Death of the Dollar: A New World Money

Since the creation of the international monetary system, the divide over financial and monetary policy has always been present. With the evolutionary rise in power of a new world money, everything has changed.

Understanding the history, construction and evolution of this new world money system will allow you to better position yourself for the future.

The U.S dollar has been the world’s reserve currency for decades since World War II. The dollar has been synonymous with strength, stability and general confidence in the United States Government.

That is all in question now.

Studying the real history of the special drawing rights (SDR), what some have coined as new world money, will allow you to understand exactly why the evolution of the international currency matters even more today.

“Good as Gold”

Following the conclusion of World War II, the United States held an estimated 60% of all of the world’s gold reserves officially on record. As one of the few regions that was geographically isolated from being a physical battleground, war-inflicted countries had high demand for U.S goods and services that were continuing to produce at high levels without major disruption.

The massive flow of capital both in and out of the United States in the 1940s left considerable fear of dollar shortages in order to account for demand.

As European countries began to rebuild, so did their gold and dollar reserves.  Once the European continent and other developed countries began redeveloping their national currency institutions, an overwhelming demand to convert dollars back to gold began.

The U.S status as “good as gold” was no longer as hot on demand as the ultimate reserve currency. The international demand hit critical mass and pressure mounted for a diplomatic resolution.

The IMF: Aftermath of WWII

Developed at a United Nations gathering in Bretton Woods, New Hampshire in 1944 the international community sought to build a new monetary system.

The gathering was officially titled the United Nations Monetary and Financial Conference. The outcome would bring about the creation of International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF). These institutions were the first of their kind.

The IBRD would later develop under the World Bank Group of organizations which would be responsible for developing poverty reduction programs. The World Bank primarily functions as an institution that offers loans to developing countries and a variety of infrastructure based projects in the developing world.

At the time the organization was built up with 44 member state countries.  Respectively, every participating member put forward constructive efforts to build a method for economic cooperation in order to not only save succeeding generations from the scourge of war but to avoid another Great Depression of the 1930s that devastated the global economy.

At the time of its creation the IMF was established in order to maintain stability and effectiveness of the international monetary system.  The IMF was directed by the participating member states to ensure a secure system of exchange rates and ultimately facilitate countries in having international financial transactions with one another.

Tradition

The IMF maintains a history of selecting executive leadership of European nationality.  The organization was a de facto European rebuilding and restructuring facility upon its creation at the conclusion of World War II.  The European continent was in economic disarray and required significant coordinated effort to emerge from the deep divide created.  As an institution created primarily by western member states, it became a mechanism for the west – by the west in many ways.

Monetary policy and financial discrepancy was, then, at the forefront of IMF focus in redeveloping Europe.  That would quickly evolve as the IMF began to reach into the financial dealings of nearly every major economy around the world.

Since that time, the modern age of the IMF has held tight to its tradition of promoting Europeans to lead as Managing Directors of the Fund. Recently, scandal has flooded the leadership ranks of the Fund.

The former head of the IMF, Dominique Strauss-Kahn, was forced in 2011 to resign after a major required him to step down.

Currently, Christine Lagarde, another French national holds the title of Managing Director. Lagarde is the fifth French head of the organization and the first female to hold such a role. She has also face considerable legal backlash and eventually was convicted in French courts on charges of misusing public funds.

Examining its counterpart, the World Bank is currently under leadership of its 12th American leader. American nationals have unanimously held the Presidency role at the World Bank since the Bretton Woods inception.

Both organizations are headquartered in Washington, D.C and are within several blocks of the White House. The traditions held of both the IMF and the World Bank will later prove to be critical in the shaping of this new world money.

As the spread of the fiat currency system continued, it took leadership finesse to not only sell the system being proposed – but to impose a system to rival the dominance of the U.S dollar in the future. World money was not the end goal, it was a byproduct of leadership understanding and member state desires for separating from the U.S dollar.

Soviet Opposition

At the time, the United States controlled nearly two thirds of all of the official gold reserves in the world.

Under these conditions, the U.S dollar and gold would be the standards at which the world would flock toward for security and stability.

During the Bretton Woods gatherings, the former Soviet Union was present and had representatives in attendance but would decline ratification of the final conclusions from the meetings.

The USSR would charge that the institutions creation were simply, “branches of Wall Street.”

A later Soviet Foreign Ministry memorandum discovered from December 1945 revealed the central sentiments of the gathering by summarizing,

“It is known that the Americans made credits to Britain conditional on joining the Fund… [A]s the government of the USA did not offer the USSR a credit… our membership in these organizations could be read as our weakness, as a forced step taken under the pressure of the USA Our negative attitude toward membership in the Fund and the Bank would show our independent position in this matter.”

