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BRICS Targeting the Dollar: Invest in Gold

Why Gold is About to Shine

Written by Geoffrey Pike
Posted July 25, 2014

I continue to maintain that the U.S. dollar is slowly losing its status as the world’s reserve currency.

More steps toward this developed recently. A meeting between the leaders of the BRICS countries resulted in an agreement on a new financial system and currency pool.

American dominance — including the dominance of the U.S. dollar — came about around the end of World War II. The Bretton Woods agreement set something of an international gold standard, under which other countries could redeem gold in exchange for dollars.

But the Federal Reserve inflated the money supply to the point where there was not nearly enough gold reserves to make the dollar redeemable, and in August 1971, Richard Nixon abandoned the last remnants of a gold standard.

While Nixon was part of the problem, he can’t be fully blamed for this. It was inevitable based on the system that had been set up and the money creation that had taken place.

Part of Bretton Woods was also the creation of the International Monetary Fund (IMF) and the World Bank. To this day, the U.S. government mostly controls these institutions.

There are various reasons for U.S. dominance over the last 70 years. Some say it is because the U.S. has the most powerful military. Others say that it is because the U.S. has the largest economy, which it does.

I think it is a combination of these reasons. The U.S. and Soviet Union were really the only two superpowers left after World War II, but the Soviet Union was under communism.

The U.S. has also had the biggest economy of any country in history. There may be some tiny countries today that surpass the U.S. on a per-capita basis, but the U.S. economy remains number one among the world's large countries.

In addition, while the U.S. dollar has had its problems over the years — particularly in the 1970s — it has generally been the most stable currency of the large countries.

BRICS

I used to refer to the top emerging economies as the BRICs: Brazil, Russia, India, and China. For this article, I refer to the BRICS countries, adding South Africa, whose president was part of this latest meeting.

While I am down on the U.S. dollar for several reasons, it doesn’t mean I’m impressed with these other countries.

Brazil is a large country and not insignificant, but it is a relatively poor nation. South America seems to be the face of currency crises. It seems there isn’t a moment when some country is not having some kind of near hyperinflation event.

Brazil does not escape this criticism — its currency is terrible. It had something resembling hyperinflation in the 1980s and 1990s. The country would be better served if it used U.S. dollars, and that is coming from someone who frequently criticizes the dollar.

Russia, meanwhile, is a former piece of the Soviet Union. It is better there today than it was 25 years ago, to be sure, but the country still struggles from its past.

While it is rich in oil and natural gas, there is not a lot else to point to. Its economy is still quite small in comparison to the United States.

India has a population of well over 1 billion, and you would think a country with such a huge population would have more economic significance. But it is an extremely poor country, plagued with bureaucratic regulations and a terrible currency.

A good portion of the smartest people get out and move to the U.S. or somewhere else where property rights are more respected.

I think India has a lot of potential in the future, especially as technology and communications continue to increase on a global scale. But as of right now, it is hard to take the country and its government seriously. It is a terrible place to do business.

We speak of the top 1% in the U.S., but this is more exaggerated in India, where there is not much of a middle class at all. Most people are really poor, while a tiny percentage controls most of the wealth — which isn’t a whole lot for a country of well over 1 billion people.

The only real significance India has for me as an investor is the demand for gold coming out of the country.

China is a country to take seriously. For the last 35 years, we have seen China somewhat liberalize its economy, resulting in one of the greatest gains in wealth in history over such a short time span. Hundreds of millions of people have been lifted out of extreme poverty.

We do have to remember that China is still a communist country, even if in name only. The politicians there may not follow the communist model, but they do follow a model of central planning. While it is better than it used to be, it's still not great.

China's currency is not freely floating. This is a major problem, and it means the currency is not likely to replace the dollar as the world’s reserve currency, as some have predicted.

China also has a massive real estate bubble that is about to pop. Its biggest leverage against the U.S. is the more than $1 trillion in U.S. Treasuries that it owns and continues to buy.

As for South Africa, there is not a lot to say. The nation has major problems of racial division, and the crime rate is extremely high. It is certainly economically better than most other countries in Africa, but that is not really saying a lot. Property rights have been weakened there, and the country is quite insignificant in economic matters.

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A Currency Pool

The meeting between the leaders of the BRICS countries resulted in the signing of an agreement to create a BRICS Development Bank, which includes a currency pool worth over $100 billion.

The move is being seen as an attempt to move away from the IMF and World Bank. In other words, it is a move away from using the dollar in international trade. The countries may also consider allowing entrance to other countries in the future.

While these five countries contain about 42% of the world’s population, they represent a much smaller portion of the overall world economy. Still, the trade between the countries is estimated at 17% of the world’s total.

Ironically, if these countries would just stop destroying their own currencies, they probably wouldn’t need to take such steps. But because they all continually destroy the purchasing power of their money, the currencies are not trusted and don’t make for good trading.

If China is buying goods from Russia — regardless of whether this is between individuals, businesses, or governments — why can’t the Chinese just use yuan to pay for the goods? The Russians could instantly convert the money back in to rubles if they wanted. The problem here is that the yuan is neither a free currency nor a trustworthy one.

These five countries have a horrendous record of monetary policy, so it should be no surprise that they can’t do this and that they still rely on the dollar. There are no major countries that have far more stable currencies than the dollar (Singapore and Switzerland are not major). The yen and euro aren’t terrible, but they aren’t any better than the dollar.

Your Money

Despite my criticisms of the BRICS countries, their move is still significant. The world is slowly shifting away from dollars.

In some ways, I see this as positive for Americans — after all, the government will not be able to run huge deficits as easily if other countries stop buying a good portion of the debt.

The long-term key for Americans is what the Fed does, assuming it still exists in 20 years. If there is high monetary inflation like the past six years, then it will mean lost purchasing power and a weaker economy due to resources being misallocated.

If the Fed keeps its money creation under control, then Americans will be fine, even if other countries stop using dollars in international trade.

The ultimate answer probably lies in a return to the use of gold as money.

Either way, gold should be part of your answer in hedging against a declining dollar. The U.S. dollar will decline in international trade, even if the other currencies are not much of an alternative at this time.

Over the long run, a weaker dollar means gold will shine.

Until next time,

Geoffrey Pike for Wealth Daily

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