold gold – 10% of your portfolio at the very least.

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  • Sceptical

    I’m inclined to the view that the USD will remain the reserve currency for quite some time, particularly when/if the USA starts to export the product of its shale gas etc revolution.

  • vanHunks

    You wrote : “Gold may not be the world’s next reserve currency, but during the transition period, I suspect it will provide a pivotal role. It’ll likely form part of the mechanism that spans the chasm between the dollar and the new “thing”. ”

    It would be interesting to see on the graph an indication of demand for gold (price, volumes traded, volumes mined etc – I’m not an economist) and if it’s correlated with the evolution of the reserve currency over the centuries, if such data are available.

  • osprey

    “investibility” (?!?) … that’s some construction, bengt … proof, i suppose, that languages evolve!

  • 4caster

    The transition from one Reserve Currency to another is much more gradual than you suggest. Sterling was still being called a reserve currency in the 1950s, along with the dollar, even though it had been devalued again the dollar at least twice.
    When I worked in Singapore from 1968 to 1971, between 5 and 8 years after independence from Britain, the Singapore Monetary Authority was still talking about their “Gold and Sterling Reserves”.

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