The USD standard and the Gold standard, some historical background, possible transition currencies

This is a very broad discussion of the USD and gold as reserve currencies and how this relates to the deleveraging world economy and the present Euro crisis. It is very broad brushed. We discuss various uses of the USD standard to deal with world crises.

Many gold bug fans may disagree, but it's a fact the USD has been used to support the West. They only want to talk negatively about the USD. However, I love gold too. I really think that some gold bugs could benefit from a few examples of how the USD was used in the past to stabilize the world. Even if now we are having major abuses.

And if you think this is bunk, I would like to point out that our newsletter called the USD rally April 25, 2011 about a week in advance, the CRB crash by two months advance, and last but not least the Gold correction from near $1800 this year to its present levels, by about two days' notice...why do I say that? Because you might want to consider our credibility, when we are also trying to show history about the USD. There were some so called gold bugs of fairly wide influence who have also stated for years the Euro was a haven. Laugh. We stated for years that was nonsense. Those same people are still trying to say the Euro will recover. Uh... no, not in its present form, to say the least.

And now to make everything worse, I think that the US Fed and Geithner and Bernanke saved the world from a huge banking crisis (that will really get people mad at me). But how they did it was probably wrong as all they did was buy time by bailing out unscrupulous speculators. But, in their bailouts the USD was used to avert a huge bank crisis in both 2007 (Bear) and 2008 (Lehman) right or wrong. It appears the US is nearing the end of using the USD to save the world over and over (speaking metaphorically). And I admit fully, the USD standard may be near an end.

Obviously, like everybody else, the US fiscal situation is a disaster. And, gold has constantly risen since roughly 2002, when US fiscal deficits went haywire. George Bush doubled the US national debt as I recall, and Obama has also again doubled it, but in only one term. So that's the present. Let's look back a bit.

Folks I am sorry but the USD is not all bad!

I want to take a step back to the end of World War 2, and talk about how the USD was implemented to save the West during WW2 and then after what they did with the USD. But first, I want to discuss gold going back to roughly 1980...we can then extrapolate back to 1970 and also to 1910...



This chart only goes back a few years but you can see how the faltering world economy led to a spike and then stall in gold prices. Much of that is related to dropping economic demand and to the falling CRB commodities basket. But this discussion goes a lot deeper than this. You are going to have to know the history of the gold prices to follow this piece since we go back to 1940 in the discussion. So we are broad brushing this paper.

WW2 and Breton Woods

First, let us cut to the thesis. The US saved Western Europe in World War 2 by using the USD and its gold reserves to back the UK pound and the European banking system during the mid stages of the war. The US and allies did not just fight the war, they financed it or supported the EU currencies during the time too. After it was almost over, the US instituted the Breton Woods agreement to use the USD and the accumulated US gold to support the Western European currencies and the UK Pound. This enabled the Allies to finish the war and win against Germany and the Japanese, both of whom had governments who believed in slave labor and ethnic monoism (superiority) at the time.

Then Western Europe had to rebuild, and so did Japan. They used US support such as the Marshal Plan to expedite it and to limit the suffering and starving populations. If you don't know the history just close this article. Because the USD was used to help win WW2. So much for the people who say the USD is so evil...

Continuing the thesis, the US then tried a Guns and butter program after WW2, and then in our presesnt times is they are using the USD to bail out the banking system and also the speculators plus 'guns and butter'. Let me state here that using currencies to bail out unscrupulous speculators is wrong. And what is happening right now is that every time the Fed ECB BOE etc BOJ do another bailout, the speculators just drain it. That process has an inevitable end of failing. The Guns and butter problem persists...for everyone but let's not digress. We are discussing examples.

Guns and Butter

After WW2, the US started this ridculous Vietnam war and then this gigantic guns and butter program under the super socialist Johnson who perfected the US implementaion of vote buying with US public funds. His welfare plans, the Great Society, threatened to bankrupt the US. By 1970 Nixon had to start looking at this problem. The US goes off the gold standard. Gold at the time fluctuated around $50 plus an ounce (being very rough here). France was draining the US of gold.

The US goes off the gold standard, and between the early 1970s and 1980 gold rockets to $870 in 1979 dollars. Inflation explodes -our inflation calculation is roughly 4 times since '79 for prices not including food and energy. If we were to update that peak of $870 to today it would be roughly $3400. Gold IS indeed worth $3400 now...but again that is another story. Gold will suffer for a while with the CRB collapse.

Mid East oil and religious wars

The 1960s and 1970s Israeli and Mid East wars occur. The US implements the gold for oil and USD for oil trade policies. Oil is priced in USD. Another war ends. The USD was used to accomplish this. Again a USD mechanism which helped stave off a war, even though the US was forced off its gold standard. People might disagree that the USD was used to end that war, but the Mid East wars back then threatened the world with nuclear combat. Gee we see the same problems arising again now with Iran Israel! It cannot be disproved that the USD oil ties with the Mid East coincided with the end of those Mid East wars. And those were truly religious wars, not just economic. The USD standard was used as part of that solution. But of course the US was very wealthy at the time too, with low debt.

Gold hovered in the mid $200 to $400 range in the 1970s (if I recall right) but explodes to $870 by 1979/80 with US inflation running well over 12 pct. Volker spikes US interest rates to 20 pct to combat inflation and it stops. US has recession in early 1980s. The oil price spikes and shortages seriously caused/contributed to the US inflation spike. This subsides.

Jumping ahead; tepid times and booms and busts

US prosperity bubble of 1980s and then the US tech bubble of the 1990s follows. Tech boom and crash, 2001/2. I was an Oracle Systems engineer, just by way of comment, at this time. I am doing research related to tech being another economic salvation from the West but again that is another side story.

