The End of Dollar Hegemony, Part I

In a speech before the U.S. House of Representatives last week, Congressman Ron Paul stated that the United States’ dollar dominance is coming to an end…and when this paper money runs out, wealth and political stability is lost. You can read the first part of his speech, below…

A hundred years ago it was called "dollar diplomacy." After World War II, and especially after the fall of the Soviet Union in 1989, that policy evolved into "dollar hegemony." But after all these many years of great success, our dollar dominance is coming to an end.

It has been said, rightly, that he who holds the gold makes the rules. In earlier times it was readily accepted that fair and honest trade required an exchange for something of real value.

First it was simply barter of goods. Then it was discovered that gold held a universal attraction, and was a convenient substitute for more cumbersome barter transactions. Not only did gold facilitate exchange of goods and services, it served as a store of value for those who wanted to save for a rainy day.

Though money developed naturally in the marketplace, as governments grew in power they assumed monopoly control over money. Sometimes governments succeeded in guaranteeing the quality and purity of gold, but in time governments learned to outspend their revenues. New or higher taxes always incurred the disapproval of the people, so it wasn’t long before Kings and Caesars learned how to inflate their currencies by reducing the amount of gold in each coin – always hoping their subjects wouldn’t discover the fraud. But the people always did, and they strenuously objected.

This helped pressure leaders to seek more gold by conquering other nations. The people became accustomed to living beyond their means, and enjoyed the circuses and bread. Financing extravagances by conquering foreign lands seemed a logical alternative to working harder and producing more. Besides, conquering nations not only brought home gold, they brought home slaves as well. Taxing the people in conquered territories also provided an incentive to build empires. This system of government worked well for a while, but the moral decline of the people led to an unwillingness to produce for themselves. There was a limit to the number of countries that could be sacked for their wealth, and this always brought empires to an end. When gold no longer could be obtained, their military might crumbled. In those days those who held the gold truly wrote the rules and lived well.

That general rule has held fast throughout the ages. When gold was used, and the rules protected honest commerce, productive nations thrived. Whenever wealthy nations – those with powerful armies and gold – strived only for empire and easy fortunes to support welfare at home, those nations failed.

Today the principles are the same, but the process is quite different. Gold no longer is the currency of the realm; paper is. The truth now is: "He who prints the money makes the rules" – at least for the time being. Although gold is not used, the goals are the same: compel foreign countries to produce and subsidize the country with military superiority and control over the monetary printing presses.

Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people – just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.

The pressure at home to inflate the currency comes from the corporate welfare recipients, as well as those who demand handouts as compensation for their needs and perceived injuries by others. In both cases personal responsibility for one’s actions is rejected.

When paper money is rejected, or when gold runs out, wealth and political stability are lost. The country then must go from living beyond its means to living beneath its means, until the economic and political systems adjust to the new rules – rules no longer written by those who ran the now defunct printing press.

"Dollar Diplomacy," a policy instituted by William Howard Taft and his Secretary of State Philander C. Knox, was designed to enhance U.S. commercial investments in Latin America and the Far East. McKinley concocted a war against Spain in 1898, and (Teddy) Roosevelt’s corollary to the Monroe Doctrine preceded Taft’s aggressive approach to using the U.S. dollar and diplomatic influence to secure U.S. investments abroad. This earned the popular title of "Dollar Diplomacy." The significance of Roosevelt’s change was that our intervention now could be justified by the mere "appearance" that a country of interest to us was politically or fiscally vulnerable to European control. Not only did we claim a right, but even an official U.S. government "obligation" to protect our commercial interests from Europeans.

This new policy came on the heels of the "gunboat" diplomacy of the late 19th century, and it meant we could buy influence before resorting to the threat of force. By the time the "dollar diplomacy" of William Howard Taft was clearly articulated, the seeds of American empire were planted. And they were destined to grow in the fertile political soil of a country that lost its love and respect for the republic bequeathed to us by the authors of the Constitution. And indeed they did. It wasn’t too long before dollar "diplomacy" became dollar "hegemony" in the second half of the 20th century.

