The World's True Reserve Currency Is Gold

* by Michael Pento
* June 04, 2010

Since the Bretton Woods Agreement was signed in 1944, the U.S. dollar has been viewed as the world's undisputed reserve currency. Unfortunately, however, investors the world over are now asking themselves if that should continue to be the case. They are instead increasingly relying on a more stable form of money (gold) in which to park their global savings.

Having a currency the entire planet views as a safe haven has remarkable benefits. Our "king dollar" status has allowed the United States to consume much more than it produces without having its currency collapse. It also keeps interest rates unnaturally low, which provides a tremendous boost to economic growth. Our nation's debt has now eclipsed $13 trillion dollars and the monetary base has skyrocketed to over $2 trillion. If the dollar did not enjoy such a lofty position in the opinion of global currency investors, U.S. interest rates would soar as foreign central banks sold off their U.S. debt holdings and the dollar's value would plummet. Therefore, one of the most important factors for the future stability of our economy is that traders and investors across the globe consistently regard our dollar and our bond market as a safe harbor—without peer.

However, foreign governments and central banks have recently displayed a significantly greater inclination to boost the value of their currency than has the United States. Unlike our recalcitrant Federal Reserve, the Bank of Canada recently raised its target rate on overnight loans between commercial banks to 0.50% from 0.25%. Indeed, there is a growing list of countries that have recently sought to protect the value of their currency by raising interest rates this year, including Brazil, Malaysia and Peru. And even though the Reserve Bank of Australia opted out of boosting rates this last go-round, they still have a comparatively high rate of 4.5%, which was reached after six increases since October 2009.

The fact is our central bank has not displayed any effort whatever to preserve the dollar's status as the world's reserve currency. In fact, they have simply taken it for granted and shown disdain for the greenback's eminence. The Fed's balance sheet remains over $2.3 trillion even though their purchases of mortgage-backed securities ended over two months ago. Not to be outdone by our central bank, the current administration believes the major problem we face is that we do not yet have enough debt.

President Obama's Chief Economic Advisor Lawrence Summers has advocated an additional $200 billion in deficit spending saying, "I cannot agree with those who suggest that it somehow threatens the future to provide truly temporary, high-bang-for-the-buck jobs and growth measures," he said. "Spurring growth, if we can achieve it, is by far the best way to improve our fiscal position." But how can anyone believe that government can create viable growth or sustainable wealth? The truth is it's incapable of any such thing. Redistributing savings from one part of the economy to another cannot lead to growth. Borrowing money from foreign sources only amounts to a deferred tax on future production with interest. And inflation is just another cruel tax placed upon the middle class without their consent.

But the real problem with thinking what the United States needs to do is spend more and keep interest rates in the cellar is that most of the world has already started to repent. Other countries now understand that they must reduce leverage instead of borrowing more and are raising interest rates to protect their currencies.

The twentieth century has taught Europeans two valuable lessons. Namely, that killing each other isn't really a good way to bring about peace and that massively inflating a currency doesn't engender prosperity. Now the twenty-first century is hopefully teaching them that debt cannot be bailed out by issuing more debt. Case in point, Italy recently joined Greece, Spain and Portugal in enacting austerity programs to slash budget deficits. In the case of Italy, their plan is to cut spending by 25 billion euros this year with the aim to slash the budget deficit to 2.7% of GDP by 2012. So while Europe is embracing austerity, the U.S. is headed in the opposite direction.

The two most important factors in protecting the value of any nation's currency is to have the central bank provide interest rates that are above the rate of inflation and for the government to ensure the debt of the nation can always be easily serviced. Canada, Europe, South America and Asia are moving slowly towards that goal. Those economies are also learning that any fiat currency (even the "almighty dollar") can never truly be an adequate substitute for owning gold—especially when our government and Fed are determined to undermine the dollar's purchasing power. But the pressing question has now become how long those economies will continue to squander their savings by parking them in U.S. dollars if we continue to debase both the value of our debt and the currency on which it is based.

Michael Pento is chief economist of Delta Global Advisors.