Ben Steil, author of “The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order,” even theorizes that the Soviet Union saw the gathering as a point to instruct a senior U.S. Treasury official who was deemed a Soviet spy, Harry Dexter White to undermine efforts of major British economists.

The Soviets viewed the gathering at the Mt. Washington Hotel in Bretton Woods as the U.S positioning itself to take over from Great Britain’s history of dominance as a global financial power and to officially lament the dollar as the major global reserve currency.

The USSR was not entirely isolated from the international community, however. The Soviets maintained firm engagements at the United Nations where the remained a permanent voting member of the Security Council – allowing them veto power on any international action to be taken by the body.

The Chinese would later take the understanding of the Soviet empire and apply it when navigating world money to come.

Triffin’s Dilemma 1961

Robert Triffin was a Belgian economist that was an academic and professor at Yale and Berkeley College. He is widely celebrated as a gold, international monetary system and overall currency expert.

Within his writing from 1961 on Gold and the Dollar Crisis: The Future of Convertibility, the IMF received its greatest pushback on the value systems inherent flaw, commonly known as the Triffin Dilemma.  What Triffin theorized was that as long as the U.S dollar remained the leader in foreign exchange reserve assets, the world would continuously elevate trade and finance that comes with a growing supply of dollars.

The increase in stock of dollars would, in effect, require a constant deficit in the U.S balance of payments. What Triffin believed was that along with continued deficits, the pressure on the U.S dollar would shake confidence and disrupt the Bretton Woods established monetary systems in place.

This would continue to place considerable pressure on the overall value of the U.S dollar.

Throughout the 1960s and 1970s, the Vietnam War raged on which caused the United States to build up considerable trade deficits, causing the dollar to be seen as overvalued. Those governments who held dollars believed they had to offload, diversify or attain gold in reserves.

The theory highlighted a clear division of interests between domestic and international  objectives in the global economy.  Those official holders of U.S dollars would continue to have a concern that the value of their reserves would (or could) decrease in comparison to the value of gold.

Group of 10 Meeting 1966

The “Group of Ten” that consisted of the Ministers and Governors of the countries participating in the IMF issued an official request for international collaborative research on improvements needed to the international monetary system. By 1966 the IMF produced a report on behalf of guidance from its 4th Managing Director, Pierre-Paul Schweitzer.

Schweitzer was a French national who even survived internment in a Nazi concentration camp. Under his leadership the IMF produced a now infamous annual report that highlighted the “Need for Reserves.” He understood well the need for monetary funds outside of a centralized system.

The report concluded that:

“Countries would use reserves in the form of automatic drawing rights in the same way as they now use existing drawing facilities in the Fund, i.e., by purchasing foreign currency from the Fund in exchange for their own.”

It went on to set the foundation that, “Drawing rights are thus effectively transferred from the drawing country to the drawee country; the currencies purchased are used directly, or after conversion, for the settlement of international transactions.”

Keynes and Visions of World Money

John Maynard Keynes, a British economist, developed his own type of international currency after elaborating in his notable works in The Means to Prosperity (1933) and his proposal for the creation of an International Clearing Union (1944).  Keynes developed a conceptual theory of expanding the global integration of a single international monetary policy.

Keynes took it a step further. His proposal was for a new supranational currency, which he titled bancor, that the celebrated economist later devised should be used as international standard. He wrote:

“We need an instrument of international currency having general acceptability between nations… We need an orderly and agreed upon method of determining the relative exchange values of national currency units… We need a quantum of international currency which is governed by the actual current [liquidity] requirements of world commerce, and is capable of deliberate expansion. We need a method by which the surplus credit balances arising from international trade, which the recipient does not wish to employ can be set to work…”

Sourced via IMF reform on Keynes Plan

What Keynes developed was what some consider the original groundwork for SDR’s. His idea of bancor may have been more cosmopolitan, but the theoretical commodity at least had a proposed backing that included gold.

In comparison, what would later become SDRs are constructed purely of confidence in the system.

While Keynes might have had commodities integrated in support of his fictitious currency, the SDR does not even offer to make such arrangements in the future.

September 1967

Finance ministers gathered in Rio de Janeiro to discuss bookkeeping issues in September 1967. The creation of the Special Drawing Rights was officially outlined. The terminology of “special drawing rights” were given as an alternative to “reserve drawing rights” after the French leadership of the organization insisted that the SDR unit would be observed as a loan from the IMF, not a currency unit.

This SDR would be offered as a direct substitute for supplementary gold and dollar reserves held by government organizations, primarily central banks.

