Power Up Wealth podcast – Global Reserve Currency Part 2 – Episode 50 transcript:
James Derrick 0:00
The US Dollar dominates global trade and brings Americans all kinds of benefits. This is part two in a series on the US Dollar as the global reserve currency. I am James Derrick, Chief Investment Strategist at Smedley Financial Services, and today my guest will be Jordan Hadfield. Jordan is going to help us understand how the United States got here and what lessons we can learn from the past.
Sharla Jessop 0:32
Welcome to the SFS Power Up Wealth podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
James Derrick 0:55
Jordan, thank you for joining me today.
Jordan Hadfield 0:57
Yes, thank you for having me.
James Derrick 0:59
Jordan is a wealth consultant and financial advisor at Smedley Financial Services. He has a CFP designation, a university degree in financial planning, and is an entrepreneur. Jordan, last time we spoke about what a reserve currency is, and all the benefits. There are a few downsides as well. But the benefits outweigh the costs for sure.
Jordan Hadfield 1:20
Absolutely, they do.
James Derrick 1:21
So now we’re going to dive into history. Traditionally, money has been linked to precious metals, especially gold. Why is that? Why does it matter? Obviously, we’re not there now. Fill us in on a little bit of how this what we call fiat money is linked to precious metals.
Jordan Hadfield 1:42
Most of my listeners I’m assuming have heard of the gold standard. And the gold standard is a monetary system which links the currency of a country directly to the gold it possesses. This does a number of things. Number one, and probably most importantly, it gives the currency, some physical value that can be trusted. In other words, if you hand me a piece of paper, and you tell me that it’s worth 10 units, right, how do I know that that is worth 10 units?
James Derrick 2:13
It’s 10 peanut butter cups.
Jordan Hadfield 2:14
10 peanut butter cups, right. And then if I go to trade that piece of paper you handed me with somebody else, they might disagree that it’s worth 10 units. But if it’s linked to gold, if you’re like, this piece of paper is worth 0.4 ounces of gold, and I can trade it for gold at any time. Now I’ve got trust in that piece of paper you’ve handed me. And when I go to buy, you know, these 10 peanut butter cups, the seller recognizes that they can take that piece of paper and exchange it and anytime for .04 ounces of gold. And so it creates trust in the monetary system. And the gold standard is a very, very important part of economic history.
James Derrick 2:54
So hundreds of years ago they used to the currency was actually made out of metals?
Jordan Hadfield 2:59
Yes.
James Derrick 2:59
And then they move away from that. And it went to paper. But the paper represented metals like gold?
Jordan Hadfield 3:05
Exactly. And it’s important to understand that during the gold standard, anybody could change their paper at a central bank for the gold that it represented.
Now, there were other reserve currencies before us that would have been doing the same thing.
Exactly.
James Derrick 3:17
What happened to them?
Jordan Hadfield 3:17
Since 1450. There have been six world currencies. And the latest one was Great Britain. They held the reserve currency status in the 19th century in the early 20th century. And most international trade was done in Pound Sterling. And the Pound Sterling, of course was linked to gold. They used the gold standard. What happened was with Great Britain is they entered the war, World War I, their economy as economies all over the world began to struggle, right. Being linked to gold has some advantages and has some disadvantages. You cannot print money if you’re on the gold standard, unless you have gold to back that money. In other words, if you want to print more money, you have to first obtain more gold. Well as we entered World War I and Britain’s economy started to struggle. They tried to implement economic policy to stimulate their economy. And what that requires is printing more money. They weren’t able to obtain more gold to print that money. So they momentarily went off the gold standard so that they could print more money and stimulate their economy. When they went off the gold standard, people lost faith in the Pound. The Pound actually dropped 35% for a period of time after they went off the gold standard. And what they were doing, as well as almost every other American ally country in the world is they were shipping gold to America in exchange for weapons so that they could go fight in World War I and later World War II. So America is collecting all this gold from Allied nations. And they’re exporting a tremendous amount of weapons. And so that brought stability to the American currency during this time. The American, the Americans were able to stay, the United States was able to stay on the gold standard. Well, Great Britain had to had to abandon it. You know, a few years later, Great Britain wanted to cement their status as the world currency issuer, and they tried to go back to the gold standard. What happened was, without getting into too much boring detail, they tried to inflate the Pound, trying to return to old exchange rates, and other countries weren’t buying, right that they viewed the Pound is overvalued. And because the Pound was overvalued, gold in Britain was undervalued. And so people were exchanging with other countries, international trade was taking place outside of Great Britain. And this just furthered the financial and economic stress in that country. And people started to look to America. By 1940, the United States had 70% of the world’s gold supply.
