THE END OF DOLLAR HEGEMONY, PART I

by Hon. Ron Paul of Texas

A hundred years ago it was called "dollar diplomacy." After World War II,
and especially after the fall of the Soviet Union in 1989, that policy
evolved into "dollar hegemony." But after all these many years of great
success, our dollar dominance is coming to an end.

It has been said, rightly, that he who holds the gold makes the rules. In
earlier times it was readily accepted that fair and honest trade required
an exchange for something of real value.

First it was simply barter of goods. Then it was discovered that gold held
a universal attraction, and was a convenient substitute for more
cumbersome barter transactions. Not only did gold facilitate exchange of
goods and services, it served as a store of value for those who wanted to
save for a rainy day.

Though money developed naturally in the marketplace, as governments grew
in power they assumed monopoly control over money. Sometimes governments
succeeded in guaranteeing the quality and purity of gold, but in time
governments learned to outspend their revenues. New or higher taxes always
incurred the disapproval of the people, so it wasn't long before Kings and
Caesars learned how to inflate their currencies by reducing the amount of
gold in each coin - always hoping their subjects wouldn't discover the
fraud. But the people always did, and they strenuously objected.

This helped pressure leaders to seek more gold by conquering other
nations. The people became accustomed to living beyond their means, and
enjoyed the circuses and bread. Financing extravagances by conquering
foreign lands seemed a logical alternative to working harder and producing
more. Besides, conquering nations not only brought home gold, they brought
home slaves as well. Taxing the people in conquered territories also
provided an incentive to build empires. This system of government worked
well for a while, but the moral decline of the people led to an
unwillingness to produce for themselves. There was a limit to the number
of countries that could be sacked for their wealth, and this always
brought empires to an end. When gold no longer could be obtained, their
military might crumbled. In those days those who held the gold truly wrote
the rules and lived well.

That general rule has held fast throughout the ages. When gold was used,
and the rules protected honest commerce, productive nations thrived.
Whenever wealthy nations - those with powerful armies and gold - strived
only for empire and easy fortunes to support welfare at home, those
nations failed.

Today the principles are the same, but the process is quite different.
Gold no longer is the currency of the realm; paper is. The truth now is:
"He who prints the money makes the rules" - at least for the time being.
Although gold is not used, the goals are the same: compel foreign
countries to produce and subsidize the country with military superiority
and control over the monetary printing presses.

Since printing paper money is nothing short of counterfeiting, the issuer
of the international currency must always be the country with the military
might to guarantee control over the system. This magnificent scheme seems
the perfect system for obtaining perpetual wealth for the country that
issues the de facto world currency. The one problem, however, is that such
a system destroys the character of the counterfeiting nation's people -
just as was the case when gold was the currency and it was obtained by
conquering other nations. And this destroys the incentive to save and
produce, while encouraging debt and runaway welfare.

The pressure at home to inflate the currency comes from the corporate
welfare recipients, as well as those who demand handouts as compensation
for their needs and perceived injuries by others. In both cases personal
responsibility for one's actions is rejected.

When paper money is rejected, or when gold runs out, wealth and political
stability are lost. The country then must go from living beyond its means
to living beneath its means, until the economic and political systems
adjust to the new rules - rules no longer written by those who ran the now
defunct printing press.

"Dollar Diplomacy," a policy instituted by William Howard Taft and his
Secretary of State Philander C. Knox, was designed to enhance U.S.
commercial investments in Latin America and the Far East. McKinley
concocted a war against Spain in 1898, and (Teddy) Roosevelt's corollary
to the Monroe Doctrine preceded Taft's aggressive approach to using the
U.S. dollar and diplomatic influence to secure U.S. investments abroad.
This earned the popular title of "Dollar Diplomacy." The significance of
Roosevelt's change was that our intervention now could be justified by the
mere "appearance" that a country of interest to us was politically or
fiscally vulnerable to European control. Not only did we claim a right,
but even an official U.S. government "obligation" to protect our
commercial interests from Europeans.

This new policy came on the heels of the "gunboat" diplomacy of the late
19th century, and it meant we could buy influence before resorting to the
threat of force. By the time the "dollar diplomacy" of William Howard Taft
was clearly articulated, the seeds of American empire were planted. And
they were destined to grow in the fertile political soil of a country that
lost its love and respect for the republic bequeathed to us by the authors
of the Constitution. And indeed they did. It wasn't too long before dollar
"diplomacy" became dollar "hegemony" in the second half of the 20th
century.

This transition only could have occurred with a dramatic change in
monetary policy and the nature of the dollar itself.

Congress created the Federal Reserve System in 1913. Between then and 1971
the principle of sound money was systematically undermined. Between 1913
and 1971, the Federal Reserve found it much easier to expand the money
supply at will for financing war or manipulating the economy with little
resistance from Congress - while benefiting the special interests that
influence government.

Dollar dominance got a huge boost after World War II. We were spared the
destruction that so many other nations suffered, and our coffers were
filled with the world's gold. But the world chose not to return to the
discipline of the gold standard, and the politicians applauded. Printing
money to pay the bills was a lot more popular than taxing or restraining
unnecessary spending. In spite of the short-term benefits, imbalances were
institutionalized for decades to come.