After continued French opposition to currency unit status and pressure toward creating an autonomous IMF “loan unit,” the SDR would be implemented for repayment purposes, and not have associated inflationary fluctuations. This distinction would be highly disputed and shape the eventual direction of new world money.

U.S Reaction

The U.S Treasury Secretary in 1967, Henry Fowler, remarked, “”This is the most ambitious and significant effort in the area of international monetary affairs since Bretton Woods.”

Even the U.S Federal Reserve Chairman William McChesney Martin, who rarely made public statements or positive reaction called the agreement for SDRs a true “milestone” for the United States.

By 1968, a year later, Chairman Martin testified before the United States Senate Committee on Foreign Relations noting that,

“Establishment of the system of Special Drawing Rights in the International Monetary Fund will mean that the growth of international monetary reserves will for the first  time be subject to rational international decision. The need for establishing such a system arises from vital  interests in maximum employment, production, and trade.  All countries want their reserves to grow over time, with the growth of international trade and payments, but the supply of existing kinds of reserve assets, including gold, clearly will not be enough to meet this need.”

The Fed had officially made its argument to the U.S government in full, following the international efforts, to back the SDR and have the U.S be an active participant in the monetary system.

This new world money not only had a name, now it had value given from the strongest economic authority.

New World Money Emerges 1969

Meeting on October 2, 1969 the “Group of 10” would officially agreement to support the creation and applications of the SDRs. The unanimous vote was met with caution from all sides, as the U.S viewed the European block as a threat and consequently the Europeans (in particular the French) were hesitant about the influence of the U.S dollar.

News of the drawing rights vote never managed to make it to front headline news. The New York Times ran the story on page 78 and devoted a meager 10 lines to the landmark deal.

The new world money at the time of its creation was set at an equivalent to 0.888671 SDR for a gram of fine gold. At that time, the exact figure just so happened to also be the amount of gold that could be purchased with one U.S dollar.

This world money would officially equal the amount of foreign exchange reserves for which a member country was allowed to contribute. The SDR could only be held and utilized by member countries, the IMF (which applied it as a unit of reserve accounts in holding), and specifically designated organizations (like the World Bank).

As one academic study concluded:

“Even in 1967, Otmar Emminger the Vice President of the German Bundesbank asked whether the SDR “is a zebra a white horse with black stripes or black horse with white stripes” (Eichengreen, 2011). Emminger doubted that the implications of establishing an alternative to the Triffin Dilemma would make any difference to the status quo.”

Economist Jim Rickardsreviews, “So the U.S ran trade deficits, the world got dollars and global trade flourished. But if you run deficits long enough, you go broke. That was Triffin’s dilemma.”

“Any system based on dollars would eventually cause the dollar to collapse because there would either be too many dollars or not enough gold at fixed prices to keep the game going.”

“This paradox between dollar deficits and dollar confidence was unsustainable.”

In the chart listed you will find the first allocation of special drawing rights listed out with the top ten net contributors to the mechanism from January 1, 1970.

The underdeveloped countries that contributed had allocations of SRD’s that totaled $275 million, or about one half of the amount allocated to the U.S in the first year.

The benefits of this so-called “paper gold” would be monopolized by the victors of WWII and the primarily western member states. The SDR would be applied to emerging markets as a tool of the developed world, for the developed world.

Nixon Nix’s The Gold Standard

As the United States continued attempts to repair its trade and budget deficits, the world began to lose confidence in the reserve status of the almighty dollar.

The U.S would not be able to repair, in appropriate timing, its deficit problem. It did quite the opposite. Contending with massive spending during the Vietnam War and surrounding Southeastern Asian countries,it only deteriorated further. The hit took its toll on Fort Knox with continued demand as Switzerland, France and Spain drained U.S. gold supplies.

While SDRs did exist in theory at the time, they were not applied in practice.

Nixon would see this as a golden opportunity.

In a surprise interview that aired on national TV, Nixon addressed the nation (and the world).  In what many deem as Richard Nixon officially removing the U.S from the gold standard what he actually did was merely set up the beginning of the end for the commodity link to the dollar.

On August 15, 1971 Nixon officially ordered all conversions of U.S dollars to gold to be “temporarily suspended.” The expectation was that the U.S, after establishing new standards and exchange transactions, would return to some element of the gold standard once new appreciation values of paper money to gold were established.

Nixon told the nation that, “the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy–and the American economy is by far the strongest in the world. That would never come to fruition.” He went on to elaborate “I am determined that the American dollar must never again be a hostage in the hands of international speculators.”