That is unbelievable!
Tremendous amount.
James Derrick 5:05
So I imagine that the British Empire probably peaked around the time of the American Revolution. So they were the reserve currency for a very long time. And I imagined then that it was a very slow degradation. And then it happened very fast at the end.
Jordan Hadfield 6:28
Yes, it did. I mean, within just 10-15 years.
James Derrick 6:32
And once that happens, you can’t force it. You can’t take it back, and force the world to accept your currency anymore.
Jordan Hadfield 6:40
Yeah. I mean, people were still trading in the Pound, but in much smaller amounts. And people begin to trade in 1920, people can begin to trade more and more with the US Dollar.
James Derrick 6:50
So between World War I and World War II, maybe the reserve currency was debatable between the two, but more and more of the American dollar. After World War II, you said the United States had 70% of the gold in the world, which is unbelievable. So we were the de facto reserve currency. Is that something officially that happens? Or is it just unofficially happened like an unwritten rule, we now want to trade in dollars?
Jordan Hadfield 7:19
Um, so in this case, it was unofficial in 1920. But because America, the United States had accumulated so much of the world’s gold, other countries could no longer implement the gold standard with their own currencies. And so it created a problem for all countries throughout the world.
James Derrick 7:37
Everybody’s going off the gold standard.
Jordan Hadfield 7:39
They didn’t have a choice. We had accumulated so much of the world’s gold, there wasn’t enough gold in other countries to support their currency. And so we needed a new international trade system. We needed a new global economic system. And so in 1944, 44 different countries met in New Hampshire to discuss how to best handle this.
James Derrick 8:02
This is the Bretton Woods agreement.
Jordan Hadfield 8:05
This is known as the Bretton Woods Agreement. And these countries agreed to implement a new economic system. What happened was, is all of these countries linked their currency to the United States dollar. So rather than these currencies being backed by gold, these currencies were pegged to the US dollar, and the US dollar was pegged to gold. So indirectly, everybody was able to back their currency with gold, but they did so through the United States dollar. Now, unlike the traditional gold standard, where anyone could go in and exchange their money for gold, at this point, Americans could not trade their money in for gold. A lot of people don’t realize that. But in since the Bretton Woods Agreement on, you couldn’t walk into a bank and exchange your dollars for gold. However, the government allowed other countries to do so. So other countries had the ability to exchange the US dollar that they had in their reserve system for gold. And so it gave the dollar strength and value in the world economy. And that was hugely beneficial. I mean, the Bretton Woods Agreement was advantageous in a number of different ways. But that is the big one.
James Derrick 9:19
So I find that fascinating, because when I think of the gold standard, I think of the 1970s when we came off of it, but really Americans could not exchange for gold long before that.
Jordan Hadfield 9:32
Yeah. I mean, there are places you could exchange for gold, but you couldn’t walk into the bank and exchange your money for gold after the Bretton Woods Agreement like you could pre 1944.
James Derrick 9:40
You couldn’t do it with the US government. You had to do it with a third party.
Jordan Hadfield 9:44
Yep.
James Derrick 9:44
So tell us now about the Nixon shock of the 1960s.
Jordan Hadfield 9:49
So in the 1960s, the government finances came under stress, and that’s because they were spending too much money. They were funding the Vietnam War. They were funding social programs. The economy started to weaken due to all the government spending, and something had to be done. Just like World War I with Britain, something had to be done to stimulate the economy. And so what did the United States government do? They did what Britain did. They printed more money. And with more money in the system, other countries started to question whether or not we had the gold to backup our dollar. These other countries started to say, hey, the dollar is overvalued, I’m gonna start exchanging it for gold. And so Nixon feared that there would be a run on the US gold supply. All of these other countries, France was a big one, there were other countries involved, too, that started exchanging their dollars with the United States government, for the gold that the government had in reserves. This is obviously problematic, and.
