Divorcing the Dollar and Marrying Gold

by Michael S. Rozeff

With their money and banking system having presented them with a case of system failure by
disintegrating before their eyes and taking the economy with it, America’s economic experts who
support and run the FED’s central banking-inconvertible paper dollar system cannot place the
blame for this where it belongs, which is on the system itself, its supporters, and those who make
its policies. They cannot bring themselves to diagnose the system’s ills and rectify them because
they are at the center of them. They cannot stare the failure of inconvertible paper money
squarely in the face and move to eliminate it. If they did, they’d be out of jobs and out of power.

American central bankers, manned by expert economists, have in vain dealt with the crumbling
banking system and dollar by manufacturing massive new credits infused into the players with
the most leverage and the weakest balance sheets. In the not-too-distant future, this promises to
unleash a second and greater credit debacle that may unravel the entire system and bring down
the government with it.

A good many foreign central bankers are no better at the inflation game than the FED, as they too
have presided over banks swollen with overpriced real estate and other loans. Many of these
central banks, sharing the aversion to non-income-producing gold, have elected to hold U.S.
Treasury securities as assets and to issue their individual currencies against these assets, thereby
producing a derivative currency whose value depends on the value of U.S. Treasuries and the
dollar in which they are denominated.

Suppose a foreign central bank holds U.S. t-bills as its main asset. Against this it issues its main
liability, which is its own currency. Now suppose that the U.S. dollar falls in value by
depreciating against gold. The reserve asset, t-bills, is now worth less against gold. Hence, its
currency must be worth less against gold too.

Suppose that the central bank held ruble bills, and Russia drove the ruble to much lower worth,
then the bank's derivative currency would also fall in worth. But this might not happen right
away because the people who use the currency cannot redeem it in anything of value. People will
continue to use the overvalued currency as money for a period, until they recognize that it has no
backing. At that point, they will attempt to rid themselves of their low-worth currency. They will
shift to currencies, goods, and assets, such as gold, that have known values. Prices in terms of the
low-worth currency will rise.

Foreign central banks have often ignored or sold off gold. The central banking experts have not
understood the central position of gold as a reserve asset of unquestioned liquidity, acceptability,
and value. Instead they have fallen into the trap of holding securities as reserves. They have taken
on a counterparty risk that gold does not present, that counterparty being the central bank that
issues the currency in which the securities are denominated. For what happens to the values of
these foreign currencies when these securities held as assets decline in value, which they do when
the dollar declines against gold? Since these dollar assets stand behind the foreign currencies,
these currencies must also decline in value against gold. U.S. inflation in this way, through
central bank holdings of U.S. securities as reserve assets, is exported to the world.

The fateful step away from gold occurred on August 15, 1971 when President Nixon closed the
gold window and stopped redeeming the claims of foreign central banks in gold. Now, 38 years
later, some of these banks are in the most halting fashion taking steps to get off their self-chosen
hook, which is the connection of their currencies to a watered-down dollar whose own link to
gold grows weaker with every FED purchase of mortgage-backed securities.

If one or more foreign central bankers, such as those in China, Russia, Brazil, and the Middle
East, have finally decided that they no longer wish to accept dollars that are inconvertible into
gold, they have no choice but to establish their monetary systems with gold as a reserve asset.
Press reports suggest that they do not yet acknowledge such a move in the full totality of its
meaning or in their own actions. We read of replacing the dollar by the SDRs of the IMF. We
read of replacing the dollar by a basket of currencies, such as the yen, the euro, and the yuan.
These are less-than-halfway measures and they cannot succeed in producing a sound and stable
international monetary system.

Replacing one currency that is inconvertible into gold with a mix of several other currencies that
are also inconvertible into gold won’t produce sound currencies and sound banking systems. The
central bankers want freedom from the dollar and FED slavery. This they have made clear, but
they still want to maintain the discretion to inflate their own currencies. The statements of central
bank experts and officials do not remotely acknowledge that they wish to produce a fully gold-
based system.

Their actions, however, can only go in one direction: toward holding more gold as a reserve
asset. There is no other way to sever the link to the dollar. If securities denominated in yen, yuan,
and euro become major reserve assets, what is to stop the respective central banks that produce
these currencies from inflating them? Only if they hold gold in a respectable proportion to their
currency liabilities (at least 40 to 50 percent) can a degree of stability in exchange rates be
produced. Foreign central banks cannot obtain a final divorce from the dollar without marrying
gold. If they seek the mistress of a basket of currencies that is not firmly linked to gold, they
substitute one unstable partner for another.

Intellectual experts turn dangerous when they acquire a degree of unchecked power. Central
bankers have this now, and they are dangerous now. They are not anxious to give up this power.
Divorce from the dollar is a means of acquiring more power. This will not solve the people’s
problem, which is to have a stable money and a stable banking system, not unless the system
moves toward gold as the reserve asset.

The last thing that an expert with a high degree of unchecked power wants to do is publically
admit deep error on his part or that of the system of which he is a part. This is tantamount to
admitting his responsibility to the public. It means that his power is in some degree not
unchecked but conditional on public approval and confirmation. It means that his expertise is
questionable and/or the system of expert rule is itself questionable. The rightness of one’s power
does not inspire confidence when one admits that one is continually misusing it.

One cannot expect Ben Bernanke or Alan Greenspan to defrock themselves as priests of the order
of central bankers. What they do in the face of difficulties for which they are responsible is blame
someone or something else. They obfuscate and cloud the issues. They use complex language.
They fabricate stories and make up history so as to extract benefit from their own errors. They
paint themselves as essential saviors for any problems that have arisen. According to their self-
promotion, they are working tirelessly to come up with remedies for these unforseen problems.
They are quick to devise and advertise new solutions. These always involve the further use of
even more experts, not to mention themselves. Their remedies always involve more power to the
experts, never less, except as a tactical maneuver. Nevertheless, the day is approaching when
these experts will be forced into a position of uttering a syllable that they now are reluctant to
acknowledge. That syllable is – GOLD.

On the first day of 1975, gold became legal for U.S. citizens to own. This was an enormously
important step toward reinstating gold as a reserve asset. As foreign central banks move out of
dollars into currencies with greater gold backing than the U.S. dollar, and as people in their own
wisdom move out of U.S. Treasury securities and into gold, for the sake of safety and wealth
preservation, the gold window closed by Nixon will be, for all practical purposes, reopened.

It is of the utmost importance that the private market in gold be kept open so that its discipline,
brought about by those who seek gold out, can act, albeit indirectly, upon the FED and the other
central banks. Stressing the economic importance of having this market open does not mean that
I now see a substantial risk of the market for gold being closed to U.S. citizens. I do not. There is
some risk, however. Desperate officials can take desperate actions in desperate circumstances. I
can imagine scenarios in which powerful experts and officials blame a rise in the price of gold
for inflation that they have caused or in which they take action against gold because of severe
economic problems that they have brought about. Such moves would, in conjunction with other
such controls, tend to isolate the U.S. from the world economy, which would drastically
undermine the U.S. economy. I certainly hope that nothing like this transpires, and I don’t think
it’s the most likely possibility. I believe that, rather than going the way of Argentina, currency
reform is a more likely outcome if the economic problems mount up to an unmanageable level.

In the end, no matter how the divorce from the inconvertible dollar occurs or what travails we
must go through to get the final decree, the outcome is going to be a marriage to gold.

October 7, 2009