Gold had hoverd around just below $300 right about then, before it began this long upspike to present day prices of around $1600. The US housing /refi boom begins as the US implements historically low 1 pct interest rates, and gold rises and explodes after the housing boom crashes as the US deficits explode from roughly $200 billion a year to our present $1.4 trillion a year.

2007/8 bank crisis, financial wars with speculators who securitized the world economy

Bear Stearns starts the banking crisis in Summer 2007 (which few seem to remember; due to derivative losses related to housing securities). Then things really exlode in Fall 2008 and we have the Lehman crisis. The US Fed pumps out $4 trillion dollars in those two years, part of which was the much debated TARP program to save US banks. Gold rockets. The US banks are saved to rescue the speculators. Things now turn into a quasi financial war with the speculators!

USD leveraged 100 to 1 since Breton Woods

Here I want to include a chart we made years ago showing how speculators have increased world leverage since decades ago:


In this chart we see that the financial speculators all across the West have progressively leveraged the world economy and securitized it leaving all nations' public treasuries at great risk and collapse; each oval subsumes the previous one. Eventually it all collapses, evidently at a 60 to 1 ratio of leverage at the time of Bear in 2007.This is where we are now in 2012-The Large green oval is a leverage of up to 100 to 1. A thesis point here is that the USD being the world reserve currency to date is leveraged against its public treasury at 100 to 1. Not good. Using the USD to support the world economy after WW2 has led to this dilemma. It did NOT have to be this way. This is the reason the US Fed has to send out tens of trillions of USD to try and stem the deleveraging which speculators in the main created and expanded. How is the USD leveraged at 60 to 1 or 100 to 1? Because the Fed/US backs/has to back the financial institutions who created that leverage!

Europe starts to crash threatening the EU banks and the Euro

European real estate markets turn down after the US crashes. Then today Asian real estate markets are crashing. This causes the commodities markets to crash.The EU starts to see financial and banking collapse. The EU goes into economic depression. The US funds over $20 trillion of funds to support both EU and US banks and such. That money is more or less wasted into derivative black holes (derivatives are leveraged bets on every economic activity and are the source of the incredible speculator leverage). The US financial institutions don't reform their ways. This continues today. The EU banks also don't reform. They are held aloft to rescue the debt created by speculators in bond debt markets which are used to form derivatives of massive leverage. Didn't I say the latest bubble is 100 to 1?

Now we are at another Bretton Woods scenario. The building Euro collapse.

Will the US again try another Bretton Woods and use the remaining life of the USD to save the Euro? That is an open question. It seems unwise if at this juncture, the US is to rescue the speculators again, whether they are here in the US or in the EU.

The Western banks are continuing to speculate and making huge gains and losses, the losses are forced on the public treasuries. Morgan's latest ten or tweny billion dollar losses which will be foisted on the US Treasury, are the latest example. Morgan evidently had been speculating in EU debt derivatives. So much for banking reforms that were supposed to solve the Lehman crisis.

Gold's role as a reserve currency here

There are several world reserve currencies, you can use any large currency out there, but the USD and gold are the two main ones desired and used by today's central banks. Gold since 1970 has done an excellent job of tracking inflation. But even further back, if you look at prices back in say 1910 to 1920, a loaf of basic bread in the US was 10 cents. A gallon of gas was about 20 cents. Today a loaf of bread is about $3 and a gallon of gas is about $4 in the US. This is about 20 to 30 times price inflation over a century. Gold back then was very roughly $20plus an ounce and now its $1600 roughly putting aside the price gyrations. Also the West has accumulated an immense debt in this period. Gold is also reflecting that. The gold price is over 60 times its old pre inflation prices back near the turn of the 1900s around say 1910. Gold has held its value quite well. Silver is way to chaotic to translate to the same analysis in my view ie going back that far.


It appears the US will find soon that trying to use the USD to save the Euro and the world banking - debt crisis will be impossible. The reason is that, since the USD is already leveraged 100 to 1 against all manner of debt and claims around the world, it would be impossible to try and stay ahead of deleveraging. So, trying to use another Bretton Woods agreement to save the Euro for example will not work.

Gold also might not work because it cannot be inflated magically (during crises if necessary all purity aside here; insisting on a gold standard at this juncture can work but only if there is massive world debt forgiveness, essentially to zero). The end result will be that the speculators will end up losing whatever remaining money the public treasuries will be able to borrow. At that point there will have to be a new world currency system, likely not based on the USD this time, but based on some other plan. I doubt that a system based on the Yuan for example has the size to work. Besides, China has their own problems.

Possible transition currency havens

Until these currency crises resolve, we think the UK Pound will be a haven alternative to the Euro to some degree. Probably the Russian Ruble too as well as the CAD and AUD and to a degree the USD (understanding that the USD is part of the fail problem) and the Asian currencies will likely struggle with their own dilemmas like local trade collapsing if the West fails like it appears to be doing.

The Yuan would be stronger in this situation but they are going to have some big social problems of their own particular character. We don't think Asia is much of a haven for the long term or at least trying to get past the initial collapse of the USD and Euro systems...We see other currencies above as being intermediate alternatives to try and save wealth when for example the Euro breaks down. Of course gold and silver and platinum as well. But Gold primarily. Gold IS a central bank reserve asset. Silver and Platinum are a bit too industrial for a perfect money. Basic commodities are OUT because collapsing demand will collapse them. I am not terribly swift on the Swiss Franc because they are right in the middle of the EU mess. I also think that diamonds are ok but the problem with precious stones is that they are hard to grade. I would really rule them out. I am just giving a few examples here.

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Copyright 2012

Christopher Laird

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Chris Laird is a mathematician, Oracle systems engineer, and publisher of the PrudentSquirrel newsletter.

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