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     Jun 4, 2005
The dollar: Time for a change
by David Champeau

Speaking Freely is an Asia Times Online feature that allows guest writers to have their say. Please click here if you are interested in contributing.

The US dollar has experienced many changes since its inception. During the first session of the new Congress, on April 2, 1792, the Act Establishing the US Mint was passed, which defined the dollar. Section 9 of the Act stated: "Dollars or Units - each to be of the value of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy-one grains and four-sixteenth parts of a grain of pure, or four hundred and sixteen grains of standard silver." This act also defined the eagle, half eagle, quarter eagle, half dollar, quarter dollar, dime, half dime and cent. The ratio between the value of gold and silver was defined as 15:1, which undervalued gold because other countries, such as France, had established a ratio of 15.5:1.

This is where our story begins: the dollar equals a certain amount of silver. During the early years of the 19th century, Congress enacted various laws with regard to legal tender. Most of these laws pertained to accepting foreign gold and silver coins as legal tender.

In June, 1834, 42 years after the dollar was defined, the Congress changed the ratio of gold to silver by reducing the amount of gold in the Eagles, setting a new ratio of 15.98:1, thus undervaluing gold. The reason for this was that speculators were withdrawing gold from circulation due to its undervaluation against silver. President Andrew Jackson wanted large denomination gold coins to take the place of bank notes and bills issued by the United States Bank, the second attempt at a central bank in America, which he had just shut down. Even with this act of Congress, the silver dollar still remained the unit of account.

In 1849, Congress changed the laws again and this time introduced the gold dollar. "There shall be from time to time struck and coined at the mint of the United States and branches thereof - conformably in all respects to law, and conformably in all respects to the standard for gold coins now established by law - coins of gold of the following denominations and value; viz, double eagles, each to be of the value of twenty dollars or units, and gold dollars, each to be of the value of one dollar or unit." Thus, the US then had two "dollars" in circulation, one of gold, and one of silver.

On February 21, 1853, another act of Congress reduced the weight of the fractional silver coins and also, for the first time, limited the legal tender quality of all silver coins. "The silver coins issued in conformity with the above section shall be legal tender in the payments of debts for all sums not exceeding five dollars." At the time of the passage of this act, the bullion in the silver dollar was more valuable as a commodity than the bullion in the gold dollar, consequently the silver dollars were withdrawn from circulation and sold as bullion in the European markets at a profit. To remedy this, Congress reduced the weight of the fractional silver coins, and limited their legal tender debt-paying power, but left the coinage of the silver dollar free and unlimited.

The next big change in the dollar occurred on February 12, 1873, with the Coinage Act of 1873. This act demonetized silver and, for the first time, made the gold dollar the unit of account. An amendment to this act, passed in 1874, created a "trade" dollar. The 1874 law specified that the new silver coins (dollar, half dollar, quarter dollar and dime) were to have limited legal tender in this country not exceeding five dollars, merely to provide the fiction that silver coins were circulating. In addition, depositors of bullion had to pay a fee of 0.5% to have their silver made into "trade dollars"; this was to discourage dumping the coins in this country.

The government made strenuous efforts to see to it that these new coins were readily accepted in the Far East, especially China. Japan and India were secondary targets and strong attempts were made in those two countries also. Diplomatic and consular officials were given "marching orders" to do everything in their power to put the "trade dollar" into active Far Eastern use. Thus for the second time in US history, we have two "dollars", one of gold for domestic circulation and the other of silver for external circulation.

Thus far the major changes in the dollar have occurred in 1792, 1834, 1849 and 1873. The intervals of these changes follow a pattern of roughly 20-40 years apart, roughly the duration of one-two generations. Another 20 years later, in 1890, we saw the attempt to remonetize silver with the Sherman Silver Purchase Act. This attempt failed after less than three years, when the act was repealed in 1893.

The next major change came in 1913 with the creating of the Federal Reserve System. Forty years after the demonetization of silver, the next step was the demonetization of gold, and the replacement of all notes circulating in the US (such as National Bank Notes, Silver Certificates, US Notes and Gold Certificates) with Federal Reserve Notes.

One part of the Federal Reserve Act pertaining to gold reads as such: "SEC. I6. Federal reserve notes, to be issued at the discretion of the Federal Reserve Board for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are hereby authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues. They shall be redeemed in gold on demand at the Treasury Department of the United States, in the city of Washington ... or in gold or lawful money at any Federal reserve bank." In other words, Federal Reserve Notes are redeemable for gold.