James Derrick 10:51
They’re giving us paper money, and we’re giving them gold.
Jordan Hadfield 10:54
And we’re giving them the gold back. And they recognize that this trade was benefiting them, because the value of the dollar had dropped. And so Nixon recognized that this was a problem. And if it continued, there could be a run on America’s gold supply, which would be devastating. So he suspended, he temporarily suspended all trade of the US dollar to gold.
James Derrick 11:16
Which was only being done by other countries. Americans couldn’t do it.
Jordan Hadfield 11:19
Correct.
James Derrick 11:19
As you mentioned.
Jordan Hadfield 11:20
Yep. And so he stopped this, and this caused panic. Many people during this time, thought this was the end of the United States dollar as the world currency. Fears shot up. The dollar dropped on the global stage. It was it was a rough time, right for for the American economy and the dollar going forward. What happened was, though, over time, is that it actually strengthen the dollar. That sounds like it should have been the opposite. Right?
James Derrick 11:49
It certainly didn’t happen for Britain. As you mentioned it dropped 35%. Let me interject here, though, with one other point of view on the dropping the gold standard, because the other problem was that dollars were in such great demand that we didn’t have enough dollars to support global trade. And so this is, this is a slightly different problem, this is the problem that we have to if people are going to trade in dollars all over the world, there have to be enough dollars. And if we are restricted by the amount of gold we have, then we’ll either lose the reserve currency, or we need to drop the gold standard. So if you drop the gold standard, and allow more dollars out there, then global trade can take place between Saudi Arabia and Britain in dollars, and we don’t have to have the gold. And that does strengthen the dollars place in the world.
Jordan Hadfield 12:46
You’re absolutely right. And that’s where I’m going. And the difference was between America in 1971, and Britain, you know, in the in 1914, was that the global economy is so much bigger at this point in time. And so I like to think of the gold standard as training wheels on a bicycle. The gold standard provided safety and security, just like training wheels do on the bike. But nobody’s winning the Tour de France with training wheels, right. In other words, the gold standard has a lot of benefits. But one of the drawbacks is you can’t print more money if you don’t have more gold. And because the world economy had grown to such an extent that we needed more money in the system, in order to support the demand in the system. In other words, when there are more goods and services, we need more dollars in the system to be able to purchase those goods and services and grow the economy. So yeah, you’re absolutely right. That was a huge difference. In this time, a lot of people feared the dollar was going to lose its status, and it didn’t. The American dollar got stronger and the American economy got stronger. The government printed more money into the system to meet this demand for that money in the system, both domestically and internationally. And we’ve been reaping the benefits of that ever since. So it was called the Nixon shock because it shocked the system. It broke the Bretton Woods Agreement. From that point forward, you know, we had de-pegged our dollar to gold, which is what we agreed to do to support all the other currencies in the nation. That went away. We’ve now adopted a floating rate system, right where the rates of different currencies float and fluctuate. They’re not pegged to any one currency or one precious metal, but it stimulated growth way beyond what was possible if we had stayed to the Bretton Woods Agreement. And definitely, far beyond what the gold standard could have provided us.
James Derrick 14:36
Well put. Let’s wrap this up with a discussion on how dominant is the US dollar?
Jordan Hadfield 14:43
So about 59% of world trade is still done in the US dollar. Now, a lot of people are saying well, that’s come down, you know, it’s hit, high 60s, you know, 70% of world trade was once done and dollars, but it’s also been lower. 59% is a healthy percentage. And the US dollar continues to be strong in the global market. When crisis hits in the global market, people come to the US dollar. In the 2008 financial crisis. This was another period of time where there was great fear of the American dollar losing its its global status as the world currency. People flooded to the dollar. And that provided stability to the American economy. It fueled future growth in the American economy. The dollar is still very, very strong. Part three the next time we meet, I look forward to diving into this topic a lot more. There’s a lot here to discuss. I’m very excited about that. But currently, the dollar strong.
James Derrick 15:39
Thank you, Jordan for coming in. And I really appreciate your knowledge.
Jordan Hadfield 15:43
Yeah, thank you so much for having me. I look forward to coming again.
Shane Thomas 15:45
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn. The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
