After long years of studying monetary economics, the research leads us to a significant conclusion - the international monetary system is heading towards collapse.
By this, we mean there will be a loss of confidence in paper currencies worldwide, not just limited to the dollar or the euro but affecting all paper currencies.
Throughout the last century, the global monetary system has undergone changes approximately every 30-40 years. Before 1914, it relied on the classical gold standard. In 1945, the Bretton Woods system emerged, with the dollar as the leading reserve currency, backed by gold at $35 per ounce.
However, in 1971, Nixon ended the direct convertibility of the dollar to gold, leading to a system of floating exchange rates without a gold anchor. Now, more than 50 years later, it's clear that the existing monetary system is overdue for a new arrangement.
Recent unprecedented sanctions imposed on Russia due to its actions in Ukraine have accelerated the shift towards a new monetary system. These sanctions, utilizing the U.S. dollar as a principal weapon, have made nations realize their vulnerability to the control of dollar payment systems, largely operated by the U.S. and major European and Japanese banks.
To escape these sanctions, countries are increasingly looking for alternatives to the dollar. This has given rise to the development of the new BRICS currency, set to be announced soon. While the anti-dollar trend has been underway for some time, these sanctions have sped up the process.
The transition away from the dollar as the leading reserve currency will likely not happen overnight, just as it took decades for the dollar to replace the U.K. pound sterling in that role after the Bretton Woods conference in 1944.
Many observers assume the Bretton Woods conference was the moment the U.S. dollar replaced sterling as the world’s leading reserve currency. But that replacement was a process that took 30 years, from 1914–1944.
The 1944 Bretton Woods conference was merely recognition of a process of dollar reserve dominance that was decades in the making.
Nevertheless, the unprecedented sanctions against Russia have fastened the shift, and investors should be prepared for potential changes sooner rather than later.
To understand this situation better, it's essential to comprehend currency wars - what they are, why they occur, and how they ultimately conclude.
Currency Wars
Currency wars are a crucial aspect of the global financial system today.
In simple terms, a currency war occurs when there is insufficient economic growth worldwide to meet all the debt obligations. This happens when growth is not enough relative to the burden of debts, which is the situation we find ourselves in today.
During times of sufficient growth, the United States usually doesn't concern itself with minor attempts by other countries to devalue their exchange rates to attract foreign investment. Such actions are relatively inconsequential on a global scale.
However, when growth is scarce, it's like a group of starving people fighting over limited resources. In such scenarios, no one benefits, and everyone suffers. Currency wars do not lead to sustainable growth; they only result in temporary gains for one country at the expense of its trading partners, who then retaliate with their own devaluations.
At its best, a currency war involves stealing countries' growth from each other. At its worst, it can lead to a series of negative consequences, such as inflation, recession, retaliation, and even violence as nations compete for resources and dominance.
The current global currency war began around 2010, and it's important to understand that currency wars are not constant. They go through phases of intense battles followed by lulls before resuming in intense battles.
These wars can endure for extended periods, ranging from five to twenty years, meaning the current currency war could continue for several more years.
Knowing which phase of the currency war we are in can provide valuable insights when making decisions about economic growth, interest rate policies, investment sectors, and predicting inflation or deflation.
In the past century, there have been three major currency wars.
Currency War I took place from 1921 to 1936, initiated by the Weimar hyperinflation. During this period, various countries engaged in successive currency devaluations.
Before World War I in 1914, the world operated under the classical gold standard, where balance of payments deficits were paid in gold, and surpluses acquired gold. However, this stable system was disrupted during World War I when countries needed to print money for the war effort.
The world started out before World War I with the parity. There was a certain amount of gold and a certain amount of paper money backed by gold. Then, the paper money supply was doubled. That left only two choices if countries wanted to go back to a gold standard.
They could’ve doubled the price of gold — basically cut the value of their currency in half — or they could’ve cut the money supply in half. They could’ve done either one but they had to get to the parity either at the new level or the old level. The French said, “This is easy. We’re going to cut the value of the currency in half.” They did that.
This decision resulted in hyperinflation in France, depicted in the movie "Midnight in Paris," which allowed U.S. expatriates to live lavishly in France during the mid-1920s due to the devalued currency.
The United Kingdom faced a similar decision as France during the post-World War I period regarding their currency and gold standard. Winston Churchill, the Chancellor of the Exchequer at that time, made a different choice. Instead of doubling the price of gold, he opted to cut the money supply in half, returning to the pre-war parity. This decision caused extreme deflation and led the UK into a depression three years ahead of the rest of the world.
The lesson from this episode is not that a gold standard cannot work, but that getting the price right is crucial.
Currency War I, which occurred from 1921 to 1936, involved successive currency devaluations and "beggar thy neighbor" policies. This contributed to one of the worst depressions in history and was only resolved during World War II and at the Bretton Woods conference, which established a new monetary standard.
Currency War II took place from 1967 to 1987, with a significant event being Nixon's decision to take the U.S. and the world off the gold standard in 1971 to promote exports and job growth. However, the outcome was three consecutive recessions, skyrocketing unemployment, and extreme inflation, leading to the devaluation of the dollar.
The period from 1985 to 2010 was known as the "King Dollar" or "strong dollar" policy, characterized by good economic performance and stability. The U.S. maintained the purchasing power of the dollar, and this system worked well until 2010 when Currency War III began after the financial crisis.
The dangers of currency wars today are even greater due to the complexity of financial linkages across the world. In 2023, these currency wars are still ongoing, and the emergence of a gold-backed BRICS currency could intensify the situation further.
Stay alert, stay informed.
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