This transition only could have occurred with a dramatic change in monetary policy and the nature of the dollar itself.

Congress created the Federal Reserve System in 1913. Between then and 1971 the principle of sound money was systematically undermined. Between 1913 and 1971, the Federal Reserve found it much easier to expand the money supply at will for financing war or manipulating the economy with little resistance from Congress – while benefiting the special interests that influence government.

Dollar dominance got a huge boost after World War II. We were spared the destruction that so many other nations suffered, and our coffers were filled with the world’s gold. But the world chose not to return to the discipline of the gold standard, and the politicians applauded. Printing money to pay the bills was a lot more popular than taxing or restraining unnecessary spending. In spite of the short-term benefits, imbalances were institutionalized for decades to come.

The 1944 Bretton Woods agreement solidified the dollar as the preeminent world reserve currency, replacing the British pound. Due to our political and military muscle, and because we had a huge amount of physical gold, the world readily accepted our dollar (defined as 1/35th of an ounce of gold) as the world’s reserve currency. The dollar was said to be "as good as gold," and convertible to all foreign central banks at that rate. For American citizens, however, it remained illegal to own. This was a gold-exchange standard that from inception was doomed to fail.

The U.S. did exactly what many predicted she would do. She printed more dollars for which there was no gold backing. But the world was content to accept those dollars for more than 25 years with little question – until the French and others in the late 1960s demanded we fulfill our promise to pay one ounce of gold for each $35 they delivered to the U.S. Treasury. This resulted in a huge gold drain that brought an end to a very poorly devised pseudo-gold standard.

It all ended on August 15, 1971, when Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold. In essence, we declared our insolvency and everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it – not even a pretense of gold convertibility, none whatsoever! Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread.

Realizing the world was embarking on something new and mind boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence "backed" the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.

This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971. Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo gold standard under Bretton Woods. It certainly was less stable than the gold standard of the late 19th century.

During the 1970s the dollar nearly collapsed, as oil prices surged and gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were required to rescue the system. The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s. The markets were not fooled by LBJ’s claim that we could afford both "guns and butter."

Once again the dollar was rescued, and this ushered in the age of true dollar hegemony lasting from the early 1980s to the present. With tremendous cooperation coming from the central banks and international commercial banks, the dollar was accepted as if it were gold.

Fed Chair Alan Greenspan, on several occasions before the House Banking Committee, answered my challenges to him about his previously held favorable views on gold by claiming that he and other central bankers had gotten paper money – i.e. the dollar system – to respond as if it were gold. Each time I strongly disagreed, and pointed out that if they had achieved such a feat they would have defied centuries of economic history regarding the need for money to be something of real value. He smugly and confidently concurred with this.

In recent years central banks and various financial institutions, all with vested interests in maintaining a workable fiat dollar standard, were not secretive about selling and loaning large amounts of gold to the market even while decreasing gold prices raised serious questions about the wisdom of such a policy. They never admitted to gold price fixing, but the evidence is abundant that they believed if the gold price fell it would convey a sense of confidence to the market, confidence that they indeed had achieved amazing success in turning paper into gold.

Increasing gold prices historically are viewed as an indicator of distrust in paper currency. This recent effort was not a whole lot different than the U.S. Treasury selling gold at $35 an ounce in the 1960s, in an attempt to convince the world the dollar was sound and as good as gold. Even during the Depression, one of Roosevelt’s first acts was to remove free market gold pricing as an indication of a flawed monetary system by making it illegal for American citizens to own gold. Economic law eventually limited that effort, as it did in the early 1970s when our Treasury and the IMF tried to fix the price of gold by dumping tons into the market to dampen the enthusiasm of those seeking a safe haven for a falling dollar after gold ownership was re-legalized.