The 1944 Bretton Woods agreement solidified the dollar as the preeminent
world reserve currency, replacing the British pound. Due to our political
and military muscle, and because we had a huge amount of physical gold,
the world readily accepted our dollar (defined as 1/35th of an ounce of
gold) as the world's reserve currency. The dollar was said to be "as good
as gold," and convertible to all foreign central banks at that rate. For
American citizens, however, it remained illegal to own. This was a
gold-exchange standard that from inception was doomed to fail.

The U.S. did exactly what many predicted she would do. She printed more
dollars for which there was no gold backing. But the world was content to
accept those dollars for more than 25 years with little question - until
the French and others in the late 1960s demanded we fulfill our promise to
pay one ounce of gold for each $35 they delivered to the U.S. Treasury.
This resulted in a huge gold drain that brought an end to a very poorly
devised pseudo-gold standard.

It all ended on August 15, 1971, when Nixon closed the gold window and
refused to pay out any of our remaining 280 million ounces of gold. In
essence, we declared our insolvency and everyone recognized some other
monetary system had to be devised in order to bring stability to the
markets.

Amazingly, a new system was devised which allowed the U.S. to operate the
printing presses for the world reserve currency with no restraints placed
on it - not even a pretense of gold convertibility, none whatsoever!
Though the new policy was even more deeply flawed, it nevertheless opened
the door for dollar hegemony to spread.

Realizing the world was embarking on something new and mind boggling,
elite money managers, with especially strong support from U.S.
authorities, struck an agreement with OPEC to price oil in U.S. dollars
exclusively for all worldwide transactions. This gave the dollar a special
place among world currencies and in essence "backed" the dollar with oil.
In return, the U.S. promised to protect the various oil-rich kingdoms in
the Persian Gulf against threat of invasion or domestic coup. This
arrangement helped ignite the radical Islamic movement among those who
resented our influence in the region. The arrangement gave the dollar
artificial strength, with tremendous financial benefits for the United
States. It allowed us to export our monetary inflation by buying oil and
other goods at a great discount as dollar influence flourished.

This post-Bretton Woods system was much more fragile than the system that
existed between 1945 and 1971. Though the dollar/oil arrangement was
helpful, it was not nearly as stable as the pseudo gold standard under
Bretton Woods. It certainly was less stable than the gold standard of the
late 19th century.

During the 1970s the dollar nearly collapsed, as oil prices surged and
gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were
required to rescue the system. The pressure on the dollar in the 1970s, in
spite of the benefits accrued to it, reflected reckless budget deficits
and monetary inflation during the 1960s. The markets were not fooled by
LBJ's claim that we could afford both "guns and butter."

Once again the dollar was rescued, and this ushered in the age of true
dollar hegemony lasting from the early 1980s to the present. With
tremendous cooperation coming from the central banks and international
commercial banks, the dollar was accepted as if it were gold.

Fed Chair Alan Greenspan, on several occasions before the House Banking
Committee, answered my challenges to him about his previously held
favorable views on gold by claiming that he and other central bankers had
gotten paper money - i.e. the dollar system - to respond as if it were
gold. Each time I strongly disagreed, and pointed out that if they had
achieved such a feat they would have defied centuries of economic history
regarding the need for money to be something of real value. He smugly and
confidently concurred with this.

In recent years central banks and various financial institutions, all with
vested interests in maintaining a workable fiat dollar standard, were not
secretive about selling and loaning large amounts of gold to the market
even while decreasing gold prices raised serious questions about the
wisdom of such a policy. They never admitted to gold price fixing, but the
evidence is abundant that they believed if the gold price fell it would
convey a sense of confidence to the market, confidence that they indeed
had achieved amazing success in turning paper into gold.

Increasing gold prices historically are viewed as an indicator of distrust
in paper currency. This recent effort was not a whole lot different than
the U.S. Treasury selling gold at $35 an ounce in the 1960s, in an attempt
to convince the world the dollar was sound and as good as gold. Even
during the Depression, one of Roosevelt's first acts was to remove free
market gold pricing as an indication of a flawed monetary system by making
it illegal for American citizens to own gold. Economic law eventually
limited that effort, as it did in the early 1970s when our Treasury and
the IMF tried to fix the price of gold by dumping tons into the market to
dampen the enthusiasm of those seeking a safe haven for a falling dollar
after gold ownership was re-legalized.

Once again the effort between 1980 and 2000 to fool the market as to the
true value of the dollar proved unsuccessful. In the past 5 years the
dollar has been devalued in terms of gold by more than 50%. You just can't
fool all the people all the time, even with the power of the mighty
printing press and money creating system of the Federal Reserve.

Even with all the shortcomings of the fiat monetary system, dollar
influence thrived. The results seemed beneficial, but gross distortions
built into the system remained. And true to form, Washington politicians
are only too anxious to solve the problems cropping up with window
dressing, while failing to understand and deal with the underlying flawed
policy. Protectionism, fixing exchange rates, punitive tariffs,
politically motivated sanctions, corporate subsidies, international trade
management, price controls, interest rate and wage controls,
super-nationalist sentiments, threats of force, and even war are resorted
to-all to solve the problems artificially created by deeply flawed
monetary and economic systems.

Regards,

Congressman Ron Paul
for The Daily Reckoning