The value of the U.S. dollar is anchored in trust. As a fiat currency, the U.S. dollar isn’t linked to any physical reserves, like gold or silver; it’s just paper. For the U.S. dollar to be worth anything, it has to be backed by an economy people have faith in. Otherwise, the U.S. dollar would collapse.
Regardless of its intentions, the Federal Reserve’s quantitative easing (QE) experiment has left America with many unintended consequences, namely a devalued U.S. dollar, growing income inequality, and a weak economic underpinning. Not the best framework for the world’s largest economy.
This might also explain why many countries are losing faith in the U.S. dollar and predicting its inevitable collapse.
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The Federal Reserve’s Easy Money Experiment
Back in November 2008, the Federal Reserve stepped in with its first round of quantitative easing, an easy money strategy designed to avoid a full-out financial meltdown and a plan to supercharge the economy.
By artificially lowering interest rates to near zero and injecting money into the system, the Federal Reserve wanted to make it easy for banks to borrow money and pass the cheap money onto people and businesses, stimulating economic growth.
Over the last six years, the U.S. has waded through uncharted economic territory. Before the financial crisis, the Federal Reserve had a balance sheet of $898 million. Today, it sits at $4.5 trillion.(1)
On top of that, America has seen its national debt soar from $10.0 trillion before the financial crisis in 2008 to close to $18.0 trillion.(2)
Unfortunately, creating trillions of dollars out of thin air and dumping it into the economy devalued the American dollar. While all of that extra money pumped into the economy was supposed to spur growth, it also did the opposite; it diminished the buying power of each dollar.
What did quantitative easing do over the last six years? It’s still open for debate, but aside from an anemic economy, the outcomes of QE are modest at best. For example, the unemployment rate is at 5.9%—basically where it was before the financial crisis.
But the official U6 unemployment rate (which includes people who have given up looking for work and people who want full-time jobs but who are stuck with only part-time jobs) remains stubbornly high—near 12%.(3) Furthermore, the unofficial shadow statistic unemployment rate, which includes the long-term unemployed, sits near 23%.(4)
Americans are out of work and in debt. Fifteen percent of the population receives food stamps, wages are flat, and your dollar doesn’t go as far as it used to.(5) More bad news for an economy that gets approximately 70% of its GDP from consumer spending.
Things could get even worse for the U.S. when the Federal Reserve starts to raise interest rates in 2015. Addicted to record-low interest rates, even a small rise would see a marked increase in the cost of living. It will also cost businesses and people more to borrow, putting additional stress on those already financially strapped, especially when you consider 76% of Americans are living paycheck to paycheck.(6)
Americans may have been able to spend their way to prosperity and drive economic growth, but not anymore. (By spend, I don’t mean charge what we can’t afford to a credit card with an eye-watering interest rate.)
U.S. Dollar as Reserve Currency in Jeopardy?
The U.S. dollar has been the world’s reserve currency since World War II. That means the U.S. can deal directly with any country in the world using its own currency. In effect, the U.S. can create money out of thin air whenever it wants to buy whatever it wants or to manage its debt.
The same cannot be said for other countries. For example, if Germany buys oil from the Middle East, it does so using the U.S. currency. However, Germany can only get its hands on the U.S. currency if it sells something to someone else.
With America in serious debt and the economy on vulnerable footing, central banks around the world are increasingly wary of using a devalued U.S. dollar as their reserve currency. Should central banks and businesses eventually turn their backs on the U.S. dollar as the reserve currency, the United States will no longer be able to buy its way out of debt.
The framework may already be in place.
By the end of 2013, central banks held roughly 30,500 tonnes of gold, or one-fifth of all the gold ever mined. Most of these holdings are found in advanced economies in Western Europe and North America. This is odd since central banks only hold gold as a hedge against economic uncertainty.(7)
Interestingly, and perhaps not so coincidently, central banks started to increase their gold reserves back in 2008, right on the heels of the financial crisis and the collapse of the U.S. housing market. Are central banks predicting a collapse in the U.S. dollar?
In an effort to stabilize volatility, central banks snapped up gold to protect their country’s wealth as the world’s reserve currency fell into a tailspin. Overall, 2013 was a very busy year for individuals and institutions buying physical gold. Of the 3,756.1 tonnes of gold purchased in 2013, approximately 369 tonnes can be attributed to central banks. Aside from Russia and China adding to their reserves, Indonesia, South Korea, the Philippines, and Venezuela were the biggest buyers of physical gold in 2013.(8)
This year has been just as busy. In the recently completed third quarter, central banks acquired 93 tonnes of gold bullion. That represents the 15th consecutive quarter in which central banks have purchased more gold than they sold.
More broadly, from 2008 to 2009, China’s central bank increased its gold reserves by 75% to 1,054 tonnes. China has not updated its bullion reserves since then. Between the first quarter of 2009 and the third quarter of 2014, Russia’s gold reserve soared 116%,from 531.87 tonnes to 1,149.8 tonnes.(9)
At the current pace, 2014 will be the fifth consecutive year of net demand of gold from central banks. Before the collapse of Lehman Brothers, central banks had been net sellers of gold.
With gold prices in decline for much of the last two years, Wall Street has been telling investors to shun gold, even predicting gold prices would tumble to $1,000 an ounce or lower.
Central banks aren’t listening, though, and are more than happy to pick up gold on the cheap. For the record, 2012 was the strongest year of central bank gold buying in nearly half a century.
Since 2009—right after the U.S. financial crisis—major European central banks have essentially put a halt to selling their gold reserves. In fact, collectively, the European central banks have sold less than 25 tonnes of gold against a limit of 2,000 tonnes. Those sales were used mainly to purchase gold coins for collectors. Before the financial crisis, the market for gold coins and bars in Europe was virtually non-existent.(10)
What’s driving the increased global interest in gold? Are central banks wary of the sustainability of the U.S. recovery and preparing for the eventual collapse of the U.S. dollar?
Will the U.S. Dollar Collapse in 2015?
The U.S. is championing an economic rebound few are even aware of. But it needs to, since so many central banks are concerned with its prospects for growth and fear a devalued U.S. dollar. Unless the U.S. can get its debt under control and its economy on solid ground, the American dollar will continue to lose favor as a reserve currency.
If that happens, the U.S. will actually have to rely on its own economic output—just like every other country.
Also Read: Will the U.S. Dollar Collapse in 2016?