The IMF would note in 1972 that, “These moves set in motion a process of appreciation of most major currencies against the dollar in the weeks following August 15.”  What would really take place is a large accumulation of dollars in official holding books.

The IMF would gather on December 18, 1971 after widespread concern about the prolonged economic anxiety over floating exchange rates.

What led to be known as the Smithsonian Agreement would bring about the realignment of the U.S dollar in terms of gold and the SDR. While the SDR, this new world money, would remain unchanged. It proved to set the groundwork as the platform in which the international monetary system would flock to at times of mounting financial turmoil and uncertainty.

The Age of Fiat Currency

By March of 1973 the major world currencies would begin to float against one another.  What this meant was that member states were no longer able, or accepting, gold as a proper form of conversion.

Managing Director Jacques de Larosière signing document authorizing SDR allocation

The collapse of the Bretton Woods system had arrived. With it, members of the IMF would be able to select whatever appropriate exchange rate (outside of gold) and float its exchange against another currency, or “basket of currencies.”

Fiat money, at its core is paper money that has value purely because a government deems it currency. In principle, the strength of a currency relies on the strength of the government and economy that is attributed to the paper based currency tender.

In the chart above, you can see that the increased of foreign exchange reserves tripled in value over the two decades following the major influence of SDRs and fiat currency. Gold had met its match. Fiat had emerged.

As one research report from the Federal Reserve Bank of St. Louis concluded in 1974 at the finalization of the international gold standard, “SDRs can be expected ultimately to replace gold as a primary international reserve asset. The U.S. phase-out of gold as a monetary instrument contributes to that objective.” By 1975 the original Bretton Woods system would be a dead relic of the past.

The IMF would subsequently offer its first issuance of SDRs from 1970-1972 that was the equivalent of SDR 9.3 billion. Then, nearly 7 years later make its next efforts issuing SDR 12.1 billion from 1979-1981.

After nearly thirty years of building SDR reserves, the IMF sprung the fiat currency into real action again amidst the global financial crisis.

While at the G-20 Leaders’ Summit held in London, newly elected President Obama rallied his fellow G-20 leaders for a general SDR allocation of $250 billion to aid what the U.S Treasury Department identified as “a serious capital drain and the contagion risk facing emerging market and developing countries. The action was an exceptional measure taken to address the consequences of the global economic and financial crisis and to support global recovery.”

The actions cumulatively would total a reserve amount allocated at SDR 204.1 billion. That brought the IMF into another realm. It had offered more than ten times the combined issuance prior and SDR’s were now a common term amongst the global elite.

It was the first significant world money move taken in the modern era of the IMF to triage a financial crisis.

World Money “Basket Weights”

The IMF deemed the SDR values a “basket of weights” that since 1973 made up the overall consistency of the allocated funds.

What this meant in practice was that the IMF board and leadership would determine every five years the values of select major currencies that would construct the SDR “weight.”

The method of valuation is determined by a 70 percent majority of the total voting power, which consists of a majority of western and developed states.

Within the basket, the financial indicators are distributed in agreed upon equal shares of official reserves denominated in the member’s (or monetary union’s) currency.

The history of SDR valuation includes:

• 1978 The IMF world money basket had 16 contributing members to the SDR.
• 1980 The Funds five largest members reduced the basket to 5 currencies which comprised the basket of U.S. dollar, German mark, French franc, Japanese yen and British pound.
• 1999 The Deutsche mark and French franc were replaced to include the Euro as part of the weighted currency basket. This reduced the currency basket from 5 to 4 participants.

Chart via IMF History 2001 

China and Artisanal Money

After the fall of the Berlin Wall and the gradual inclusion of former Soviet Republics, both Russia and China began to soften to the western dominated institutions like the IMF. Following the global financial crash of 2008, China and other emerging economies began to take leadership roles within the international order.

In 2010, the International Monetary and Financial Committee (IMFC) along with the Ministers from the G20 countries instructed the IMF to construct a criteria system that would allow for expanding the composition of the SDR basket.

China saw this as opportunity.

The Chinese government officially moved to be accepted into the IMF’s new world money basket but after review by the IMF Executive Board in November 2010, the inadequacies found in the yuan did not meet the criteria to be in the SDR. It would not give up.

Central banks across the globe had blown their balance sheets to astronomical figures in order to combat the crisis of 2008.  The Fed had lead the global charge by injecting trillions of dollars into the U.S economy, but the concern was whether it could do it again.

Jim Rickards, a U.S government advisor and currency wars expert, offers his analysis, “They won’t be able to respond the same way when the next crisis strikes, which I expect sooner rather than later. They’re out of powder.

