Last week I was asked by a Wall Street Insights & Indictments reader about a new challenge to the U.S. role in the global economy that few are considering.
It's a dominant role we've held since the latter part of World War II, and for 70 years it's gone largely unchallenged.
The question isn't complicated, but it will be disturbing to some…
The Question No One Has Been Asking
The question was one begging to be asked, and I'm glad one of our WSII readers put it out on the floor. Here it is:
"I have a question which, as far as I know, has never been raised. Perhaps you can offer a viable answer.
In 1944, at the Bretton Woods Conference, the dollar was made the reserve currency for the world. This suggests to me that there are perhaps trillions of dollars floating around out there that are having little or no effect on our economy. I read that China is now trying to install the yuan as the new reserve currency, or at least at some point in the future, international trade will be done with other currencies.
What effect will that have on our dollar? This is something I've been thinking about for the past several months, wondering what we should be doing to prepare for that development. It seems to me that at some time in the future, all of those dollars will be repatriated, and yet no one that I know of has even raised the question.
Does that mean that I have it all wrong, or are people just too afraid to consider the possibility?"
To answer, first let me address what happened at Bretton Woods and what a "reserve" currency is, because understanding how a currency war will play out requires a look at past efforts to avoid one.
How the Dollar Became King
In July 1944, with World War II still raging, but with an end to the devastation in sight, the 44 Allied nations, led by the United States, met in Bretton Woods, New Hampshire. They planned to hammer out a policy to "govern monetary relations among independent nation-states."
The allies needed a financing mechanism to rebuild their countries and economies. And they needed a stable "global currency" to take the place of different currency regimes prone to competitive devaluations leading to economic disruptions.
Although John Maynard Keynes, a vocal and influential British economist at the time, proposed the "bancor" as a new world currency unit, the United States prevailed. The dollar became the "anchor" currency around which fixed exchange rates would be established.
The U.S. prevailed not only because it was by far the strongest ally. It also had the only viable economy paired with the means to help finance recovery. By that time the dollar was also the only currency still backed by gold.
Because the dollar was "reserved" by gold, the term "reserve currency" came into existence. But reserve currency means more than backed by gold, which is important to understand since Richard Nixon ended the dollar's convertibility into gold on August 15, 1971.
A reserve currency is first and foremost a currency that has the full faith and backing of its issuing government.
About the Author
Shah Gilani is Chief Financial Strategist for Money Map Press and boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker. The work he did laid the foundation for what would later become the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk and established that company's "listed" and OTC trading desks. Shah founded a second hedge fund in 1999, which he ran until 2003. Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see. On top of the free newsletter, as editor of The 10X Trader, Money Map Report and Straight Line Profits, Shah presents his legion of subscribers with the chance to earn ten times their money on trade after trade using a little-known strategy. Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on FOX Business' "Varney & Co."