What Lies Ahead for the U.S. Dollar and Gold

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

There was only one time in recent history that the U.S. dollar took a severe beating in the marketplace that was purely self-inflicted. The time was August 17, 1971, when a molehill of inflation grew to become a mountain and the cost of the Vietnam War became almost unbearable. The action was President Richard Nixon’s decision to remove the gold standard, which has held since 1944 and which required that the Federal Reserve backed up all paper money printed and in circulation with actual ounces of gold in its treasury. What happened next was “made only in America:” double-digit devaluation of the U.S. dollar sent shockwaves all over the world, paralyzing with fear anyone who had lent America any money.

Not surprisingly, a full-blown panic soon ensued. Deep inside the bellows of lower Manhattan, inside the New York Federal Reserve’s bunker, Scott Pardee, at the time a lowly New York Fed staffer, who was then only 34 years young, had the ungrateful duty of answering frenzied calls from foreign creditors and central banks, demanding that the U.S. cover all foreign exchange risk attached to the Fed’s reserve. According to Pardee, the walls simply caved in and the roof fell right on the Fed’s head.

Almost four decades later, the dollar is still the number one trading currency in the world. Even when the financial crisis of 2008 was at its worst, investors fled to the U.S. dollar, perceiving it as the only available, albeit temporary, safe haven.

However, aside from this one bright moment, the fact remains that, since 2002, the dollar has been declining steadily. Also, the moment the global economy recovered last year, the dollar’s decline resumed, which only recharged skepticism and doubt that that the dollar will remain the world’s unrivaled reserve currency for very much longer.

Now the world has to deal with the debt crisis in Greece, which, yet again, has resulted in investors flocking to the U.S. currency that, in turn, has offered some relief. To illustrate, since December of last year, the U.S. dollar has gained approximately 10% compared to the euro. Additionally, as the Fed recently decided to increase the discount rate it charges banks on short-term, emergency loans, the dollar gained more ground, as some investors speculated the end of the Fed’s spending spree in response to the financial crisis would be beneficial to the dollar.

Still, there are many economists, investors and even government officials who think that the U.S. dollar bonanza is not likely to be a lasting one. As the U.S. economy struggles under the astounding amount of deficit and global economic activity shifts to fast-growing emerging economies, such as China and Brazil, the risk of the second purely self-inflicted and potentially double-digit devaluation of the dollar becomes increasingly possible. Certainly, the devaluation may not be as dramatic as it was in 1971, but it likely would not be as slow as some might hope either.

If the world loses confidence in the U.S.’ ability to battle debt and its deficits, and/or its policies, the dollar could be in serious danger. Sooner or later, the U.S. will be forced to deal with the dollar, and it better be to find ways to bolster its trading value, unless it is ready to relinquish the dollar’s dominance in the world of trade. In the meantime, while the U.S tries to figure out what to do with the dollar, the gold, the “other,” and to many, the only true safe haven, is likely to gain significant ground.