A short story on the Long and Winding Road of Monetary History: A Tale of Gold, Oil, and Bancor
A stroll down Monetary Lane
In this first edition of Macro, we will explore the history of the international monetary system, focusing on the role of gold and oil in shaping the US dollar's position as the world's reserve currency. We will discuss key events such as the proposal of the International Clearing Union (ICU) by John Maynard Keynes, the Bretton Woods system, the end of the gold standard, and the emergence of oil as a reserve asset.
The Proposal of the ICU and Bancor
In 1941, John Maynard Keynes first proposed the ICU as a way to regulate the balance of trade. Keynes suggested a new currency called Bancor, which would be a basket of commodities designed to act as a neutral reserve asset. Essentially, if a country sold more than it bought, it would end up with a surplus and would accumulate Bancor. If a country had a trade deficit, it would have to buy Bancor to settle the deficit, effectively selling its own currency to receive Bancor. This would weaken the currency of the deficit nation against creditor nations. The system was designed to be self-regulating and could result in a less crisis-prone system.
The Bretton Woods System
However, a conference was held towards the end of World War II to establish a new monetary system. Due to the industrial power of the United States, it had accumulated over 60% of the world's gold, about 20,000 tons. As result, the Bretton Woods system was established, with exchange rates pegged to the US dollar, which in turn was pegged to gold at $35 an ounce.
The End of the Gold Standard
By 1971, US gold reserves had dwindled to about 8,000 tons. The International Monetary Fund (IMF) recommended devaluing the US dollar to $42 per gold ounce, while members of the Bank for International Settlements (BIS) proposed various rates ranging from $35 to $150. However, the Nixon administration decided to close the gold window altogether, effectively ending the gold standard and the convertibility of the US dollar to gold.
The Emergence of Oil as a Reserve Asset
In the late 1970s, following the Yom Kippur War and a subsequent 400% increase in oil prices, the US reached an agreement with Saudi Arabia to accept only US dollars for oil sales. This effectively meant that all OPEC countries would follow suit, and the oil market became large enough to serve as a reserve asset for the US dollar.
From the early 1970s to 2005, the price of oil remained within a range of $10 to $30 per barrel. The US Federal Reserve would tighten monetary policy when oil prices reached the upper end of the range and loosen policy when prices dropped to the lower end. During this period, foreign treasury bondholders were assured that their dollar holdings would buy them a consistent amount of oil.
WTI and 3-Month Treasury Rate from 1970-2023. From QE1 on, the domestic economy is put ahead of USD as a reserve currency.
The Breakdown of the Dollar-Oil Relationship
However, in 2005, oil prices began to breach the $30 threshold and continued to rise towards $50, driven by China's rapid growth and the reality of peak cheap oil. As the dollar weakened against oil, the subprime crisis emerged, forcing the Federal Reserve to choose between maintaining the dollar's value in terms of oil or addressing the domestic economy's needs.
The Fed opted for a looser monetary policy, which led to oil prices skyrocketing from $70 to $150 in a short period, causing the dollar to plummet against oil. This choice marked a shift from the 1980s, when then-Fed Chair Paul Volcker prioritized the dollar's value as a reserve currency by implementing austerity measures and high interest rates to combat inflation.
A few trading days later
In March of 2009, the head of the PBOC Peoples Bank of China decided to publish a white paper at the BIS https://www.bis.org/review/r090402c.pdf a few trading days after the US went from buying mortgage backs to printing a trillion dollars to buy treasury bonds.
The title of the paper reads “Reform the international monetary system” this was the first time the it was visible to a non-insider that there was dissatisfaction with how the US had not managed the dollar to be as good as gold for oil anymore.
China is short energy and long dollar reserves. And thus they took it seriously when the US showcased that those dollar reserves that it needs to buy oil were not going to be as good as gold for oil anymore. Hence the straightforward title.
The PBOC even specifically sighted the Keynes Bancor as a better system. A system with a neutral reserve asset.
The Euro
The Eurozone is itself short energy this became even more apparent following the sanctioning of Russian Oil following the invasion of Ukraine. The Europeans scrambled to find a new energy provider.
In 2018 then, European Commission President Jean-Claude Juncker said “It is absurd that Europe Pays for 80% of its energy import bill- worth 300 billion euros a year - in U.S. Dollars when only roughly 2% of our energy imports come from the United States” he further stated the need for the EURO to challenge the dollar as a global currency.
Following the invasion and the destruction of the Nord-stream pipeline, however, the US has become the biggest supplier of crude oil to the European Union, accounting for 18% of crude imports and the second largest supplier of gas with a nearly 20% share behind the bloc’s top source, Norway which accounts for almost 31% of EU gas imports.
Albeit the change in the EUs energy policy, it too is stuck with the same problem as China.
A fresh start
Only time will tell whether or not Eurasia chooses to move away from the dollar and into a neutral reserve asset such as Keynes proposed with BANCOR. Maybe we will go back to some form of the Bretton Woods system with gold back in the picture. However, only time will tell whether or not the US can hold onto the current system, but it is clear there are kinks in the armor.
