The Pyramid II

The Pyramid

Part II: Everyman for Himself

By: Kian Mokhtari


President Bush and Henry Paulson’s application of political leverage for financial gain on China and Russia may seem a little over the top and premature but then again the true nature of dollar itself needs to be understood.

Adopted by the US Congress of the Confederation of the United States on July 6, 1785, the US dollar is the currency most used in international transactions. Several countries use the US dollar as their official currency, and many others use it in a de facto –peg- capacity.

Although the value of dollar is measured in its equivilant value in grains of gold and silver, it became apparent at the end of WWI that there would not be enough gold or silver to allow the volumes of dollar required in international trade.  

One of the major opponents of the new thinking was Winston Churchill who was appointed Chancellor of the Exchequer in 1924 under Stanley Baldwin and oversaw Britain's return to the Gold Standard. His decision, announced in the 1924 Budget, came after long consultation with various economists including John Maynard Keynes, the Permanent Secretary to the Treasury, Sir Otto Niemeyer and the board of the Bank of England. The decision was generally popular and seen as “sound economics.”

In his speech on the Bill he said, "I will tell you what it -the return to the Gold Standard- will shackle us to. It will shackle us to reality."

The advocates of US dollar as world reserve currency on the other hand, also had a good argument: Paper money’s value has nothing to do with reality so economic realities dictate the value of any currency. In other words dollar did not need to be supported by gold or silver for as long as it remained the world’s reserve currency. This means that for as long as gold, oil and most other precious commoditiers were traded in dollars, each and every country in the world would need to hold dollar reserves, be it in $100 denominations, notes or bonds.

The US Federal Reserve would then print dollars to the value of the bonds or notes -10-year, twenty-year etc- and pay an amount of interest on such bonds or notes. The world countries would then purchase the dollar and hold it as reserve currency if only to be able to continue trading in the international markets.

Economist Paul Samuelson and others maintained for sometime that the system would be full proof. That the overseas demand for dollars would allow the United States to maintain persistent trade deficits without causing the value of the currency to depreciate and the flow of trade to readjust. Paul Samuelson has now changed his mind however saying he believes that at some stage in the future a run against the US dollar would begin with serious global financial consequences.

Alan Greenspan however, suggestsed that another reason for the fall of the dollar is its decreasing role as the world's reserve currency. The dollar sank to new lows against the euro in the days following 4 March2008, with the Federal Reserve continuing to slash interest rates.

So US Treasury Secretary Henry M. Paulson’s decision to deregulate the banking institutions could mean only one thing: that things are about to go belly up for the dollar’s long reign and it would be every man for himself, as the US Treasury Department would no longer be able to maintain the dollar as the world’s reserve currency given dollar’s rollercoaster ride in value particularly since the disastrous US invasion of Iraq in 2003.

This latest twist is astonishing because the dollar was only worth the value it had printed on it, for as long as the greater majority of world trade was conducted in dollars forcing world countries to invest in US bonds and notes, facilitating thereby the printing of more paper dollars or cash.

As we mentioned in part one of this article China is holding in notes and bonds close to $1.5 trillion dollars and is not only unwilling but unable to purchase more dollars from the US. So China is now being urged by Mr. Paulson to spend its money so at least the US can get some liquidity back into its own banking system. And other countries are at present being gently –for the time being- nudged by the US to spend more.

Perhaps Winston Churchill was right in believing that any currency had to possess suitable support or backing in order to remain credible in the real world, since the US dollar is roughly based on the outlawed pyramid business scheme. It can only work for as long as the bases of the pyramid, being the world trade volumes, expand and redouble at breakneck speeds and the trade is mainly conducted in US dollars.

This would allow the US to surge ahead as the world’s leading nation with the base of the pyramid made up of the third world countries, and accordingly such scheme would require globalization as a business doctrine in order for the dollar based trade system to run ahead of others indefinitely.

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