After World War II, leaders of the victorious Allied countries met at Bretton Woods in the United States and agreed to make the U.S. dollar the world’s reserve currency. Under that agreement, the U.S. government guaranteed that other central banks could exchange dollars for a fixed amount of gold. But a couple of decades later, President Nixon closed the gold window and chose instead to establish a system in which the dollar became an unsecured IOU. Since then, the dollar’s value has depended entirely on the world’s confidence in America’s economic stability.
Governments and financial institutions reserve U.S. dollars as a hedge against fluctuations in the value of their own currencies. About two-thirds of the world’s currency reserves are in U.S. dollars. And major commodities – crude oil, gold, wheat, cattle, orange juice, coffee, sugar, etc. -are priced and traded in U.S. dollars. The resulting global demand has added significantly to the value of the U.S. dollar over the past several decades.
But the dollar is rapidly losing it luster. In recent years Americans have bought much more than they have sold and the government has borrowed huge amounts to finance its operations. The national debt is galloping toward eleven trillion dollars. And federal budget deficits loom far into the future. In 1965, the United States of America was the largest creditor nation in the world. Today, it is the world’s largest debtor nation. Major American banks and financial institutions have borrowed recklessly to finance the purchase of mortgage backed derivatives, which proved worthless when the housing bubble burst. And the U.S. government has so far been unable to stabilize the financial system – despite pouring hundreds of billions of dollars into the baks as loans and equity investments.
Now, the world is understandably losing confidence in the American dollar. A U.N. panel is recommending the replacement of the dollar as its reserve currency. Instead the U.N. would reserve a “basket of currencies.” Russia has significantly reduced its dollar reserves in recent years and is planning to propose the creation of a new reserve currency at the G20 meeting next month.
These signs are pointing to a possible collapse of the American dollar, with disastrous implications for the stock market and a far-reaching ripple effect throughout the world. It’s no wonder so many people are buying gold. When I was a young reporter in the gold mining town of Timmins Ontario, half a century ago, the precious metal was fixed at $35 an ounce. Today, gold prices are hovering near $1,000 an ounce, and it’s a pretty safe bet that it will go even higher.