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Currency Endgame in Progress?   October 6th, 2009
While Obama is busy devaluing the dollar, others are abandoning it       

 
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It's hard to tell whether this is real or conspiracy theory, but the rumblings of a worldwide move away from the dollar have definitely entered the mainstream this year. And the latest article is worrisome.

In the most profound financial change in recent Middle East history, Gulf Arabs are planning along with China, Russia, Japan and France to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.


The ramifications of a move away from dollar-dominated oil would be huge.

For decades we've been paying for imported oil and goods with money that we print. If we want to buy something from China, we pay them in money we print. If we want to buy oil from Arab countries, we pay them in money we print. Meanwhile, they amass an increasing mountain of our printed-dollars and inevitably either buy stuff from other countries with their dollars (because other countries want dollars to buy oil, too), or they just horde them.

The problem is that as we print more and more money and our national debt reaches astronomical levels, the world is legitimately worried that our dollar may not be worth much in the future.

Our dollar is already losing value. Consider that a foreigner who had $2 trillion in February 2009 would today, 8 months later, have the equivalent of $1.74 trillion because the dollar has lost 13% of its value in just over half a year . And if President Obama keeps spending the way he has promised, things are just going to get worse.

Unless the stock market tanks and causes trillions of dollars to flee from the stock market to government bonds, it seems unlikely that the Federal Reserve will really be able to stop buying government debt (printing money) this month as planned. It's only with newly-printed money that Obama has been able to spend the money he already has. With the Federal Reserve supposedly finishing its purchases of government debt this month, there's not going to be enough money available to borrow. So unless the stock market crashes and people buy government bonds, it seems entirely likely to me that the Federal Reserve will not stop buying Treasury Bonds (they hinted as much back in May)--or they'll stop briefly and then be forced to start again in order for Obama to be able to borrow all the money he wants to borrow.

So clearly other countries have legitimate concern about the value of the dollar. We can't just keep running the printing presses and expect other countries to accept our newly-printed dollars as payment for real commodities, such as oil. Those countries are obviously getting uncomfortable with accepting monopoly money in exchange for real goods. So it looks like, just like China and Russia, more countries are now getting worried and looking for some assets they can trust.

And that asset isn't dollars.

Who cares? We must care. If oil is no longer priced in dollars, that means we'll have to buy oil in some other currency (or basket of currencies). That means that we'll no longer be able to buy oil with money we've printed. We'll have to acquire this alternative currency just like other countries have acquired dollars--by selling stuff.

But what do we sell to other countries? We've had a massive trade deficit for decades as we buy stuff we can't afford with money we don't have. If oil is priced in some other currency, the U.S. will have to purchase that currency in order to buy oil. There's only two problems: 1) We either have to export stuff other countries want so that they pay us with that other currency so we can buy oil or, 2) We have to have a strong dollar that others want dollars even though they don't want to buy anything from us.

And the problem is that neither of those are the case. We don't export nearly enough stuff to other countries to buy oil priced in another currency, and other countries no longer have confidence in the value of our dollar.

To make matters worse, the only reason that China has been loaning the U.S. Government so much money is because they don't have anything else to do with it. If an alternative currency becomes used for oil, China will also want to be paid in that currency--so they can buy oil. And if China is paid in that new currency, they won't have a need or desire to invest that money in U.S. Government bonds.

What that means is that China and other countries would no longer be loaning us money for our spending binge. And that's actually a good thing in the sense that it will force us to choose literally between being fiscally conservative or becoming an absolute banana republic like Zimbabawe's million percent inflation. We would hope Obama would choose fiscal conservatism, but you never know.

In a best case scenario--where Obama chooses draconian and immediate fiscal conservatism--the impact would be massive and swift. While I certainly approve of fiscal conservatism, you can't go cold turkey. This kind of forced fiscal responsibility would essentially require us to pretty much balance our federal budget immediately. Cutting about $1.8 trillion (the amount of our deficit) from the federal budget in a year or two would be an economic shock of massive proportions. The government would be forced to massively increase taxes, lay off government workers, unemployment will increase, there would have to be significant reductions in entitlements, perhaps sack our military, and interest rates would most likely skyrocket (unless the economy collapses into recession and no-one wants to borrow money).

This kind of reckless deficit spending is quickly pushing the world away from the dollar as a reserve currency. If the world finally gives up and makes the move, things are going to change real quick.

We are the strongest military power in the history of the world right now. But our Achilles Heel is our drunken spending. Ironically, the liberal economic policies that Obama is implementing require the ability to borrow money from the world--but those same economic policies will eventually lead to the world refusing to loan us money.

If the world drops the U.S. dollar as its primary reserve currency, the current recession will be a drop in the bucket in comparison to what we'll experience. And if we are forced to choose between feeding ourselves and supporting a strong military, which will we choose?

Obama's current level of deficit spending represents not only an economic risk, but consequently a strategic military risk to the security of the United States.

Update Next Morning: I didn't mention this in the commentary above, but it should be noted that if oil is priced in something other than dollars, another consequence would be an immediate significant drop in the value (exchange rate) of the dollar.

Given that we import far more than we export, just about the only real reason for foreign countries to hold dollars is to buy oil--because that's the currency oil is priced in. If oil is no longer priced in dollars then that's one less reason for foreigners to hold dollars. If you take all the oil-related demand away from the dollar, that'd be a major decrease in dollar demand--and that would lead to an even lower value for the dollar even if nothing else changes.

I have no idea how much value the dollar would lose as a result, but it'd be significant. And that means not only would we have to purchase the foreign currency by exporting our products, it means the number of dollars we'd need to buy the foreign currency would increase.

Short story: Oil would become a lot more expensive for us to buy in the U.S. And since the value of the dollar would decrease, everything we import would become significantly more expensive.

    Update 10/6/2009: The same report I quoted caused significant moves in the gold market today, sending gold to a new record-breaking high.

    Oil and gold prices surged Tuesday, with gold hitting an intraday record high, after a news report sparked widespread talk about the U.S. dollar being unseated as the currency for trading oil and gold...

    The dollar managed to regain some ground by midday after finance officials from Saudi Arabia, Japan and Russia publicly denied that such a plan was in the works...

    But an end to dollar-denominated oil could also result in higher prices for energy consuming countries, which would potentially have to buy crude in a stronger currency, he added.

    That could eventually trickle down to the filling station and drive up gas prices. "It's negative for any kind of energy consumer," Pawlicki said.


    The same risks (higher energy prices from having to buy crude in a stronger currency) are mentioned as in my article. Of course the finance officials from the supposedly-involved countries denied the plan was underway--and it's possible there is no such plan. But who knows.

    Update 10/6/2009 3:50pm: Peter Schiff released a video saying almost exactly what I wrote last night.




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