Once again the effort between 1980 and 2000 to fool the market as to the true value of the dollar proved unsuccessful. In the past 5 years the dollar has been devalued in terms of gold by more than 50%. You just can’t fool all the people all the time, even with the power of the mighty printing press and money creating system of the Federal Reserve.

Even with all the shortcomings of the fiat monetary system, dollar influence thrived. The results seemed beneficial, but gross distortions built into the system remained. And true to form, Washington politicians are only too anxious to solve the problems cropping up with window dressing, while failing to understand and deal with the underlying flawed policy. Protectionism, fixing exchange rates, punitive tariffs, politically motivated sanctions, corporate subsidies, international trade management, price controls, interest rate and wage controls, super-nationalist sentiments, threats of force, and even war are resorted to-all to solve the problems artificially created by deeply flawed monetary and economic systems.


Congressman Ron Paul
for The Daily Reckoning

Editor’s Note: You can read the second part of Dr. Paul’s speech in Thursday’s issue of The Daily Reckoning.

Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency. He is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives: Dr. Paul never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the "one exception to the Gang of 535" on Capitol Hill.

To learn more about Dr. Paul, see here:

Congressman Ron Paul

We woke up this morning wondering how things could go so wrong.

Maybe it was something we ate. We were thinking of the economy and the war on terror, but one thought slipped into another like a bad dream. We probably began dreaming of being shipwrecked with buxom cheerleaders, and then it slid into a nightmare of globalization, serfdom and the decline and fall of empires.

The economy looks so healthy, so new, so high-tech, but people still get poor the old fashioned way: by spending more than they make. Yet, for some reason not quite clear to us, they actually think they are getting rich by doing it. The post-war, post-modern generation has come to believe that it can get rich without effort, automatically. This is "progress," and haven’t Americans always believed in progress? Only, today they can’t imagine any vision of progress that doesn’t include more money. So, why not spend today what they believe is guaranteed to them tomorrow?

But, across the broad, sunny Pacific, two billion people who have just entered the world economy, may put a twist into that comfortable story. The newcomers might still lack the skills and tools to be very competitive, but that is changing – and changing fast. The spending spree in America gives the foreigners piles of dollars to spend. The Middle Kingdom alone is expected to have more than $1 trillion in foreign reserves by the end of this year – and they spend it on new plants and equipment.

The new globalized capital markets are rapidly bringing both cash and technology to the place that will earn it the highest rate of return. Fifty years ago, that place was America. Now, it is Asia. So, the factories go up in Shanghai…not in Cincinnati. But still, in the Buckeye State, people hardly notice. They go about their business peacefully, even rather tickled not to have the factories. After all, that means they can now move up the socio economic ladder. Let the Asians do the sweating. They will do the thinking! The only question is, what will they think about? Most likely, it will be about how they will refinance their house, borrowing from Asian savers, in order to continue buying gadgets and gizmos, manufactured by Asian producers.

As they borrow more and more, these poor Sons of Liberty chain themselves to more and more debt. Not just theirs, but the nation’s. Two and a half trillion dollars in debt has been added to the federal government’s burden during the George W. Bush years; no president in American history has ever done more damage to the nation’s finances. Nor is this the sort of debt that will be paid off by the debtors. It is debt that will be carried forward, refinanced, and refinanced again…so that generations not yet in the womb will be shackled to millions of dollars worth of it before they even begin to toddle.

We recall a passage from Exodus, sent to us recently by a friend:

"The Lord…who forgives iniquity, transgression and sin; yet He will by no means leave the guilty unpunished, visiting the iniquity of fathers on the children and on the grandchildren to the third and fourth generations."

Oh, my…what kind of parents are we?

Even serfs in the Dark Ages were only required to labor one day in five for their lords and masters. But future citizens in the Land of the Free won’t have it so easy; they will have to work up to every other day just to pay their taxes – and service a debt incurred by strangers who died years before them. All of this laboring will be merely for cheap bread and expensive circuses. Thus, even to the third and fourth generations might our hapless heirs be punished.