Fast-forward 20 years to 1933. The stock market crash leads to the Great Depression. Newly elected president Franklin Roosevelt declares a four-day bank holiday, issues the Gold Confiscation Act and devalues the dollar by 41% from $20.67 an ounce to $35 an ounce, thus ending 96 years of the dollar's value being fixed relative to gold. We now have another instance of a "two-tiered" dollar: one dollar, not redeemable for gold, for domestic use and another dollar, still redeemable for gold, for foreign use.

Fast-forward 20 years again to the mid-1950s. The world is rebuilding from World War II, the US is the dominant country, and Bretton Woods, the International Monetary Fund and World Bank are all working as part of the international financial system. Gradually the amount of US dollars outside the United States increased enormously, both as a result of the Marshall Plan and because the US, which had become the main consuming market of the world after peace was reestablished in Europe, paid for imports in dollars (sound familiar?). As a result, enormous sums of US dollars came to be held by foreign banks outside the United States. Some foreign countries, including the Soviet Union, also had deposits in US dollars in American banks, granted by certificates.

During the Cold War period, especially after the invasion of Hungary in 1956, the Soviet Union feared that its deposits in North American banks would be frozen as retaliation. A British bank offered the Soviets the possibility of receiving its US dollar reserves as deposits outside the US. The British bank would then deposit that money in the US banks. So there would be no chance of confiscation because it belonged to the British bank, and not to the Soviets. This operation was considered the first to create the so-called Eurodollars. Another new type of dollar.

Fast-forward 20 years to the early 1970s. The US has mounting trade deficits and is bleeding gold. On August 15, 1971, president Richard Nixon closed the "Gold Window", removing the last formal link between gold and the dollar. The result was inevitable. In February 1973, the world's currencies "floated". By the end of 1974, gold had soared from $35 to $195 an ounce. It was also in 1973 that the world saw another new version of the dollar come to market, the "petrodollar," defined as dollars accepted by oil-producing countries and forcing the world on a dollars-for-oil standard.

From 1873, we have seen changes in the dollar in 1913, 1933, 1956 and 1971-1974, each change coming roughly 20 years apart. Silver and gold have been relegated to the sidelines. Credit-based, floating currencies make global exchange possible. We have three "versions" of the dollar in the world: US domestic dollars, eurodollars and petrodollars. We could also say that the "Asian" or "Japan" dollar was created during this time. The Japanese held $12 billion in long-term US securities in 1978, and now hold $700 billion.

The next change if the cycle were to hold should have occurred in the 1990s. With China's rise accelerating in the 1990s, China began to accumulate massive US dollar reserves. China held no long-term US securities in 1989, $18 billion in 1994 and now holds over $200 billion, second only to Japan, according to the US Treasury.

What's next?
With the euro-zone countries holding over $200 billion in US securities and Asia with $1 trillion or more, the stage is now set for another change in the dollar. If the 20/40-year cycle follows its past pattern, the next change will occur sometime around 2011-2016 and it will be a big one since it will be on the 40-year cycle. We have already seen three instances where the US has had a "two-tiered" dollar, where, in two of those instances, the domestic dollar was not the same as the dollar outside the US.

The 2011-2016 time frame makes sense not just from the cycle standpoint but also from a demographic standpoint. By 2015, the baby boom generation will be well into the belly of the retirement bell curve. We know that the US government has something of the order of $50 trillion in unfunded obligations in order to make good on the promises made to the baby boomers. This $50 trillion dwarfs what foreigners are currently holding. If we spread this over 20 years, the US will need roughly $2.5 trillion a year, the equivalent of this year's federal budget. Something has to give.

Of course the US is not alone in this predicament. The Europeans and Japanese have the same problem and the Chinese will have a similar problem a little further down the road, (although the European social welfare system is much larger and more entrenched than the Asian one). Thus the US will not be able to do whatever it is that it will have to do in isolation. Globalization, combined with the aging populations of the industrialized world, will lead us into uncharted waters. All of the industrialized world will have to experience some type of drastic change.

How all of this resolves itself I do not know. I do know that it is criminal to do what we are doing to successive generations by burdening them with this massive debt (which of course, cannot be paid). Thomas Jefferson, in a letter to James Madison, stated: "Then I say, the earth belongs to each of these generations during its course, fully, and in its own right. The second generation receives it clear of the debts of the first, the third of the second, and so on. For if the first could charge it with a debt, then the earth would belong to the dead and not to the living generation. Then, no generation can contract debts greater than may be paid during the course of its own existence."

These words of wisdom have been forgotten by many. The debts and unfunded promises are piled sky high. This time a simple two-tiered dollar may not solve the problem.

Change is in the air. A big change.

David Champeau runs a blog.

(Copyright 2005 David Champeau.)

Speaking Freely is an Asia Times Online feature that allows guest writers to have their say. Please click here if you are interested in contributing.

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