Did you miss Friday’s Southbank Live event about the death of the petrodollar? You can watch the recorded version here.

And, in keeping with what Boaz Shoshan and John Butler spoke about, let’s kick off today’s Fortune & Freedom with a clever point made by a reader about the collapse of the global reserve currency, the US dollar…

Dear Nick,

 Not long ago a reader asked you if you thought that the American dollar would collapse, and, in your answer, you said, “Collapse against what? When every country is a” rogue state” at the same time…. “

This put me in mind of a story by G. K. Chesterton in which he discusses the cleverness of the criminal mind and he poses the questions:

“Where would one hide a pebble, so that it would be least likely to be found?…… On a pebbly beach.”

“Where would one hide a leaf?…. In a forest.”

“And where would one hide a dead leaf?….

(With reference to the criminal in the story who was wishing to hide the man he had murdered, the connotation being that one would create a situation in which there was a heap of dead bodies to which the murdered man could easily be added).

And so where would one hide a collapsed currency?…. In a heap of other collapsed currencies…..???

Is this then the explanation for so many of the strange things that we see going on around us now? You comment that some other currencies might collapse sooner than the dollar. Conveniently hiding the fact of the major collapse from general understanding?

Keep up your well-balanced and thought-provoking work!

Yours sincerely,

C.P.

That’s a great analysis. I don’t think any individual nation could get away with what the likes of the Bank of England, the Federal Reserve, the European Central Bank and others have been up to this pandemic. Their currencies would crash.

New Zealand got a taste of this recently, when a single Covid case suddenly made monetary tightening dramatically less likely – and so the NZ dollar suddenly plunged.

But, when all nations pursue the policies together, so many of the consequences are hidden. That’s one reason I favour investing in gold – the currency which central bankers can’t print.

Another angle is that exchange rate manipulation is a basic part of what governments get up to. Which sounds controversial, but take a look at the last 100 years of history. Examples of co-ordinated currency intervention are everywhere.

In 1922, representatives from 34 nations gathered at the Palazzo di San Giorgio in Genoa to design a new currency system for international trade. They had to determine what would replace the gold standard which had fallen apart after World War I.

Under the new system they came up with, citizens could no longer redeem their government-issued banknotes for gold. At least, not realistically. Only untenably large gold bars were available to citizens looking to convert paper money into precious metals, as they were technically still entitled to do.

Central banks, however, could redeem currency for gold coins or bars, allowing for trade balances between nations to be settled in gold.

The effect was three-fold:

  • To separate gold from the money that was actually used from day to day.
  • To keep the gold of governments safely in the vaults of central banks, thereby safely backing the national currencies.
  • And to prevent citizens from being able to opt out of the national currency by redeeming their banknotes for gold.

In other words, the Genoa Conference made us as citizens and traders dependent on the money of governments when we go about our daily business.

Twenty-two years and most of another world war later, the most famous currency reset in history occurred in Bretton Woods, New Hampshire.

While World War II still raged, 730 delegates from all 44 Allied nations met to hash out the new international financial order that would begin after the war.

What they came up with is a little complex… but notice the way they controlled exchange rates.

Under the Bretton Woods System, exchange rates between currencies were pegged within 1% of each currency’s convertibility to gold. They did this in practice by pegging each currency to the US dollar and the US dollar to gold.

Both Genoa and Bretton Woods were dominated by the issue of war debts and how to deal with them given the constraints of gold standards. The currency system chosen focused on that problem. A similar problem to the one we have today – too much debt and too many financial crises. I wonder if our coming currency reset will look similar…

The next currency reset occurred because of the trade imbalances which fixed exchange rates under the Bretton Woods system had created.

Bretton Woods fell apart when President Richard Nixon “temporarily” suspended the gold window in 1971 – which was exactly how the Genoa System and the gold standard that preceded World War I, had fallen apart too.

Nixon’s “temporary” suspension was designed to create time for another meeting to fiddle with exchange rates again. And that was held at the Smithsonian Institution in Washington, DC, in December 1971. The outcome is known as the Smithsonian Agreement.

Under the Smithsonian Agreement, currencies were allowed to fluctuate 2.25% instead of just 1% as before. And the dollar was devalued against gold. But this fell apart when nation after nation abandoned the agreement’s fixed exchange rates in what amounted to the currency war of its day. They devalued their currencies, a bit like we saw after the 2008 crisis. But the result was a new financial order – as an era of floating exchange rates was born.

Not that this prevented governments from fiddling with exchange rates. Between 1980 and 1985, the US dollar appreciated 50% against major trading partners, effectively making trade incredibly expensive for anyone but the US to conduct. (The same thing happened during the Covid-19 crash and 2008.)

To devalue the US dollar and restore order, the G5 finance ministers (the US, UK, France, West Germany and Japan) met at the Plaza Hotel in New York City in September 1985 for another currency reset.

The Plaza Accord aimed to devalue the dollar against other key currencies to rebalance trade flows in a coordinated and cooperated way. It was market manipulation by a cartel of governments, but for a good cause.

But the central bankers and governments overdid it, triggering a collapse in the US dollar against the other major currencies. Another side effect was the asset price boom and bust in Japan’s bubble economy.

A year and a half later, the now G6 found themselves in Paris sorting out the mess of their previous currency reset by coming up with a new one.

In the Louvre Accord of 1987, the G agreed to stabilise currency markets with an awkward compromise. Currencies would be allowed to fluctuate, but only to a certain extent. Like the Smithsonian Agreement, this failed and another era of floating currencies began… at a global level.

In Europe, the story was different, given that a major story of the 1990s involved the European Currency Unit (ECU), the Exchange Rate Mechanism (ERM) and road towards the euro. However, that’s a story for another book.

As is the role which pegged exchange rates played in the Asian financial crisis.

The point is, currency manipulation is a basic part of government policy which has been visible every few years over the last century.

The real question is what they’ll come up with next.

Or whether the people decide to impose their very own currency reset on the government instead.

Nick Hubble
Editor, Fortune & Freedom