And of all the expensive circuses staged by the Bush administration, one of the most expensive is the War on Terror. We say ‘circus’ because we are always looking on the bright side. And in so many ways, this war is one for the record books. It is already the longest war in U.S. history. Neither the American Revolution, nor World War I, nor America’s involvement in World War II went on for so long.

It is also the first war in American history to be financed almost exclusively with borrowed money. The federal budget was tight enough before the war was announced, but since then, the total of federal deficits roughly equals the cost of the war. The present generation may be fighting the war, but the generations to come will be paying for it.

More news from our currency counselor…


Chuck Butler, reporting from the EverBank trading desk in St. Louis:

"As opposed to the news headline, Iceland’s currency was not downgraded! Instead, Fitch downgraded their currency outlook."

For the rest of this story, and for more insights into the world currency markets, see today’s issue of The Daily Pfennig


Bill Bonner, back in France with more views…

*** There’s a storm brewing over port security, and this time the Bush is taking heat from both parties. The Bush administration has approved a deal that would sell control of six major U.S. Ports to a company based in the United Arab Emirates. The president is pitting himself against conservatives who think that this arrangement will put our national security in danger.

"The deal should go forward," says our friend, Chris Mayer.

"First, people should understand that DP World would not own the ports, only the concessions (or contracts) to manage the ports.

"Second, security at U.S. ports is handled by the U.S. Coast Guard and U.S. Customs Service. Management companies have little to do with security. None of this changes with the deal.

"This deal was no secret. It has been reported on extensively in the financial press, as DP World was in a bidding war for P&O, eventually beating out a Singapore-owned shipping company. The deal passed all of the normal regulatory approvals.

"Dubai, located in the United Arab Emirates, is a Middle Eastern country. It is a Muslim country and as detractors are fond of pointing out, two of the 9/11 hijackers came from the UAB. Somehow, that puts everyone related to the UAB under suspicion. Politicians, and the mainstream public, are essentially acting like bigots for holding a Middle Eastern ally to a different standard. Many of the top execs at DP World are American and the port workers are Americans – regardless of who owns the concessions.

"For those who say they don’t want a foreign government running our ports: well, I have a surprise for you. China already runs a terminal at the Port of Los Angeles. Singapore runs terminals in Oakland. The fact is that around the world this is commonplace. If the U.S. government is going to exclude foreign companies (even government-owned ones) from running its ports, it will only slip back further in the global competitive race, isolating it from the biggest and most efficient port operators in the world.

"U.S. ports are already inefficient, expensive and heavily-regulated. Hutchinson Ports, the world’s largest port operator, won’t touch the United States because of how poorly U.S. ports are managed and organized.

"All of this reflects how the United States is becoming an increasingly hostile place to do business. More and more foreign companies choose not to list their shares on American exchanges, for example. This port deal is a small piece of much larger global forces that continue eat away at America’ competitiveness abroad.

"America can either encourage the open markets it so often trumpets, or it can retreat into the ugly cocoon of protectionism – with racist overtones to boot."

*** The War on Terror is also the first war in history to be launched without an identifiable enemy. It is supposed to be a war for liberty. But who is liberty’s enemy? Terror? "Terror" is a tactic, used by almost everyone at one time or another, including the United States, which means, it is the first war ever in which there is no hope of victory. The best that be hoped for is a draw – and then, only in the short run. In the long haul, terror will be around long after the United States is past tense.

In other words, in the name of liberty the average American is enslaving himself and his children and grandchildren to debt and fighting a war, against nobody, that can’t possibly be won – all while the most dynamic and flexible capitalist economy in history makes him poorer.

Irony was what was supposed to have disappeared with the World Trade Center towers on September. Suddenly, the world was supposed to work in a more straightforward way. There were good people and bad people; things were either black and white. You were either with us or against us, said America’s president.

It’s too bad. The world was not as simple as the simpletons thought.

The Daily Reckoning