Does Gold Glitter?

In 1946 the Bretton Woods System established a fixed exchange rate of $35 per once of Gold. That is when the dollar and the U.S. economy were the envy of the world. In 1971 President Nixon ended the fixed rate peg and the dollar (and other currencies) was allowed to float supported only by the strong U.S. economy, low debt and the full creditworthiness of the U.S. government. Smelling blood and lead by Russia in 2009 we saw the BRIC bloc declare their support for an alternate world reserve currency to the U.S. dollar. What will the form of this alternate currency be and what will support it? Neither of the BRIC currencies is strong enough to carry this burden and privilege. Nor can the BRIC bloc be unified enough to form the backbone of support for they are (geographically), politically, economically and culturally far apart. I don't think for a moment the BRIC thought they can actually replace the dollar as a reserve currency with another currency, not even an SDR. They also did not create a road map for the replacement. However, recent events may be turning their desire into reality no thanks to them.

The U.S. dollar is weighed down by too much debt and an uncertain regulatory terrain of the financial system to retain the title of "reserve currency". Don't be fooled by the recent tactical retreat to the safety of the dollar following the horrible but expected events in the EU. Simply put the dollar is the lesser of the evils out there at the moment.

With the announcement of the massive bailout the Euro just started down the path of the dollar. Tapping into future earnings to pay for past spending is a sure way to tame growth for years to come. This massive bailout is more of an attempt to preserve Europe's ability to face an aggressive Russia at its doorstep more then anything else; for economic unity, no matter how feeble, brings political determination.

At times of great uncertainties countries must and will do what they see is in the best of their interest. China's massive dollar reserves can be a blessing or a burden. China is facing its own economic problems stemming from fast growth. Recently the Chinese government has taken a series of steps to curb the runaway growth of its economy and what many consider a huge bubble in its housing market. Faced with a declining dollar and weak prospects of its largest trading partner, the EU, China may well decide to rid itself of some reserves- who wants to hang on to a declining asset- and preserve its wealth in gold. For over five thousand years people have been turning to gold to preserve their wealth at times of distress.

For the last couple years we saw some central banks around the world increase their gold holdings (India among them) while others declared their intention of doing so (China). Given the unprecedented amount of debt issued over the last decade and the additional debt burden assumed (think potential inflation) lately in a failing attempt to rescue the system and faced with a real slowdown both in Europe and in America (think uncertainty) signs of a perfect storm are beginning to form giving rise to all things golden and a De facto undeclared new world reserve currency.

At a time when no one currency is strong enough to be dominant the country (or countries) holding more gold has more say in the shape and composition of a future reserve currency. The competition is on.

I say gold does glitter.