History doesn’t repeat, but it heaves with echoes and rhythms. Market commentators spend their days rootling through history to draw parallels, to flag lessons seemingly unlearnt. And they are right to do so; there is a cyclicality and flow to financial events and trends that justifies such an approach.
Going back almost 600 years, global reserve currencies have tended to enjoy a prolonged but finite lifetime, spanning between 80 and 110 years (see infographic). And as today’s market carries clear echoes of the 1970s – when the US dollar’s reserve currency status came into question following the shock closing of the gold window – so we near the greenback’s reserve currency centenary. The echoes are getting louder. Change is afoot.
To have a clearer picture, it is important to go back to 1944, when the Bretton Woods Agreement formalised the dollar’s position as the world’s reserve currency, making US Treasuries convertible to gold at US$35/oz. Bretton Woods created synthetic demand for US debt and delivered the ‘exorbitant privilege’ of global reserve status to the dollar.
At that point, we still had a form of the long- standing gold-for-oil standard – Saudi Arabia was receiving gold equivalence (in the form of US Treasuries) in return for its oil. The historic gold/oil equilibrium was still intact. The 1970s, though, brought change and lots of it. In 1971, US President Richard Nixon announced a ‘temporary suspension’ of the dollar’s convertibility to gold, in an effort to address the spectre of a run on the gold window.
On the back of this, a new way of ensuring continued demand for dollars was required, and the Saudis were quick to lend a helping hand. Indeed, in 1973 Saudi Arabia agreed to accept only dollars for their oil in exchange for military support and resources. They also agreed to buy US Treasuries with these dollars. Once the rest of OPEC was on board by 1975 – agreeing to no bilateral currency deals for oil – the circle was complete once more for King Dollar. With a formal petrodollar agreement in place, gold had been formally removed from the heart of the monetary system.
Fast forward 42 years. This agreement is crumbling and gold is retaking its rightful place as apolitical money par excellence.
Countries that have not benefited from the dollar’s reserve currency status are now creating direct bilateral swap agreements, adding to their gold reserves, and reducing US debt holdings. China and Russia have done long-term oil and gas deals, in renminbi, to the value of almost US$700bn. China is paying in renminbi for oil from Iran, while India has paid for oil from Iran in gold. These are but a few examples of dollar disintermediation.
In what is a game-changer, in my view, the new Shanghai International Gold Exchange permits the direct exchange of renminbi for physical gold. So we now have the renminbi as an oil-gold intermediary, much as the dollar once was. Sell oil for renminbi and convert to gold. Let that sink in.
China has reduced its Treasury exposure by more than 15% since May 2016 – providing further evidence of this global shift. Russia and Saudi Arabia, too, are sellers. We are in a moment of flux; the East is bypassing the long-agreed way of doing things, as prescribed by the West. Projects and organisations such as the Silk Road Economic Belt and the Asia Infrastructure Investment Bank are taking the place of the likes of the International Monetary Fund (IMF) and the World Bank as the go-to provider of financial support for the emerging world. The East and the West look to be diverging, with dollars, renminbi, oil and gold at the heart of this shift.
Of course, this isn’t news to those within the IMF and World Bank. Back in 2010, the then president of the World Bank, Robert Zoellick, predicted this scenario. He spoke of how the world needs a new, co-operative monetary system that reflects today’s economic and monetary landscape. He predicted that any such new system would likely involve “a renminbi that moves towards internationalisation and then an open capital account.”
“The system should also consider employing gold as an international reference point,” he added.
With the world’s powers jostling for reserve currency status, the prospect of conflict is not a far-fetched one. The dollar’s days as the world’s reserve currency are in their autumn and the vultures are circling. But the stage is set for the IMF, World Bank and G20 to come together to formulate a mutually beneficial currency agreement with gold at the centre – rather than the might of West or East. In other words, an agreement that services all.
Such a creation would likely involve the IMF’s special drawing right (SDR), the dollar, the renminbi and – you guessed it – gold. As an aside, it is worth noting that since 1990 the 50- and 200-week moving averages in the gold price have only crossed five times. Each cross (bullish or bearish) has been predictive of at least three years of gold price direction.
The latest bullish cross occurred in January this year.
The wheel keeps turning.