The life of the dollar as the world’s reserve currency is coming under pressure from both large and small countries. The conc*ern is from allies and non-allies of the US. As expressed by Jim Willie:

The developing nations of the world are in revolt against the USDollar. They see no future in holding US$-based bonds in reserve. They see no future in accepting US$ payments for their raw commodities and finished products. The secondary central banks of the world are increasingly stocking up on gold bullion and less on USTBonds. Some are actively converting from paper reserves to gold assets, like China and Russia. Many other nations are following their important lead. A more recent development has the BRIC nations blocking the IMF. They are cooperating less in Brazil, Russia, India, and China. The concept of the Chinese Yuan is being pushed, like in compromise, which includes a greater voice of the East and a smaller voice of the West, in particular the United States.

Treasuries are increasingly viewed as risky investments by China, the UK, Japan and other countries. The solvency of the US is little different than Greece other than the US has benefited from the dollar being the world’s currency (and a large military).  On a per capita basis, debt is actually worse in the US than in Greece.

The country of Panama uses the dollar for its currency. That is coming under question. Simon Black explains how inflation is affecting this country. It results from Mr. Bernanke’s monetary and credit policies over which they have no control. This unease is reflected in other countries around the world. So too will the inflationary effects of easy money in the US.

At some point, the entire world will be taking actions to protect itself from the deteriorating dollar. Major funders of US deficits (China, Japan, etc.) are already balking in regard to increasing investments in Treasuries. With deficits well in excess of $1 Trillion per year, the US has to obtain funding from somewhere. Otherwise, the Fed will print money to cover the deficits.

At this moment on March 9, the dollar is strong, at least versus the weighted average of other currencies. But is that truly strength? One would hope it would be strong versus the rapidly diminishing (and likely to eventually disappear) Euro. As I end this piece, gold is up $12.40. That is not consistent with a “strengthening” dollar. Actually that reflects weakness in the dollar.

Kitco.com, a precious metals site, decomposes price change in gold into two components — gold demand and currency effect. To see their methodology, go here. According to Kitco, the strength in gold is $29.90 up per ounce. Offsetting part of this strength is the strength in the dollar versus other fiat currencies of $17.50. The net result is the increase in the price of gold expressed in dollars of $12.40.

In a world where fiat currencies move toward Voltaire’s definition of their intrinsic value — zero,  relative values between declining currencies may be interesting but can easily be misleading. If currency A declines at the rate of 10% per year and currency B declines at 20% per year, you lose purchasing power regardless of which one you hold. However, on a relative basis, Currency A appears to strengthen about 10% relative to Currency B. Yet both currencies purchase less than they did a year ago.

In a world where all central banks are printing money, all currencies are losing purchasing power. Relative comparisons are not very meaningful other than to indicate which country is debauching its currency faster. There is no absolute standard against which to measure currencies and the change in their purchasing power. The best proxies are hard assets because they cannot be freely created like fiat currency. Gold, silver, copper, etc. are reasonable standards against which to measure the deteriorating or improving purchasing power of fiat currencies. When these commodities are getting more expensive, it generally means that inflation (money expansion) is underway. When they are shrinking in value, it generally signals stable or increasing purchasing power of the currency.

Some of these proxies come closer to “pure money” than others. None comes closer than gold which has served for thousands of years as money. Despite government attempts to discredit, ban  and confiscate it, gold still provides a safe haven against monetary abuses. It has risen from about $250 to $1,700 over the last ten years, clearly indicating monetary abuse. Is it possible that inflation has risen that much in such a short period? Probably not, because that implies over an 80% loss of purchasing power in a ten year period.

Unfortunately, nothing dealing with human behavior is easily calculated or forecast. Engineers and physicists have it easy compared to behavioral scientists. Physical scientists typically have to deal with only a handful of variables. These variables tend to be predictive in that they do not alter their behavior in some purpose-oriented manner. Human beings, on the other hand, are affected by millions of variables, including purposeful behavior. Most of the variables, to the observer, are indeterminate. Even if they were known they could not be measured for it is the expectations of their future value or states that matter to the economic actor. All reported data are old history, irrelevant to future decisions except in the way that they may shape expectations of future values.

The impossibility of measuring expectations is one of the reasons neat relationships don’t hold in economics. How much of the beginning price of $250 represented expectations that gold was going to go up or down? Likewise, how much of the current price of $1700 reflects an expectations component? Is it a positive or negative component? No one truly can answer these questions.

Is gold under or over valued? I don’t know because I don’t know how much pessimism or optimism regarding the future purchasing power of the currency is built into the current price of gold. My bet, however, is closer to Voltaire’s expectation than what is likely built into the market.

If you believe that governments can discontinue deficit spending and get their houses in order, then hard assets are probably not the place you want to put your money. If you believe, however, that that is not going to happen and central banks will continue to print money in order that government be able to pay its bills, then some protection against a fiat currency collapse would be prudent.