The Shape of Things to Come

It seems that there are two different possible types of dollar devaluation.

One is a coordinated devaluation, where the big players all agree on a new dollar value in terms of their own currencies. This new value would be hammered out behind closed doors - and ratified later at a meeting of the G-7.

It appears to me, from reading what we have all been reading on the subject of the problems in Europe and in Japan, and not to mention those of the inscrutable Chinese, that it would be extremely difficult for the major players in the world economy to arrive at any agreement to a substantial devaluation of the dollar in order to reduce the U.S. trade deficit, running at some $400 billion a year. The rest of the world is hooked on exports to the U.S. Consequently, reducing its trade surplus means killing off a substantial percentage of exports to the U.S. To put it mildly it seems to me very difficult for a group of nations to agree to that.

So, this first type of devaluation, a concerted and agreed-to devaluation, is hardly possible.

The second type of devaluation is your good old chaotic, traumatic devaluation, the kind that destroys the lives of enormous numbers of innocent citizens. The rest of the world has seen plenty of these devaluations in the last 25 years, but the U.S. has not. The American people do not understand what devaluation means, because they have not physically suffered from the phenomenon…as yet.

A devaluation of the dollar means the dollar will be worth less in terms of most of the other currencies in the world.

There is only one way that such a devaluation can occur: and that is, with regard to a superior currency, in which all currencies, including the dollar, are denominated. And that superior currency (the numeraire as it used to be called) is, of course, gold.

The U.S. trade deficit will be, and has to be substantially reduced at the very least, if not eliminated. That requires the devaluation of the dollar. There is no other way. And that can only be achieved, through the mechanism of the price of gold.

But, that does not mean just a rise in the price of gold in dollars. If that happens, as it has been happening, no devaluation of the dollar in terms of other currencies is taking place. The price of gold in all currencies just goes up evenly around the world. The dollar is still overvalued in terms of Yen, Euros, Yuan, etc. etc.

A devaluation of the dollar with a view to reduce the trade deficit requires an uneven rise in the price of gold, expressed in terms of the diverse currencies of the world.

Here's an example of an even rise in the price of gold around the world:

Suppose the dollar price of gold at $310/oz, and the dollar is worth 1.09 euros, £0.68, and 127 yen; conditions as they are, approximately, at the moment.

It then follows gold is worth $310/oz in dollars, 338 euros/oz, £211/ozand 39,370 yen/oz.

Suppose gold rises evenly in terms of all these currencies to $350 dollars/oz, but the value of the dollar in terms of the other currencies remains stable. Then we would have:

Gold in dollars is $350 dollars/oz., 381 euros/oz, £238/oz, 44,450 yen/oz.

Obviously, the rise in gold has benefited gold holders. The dollar has devalued with regard to gold, as have the other currencies, but their relative values remain the same, so nothing has been achieved with regard to the U.S. trade deficit.

A real, gut-wrenching dollar devaluation that will trim the trade deficit means that the value of the dollar in terms of euros, pounds, yen and all other currencies is shaken to the core, and all cross currency valuations are also affected: the euro-pound rate, the euro-yen rate, pound-yen rate, the euro-yuan rate, the pound-yuan rate, the yen-yuan rate…you get the idea.

This must also mean that the rise in the price of gold in these diverse currencies is going to vary from country to country. Some countries will see greater rises in the value of gold, expressed in their own currencies than others. I do not have any idea what the new gold prices will be in terms of these various currencies. But this scenario must materialize if the dollar is to devalue significantly. It will be a free-for-all. In this scenario - which I think is likely - the price of gold will in my opinion spin out of control.

Because the significant devaluation of the dollar with regard to the yen, the yuan, and the euro will so profoundly affect the productive structures of Japan, China abd the European Union - in fact, of the whole world - there will be an attempt to maintain an even rise in the price of gold around the world. But, this will not reduce the American trade deficit. Only an uneven rise in the price of gold in terms of the various currencies can trim down or reduce substantially the American trade deficit.

The situation is hard to visualize, but it appears to me that there will be an international race to the bottom in terms of the gold value of the diverse units of each national currency. In other words, the currencies of the world will devalue with regard to gold in a race to maintain the present parity with regard to the dollar. This will be an attempt to frustrate the devaluation of the dollar. In other words there will be an attempt to keep the dollar overvalued as it is at present, and thus retain the American trade deficit in order to protect export-oriented industries in each country. No country wants to see its export industries shut down.

However, this attempt will fail. Disorder will prevail. Finally, some countries will choose not to devalue their currencies further in terms of gold. When this happens, we shall see that gold will rise in terms of national currencies to different levels. The percent increase in the price of gold expressed in dollars will be greater than the percent increase in the price of gold expressed in other currencies. At that time the dollar devaluation will have become effective. The U.S. trade deficit will trend to disappear. Americans will only be able to buy imported goods to the extent that they can pay for them with exports. The favorable part of this traumatic experience will be that U.S. industry will have a rebirth from its present ashes.

The dollar will lose its heretofire global dominance. The U.S. will take that place among nations to which the laws of economics assign it in accordance with its productivity of the goods which the rest of the world wants to buy. A place very different from that which it presently occupies as producer of the world currency par excellence. Gold will be the master.

New international trade relations will be established. When the dust settles, the world will be a different place than that we now know. "Globalization", a phenomenon that has been based on the hegemony of the dollar will be a thing of the past…an illusion that dissipates like a dream. There are other considerations like the possibility of a great war that goes along with this readjustment of world international relations. I won't go into those considerations. Suffice it to say all international trade relations and the productive structure of every country, now so heavily invested in "export for dollar income" will be very much affected. The readjustment will cause the world a great deal of real pain.

A war may obscure the change in trade relations and in world influence, but change must and will take place. The U.S. simply cannot indefinitely live off the rest of the world to the tune of $400 billion a year deficit. The dollar must and will devalue.

I have attempted to delineate the shape of things to come that describe the impending dollar devaluation.