The only financial institution with a balance sheet clean enough to respond to the crisis will be the IMF. The IMF acts like the ‘central bank of the world.’ It will have to issue massive amounts of SDRs to hold the international monetary system together.”

Whether it was acting based on this understanding or simply trying to integrate the world’s second largest economy, the IMF knew it could not afford to ignore the yuan. In the IMF’s November 2015 review its Executive Board decided to make a move and integrate the yuan officially into the world money basket.

Effective October 1, 2016 the yuan was officially added as a currency measurement to the SDR.  Andrew Tweedie, the Director of the IMF’s Finance Department remarked at the time that, “the inclusion of the RMB in the SDR basket enhances the attractiveness of the RMB as an international reserve asset. This will help with the diversification of global reserve assets.”

Nomi Prins, a former managing director on Wall Street and bestselling author, explores this and offered her take on the financial revelations in the international monetary system. Prins’ is currently working on her latest book Artisans of Money which explores the coordinated relationships of central banks and the global power stakes that have risen of these world-changing events.

Nomi reveals her insights into this artisanal money reporting that, “the Federal Reserve not only overstepped the boundaries of its stated mandate, it galvanized years of similar policies from the G7 countries to the detriment of their own economies and citizens. The IMF repeatedly warned of the dangers of what I call, artisans money policy as did the People’s Bank of China.”

Prins’ has spent time completing research in China and offers, “China was able to push itself into inclusion within the SDR basket, thereby lifting its status as an economic and financial super power and by extension a diplomatic and military one.  The IMF’s SDR is a catalog of this shift to diffuse a US and dollar and Fed cornered reserve currency system.”

World Money and the World Bank

The international community saw Chinese willingness to international inclusion as a new window for world money both in practice and in theory. If China was to be a part of the basket, then western institutions would see how far they could stretch.

The World Bank, an institution continuously under American leadership, decided to test the waters even before the inclusion. In August 2016, the World Bank received unprecedented approval from the People’s Bank of China (PBOC) to enter into the Chinese domestic market of with bonds denominated in SDR’s.  It would be the first step toward launching the SDR bond market in the world’s second-largest economy.

The World Bank would inject 2 billion SDRs (the equivalent to $2.8 billion) in China’s interbank market.  Only a month later China would host the G20 summit in Hangzhou with IMF members watching its every move.

The internationalization of the new world money as a global currency reserve had and officially elevated the IMF to the forefront of a globalized world.  One in which the U.S dollar and the financial largesse of the Federal Reserve was fading.

The Future of World Money

As global trade continues to meander in massive up and down swings, stocks enter new bubble territory and the creeping return of volatility in market many see financial turmoil on the horizon.

A President Donald J. Trump in the White House further highlights this economic agenda and places greater emphasis on what a potential economic collapse looks like. Trump has referenced China as a currency manipulator on Twitter and in multiple public forums.

This will not bode well for a currency basket that requires cooperation from the dollar and the yuan.

Bin Zhao, a senior economist at PriceWaterhouseCooper China told a state-run Chinese editorial paper that following Trump’s currency stance, “China thus has a great opportunity to make a big leap to reform its exchange rate mechanism, to ultimately become a “floating” currency and pave the way for a higher level of internationalisation.”

What this translates to is that China is seeking to make a stronger play on diversifying its currency reserves away from the dollar. It also means that the general public will see a greater impact on trading, currency and multinational influence. Globalism might be treated by some as a four letter word but what it means for the international monetary system is a diversification away from the U.S dollar.

While the general public cannot purchase SDR bonds due to the nature of the currency basket being applied by IMF member states to make loans or tender repayments, it still matters. SDR-denominated bonds will be a big target of multinational and regional based organizations seeking to diversify away from the U.S dollar and other major currency reserves.

The SDR offers governments and central banks the ability to buy and sell these reserves. While it has been used in the past during times of crisis, it could begin to be a move to be used in times of building a “financial war chest.”

Jim Rickards believes that, “The major mechanisms around the world, the balance sheets for the multinational corporations, the funds for major multilateral institutions, global capital markets and even the price of oil will all eventually be denominated in SDRs.”

This new world money may not be overtaking the dollar today, and China might not have the economic capacity to overcome the U.S position in the currency basket – but the positioning of the IMF and the SDR should bring major consideration.

The more powerful the institution, the more powerful the influence.

It is a fool’s errand to believe that the dollar’s value is only set by market forces alone. Confidence is key. In particular, confidence is where world money could offer a complex rival in the future.

Remaining vigilant and mindful of the special drawing rights and the influence of new world money on the dollar will leave you better prepared for the future.

Thanks for reading,

Craig Wilson, @craig_wilson7
for the Daily Reckoning