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July 04, 2007

Dollar Dependence on the Fourth of July
by Adrian Ash

"...Has the United States confused the cause and effect of monetary vs. military dominance? To mark Independence Day 2007, let's count the cost..."

ON THIS Fourth of July - and with the Dollar trading at a 26-year low against the British Pound - it's worth remembering that both Thomas Jefferson and George Washington implored the United States to avoid foreign entanglements.

Back then, however, Great Britain still ruled the world (if no longer the Colonies) and the Founding Fathers never guessed the Republic would one day have to defend the Dollar's "reserve currency" status worldwide.

One hundred years later, Britain's global domination seemed to prove a link between military power and monetary might. London's gunboat diplomacy of the late 19th century was matched for success by the Gold Standard backing its money.

By 1868, only Portugal, Egypt, Canada, Chile and Australia had joined Great Britain in fixing the value of their currencies to a certain quantity of gold. Some countries employed both gold and silver; most of the world relied on silver alone. But forty years later, only China, Persia and a fistful of Central American basket-cases still declined to use gold exclusively.

"The Gold Standard had become, in effect, the global monetary system," writes Harvard professor Niall Ferguson in his history of Empire: How Britain Made the Modern World - and the Gold Standard was run from London.

Fast forward one century again, and the US Federal Reserve has underwritten the world's confidence in all monetary values for more than six decades. Curiously enough, however, running the casino seems to have given the US few monopolistic advantages.

Yes, Old Europe's share of the world economy has shrunk since its various empires began crumbling in the early 20th century. According to Angus Maddison in The World Economy: A Millennial Perspective, Western Europe's share of global GDP fell from one third in 1913 to just one fifth in 1998. But the United States' share peaked in 1944 - the same year as the Bretton Woods Agreement crowned the Dollar as king of the world - and it has declined ever since. According to Maddison's study, undertaken for the Organization for Economic Co-Operation & Development, it fell from 27% in the early '50s to barely 21% by the turn of the century.

Has the United States confused the cause and effect of monetary dominance? To mark Independence Day 2007, let's count the cost.

According to the Stockholm International Peace Research Institute, the US accounted for 47% of the world's total military spending in 2004. By then, the Pentagon was spending nearly $5 billion per month in Iraq and Afghanistan alone.

Military spending as a portion of the US economy now outweighs pretty much everybody's martial burden except China and Saudi Arabia. In this fiscal year, reckons the War Resisters League, total US military spending - including pensions paid to ex-service staff, interest owing on previous martial debts, plus military spending undertaken by non-defense departments of the government - will account for 51% of total federal expenditure.

The Pentagon now owns or rents 702 overseas bases in some 130 countries, according to a 2003 Defense Department report, along with another 6,000 bases inside the United States and its territories. But that analysis failed to mention Kosovo, Afghanistan, Iraq, Israel, Kuwait, Kyrgyzstan, Qatar, and Uzbekistan. The report listed only one military base in Okinawa, even though the southern Japanese island plays host to ten separate US sites. The Marine Air Corps Station in Futenma alone occupies more than 1,000 acres.

On the eve of Gulf War II, the Defense Department bought 273,000 bottles of Native Tan sunblock (SPF 15), almost three times its tanning requirement in 1999. By Sept. last year, there were more than 1.4 million US personnel on active duty - just above 1% of the entire United States population, both men and women, aged 18-49.

Yet still the Dollar sinks on the global currency markets! Only today, the Fourth of July, it slipped back to $1.36 per Euro. Free from the clutches of Queen Elizabeth II, the almighty Dollar also dipped versus the Pound Sterling, buying just 49.5 pence for the first time since 1981.

Can't an official military budget of $585 billion - plus an extra $142 billion spent outside the Defense Department - buy a little more stability for the international Dollar Standard?

"Perhaps the most remarkable thing about Britain's dominance," writes Niall Ferguson, "was how cheap it was to defend. In 1898 there were 99,000 regular soldiers stationed in Britain, 75,000 in India and 41,000 elsewhere in the Empire. The navy required another 100,000 men, and the Indian native army was 148,000 strong. There were barracks and naval coaling stations, 33 of them in all, dotted all over the world. Yet the total defense budget for 1898 was just over £40 million - a mere 2.5% of net national product."

This was "world domination on the cheap," Ferguson goes on - and the Gold Standard in turn helped Britain's exporters secure a huge and growing market throughout the Dominions.

Here in July 2007, the current world empire - the United States of America - is a net importer of goods. Almost $2 billion must be lent to the US every day, in fact, to cover the gap between its income and outgoings. But defending the currency of the Dollar seems just as important to Washington as the Gold Standard seemed to Imperial London. Letting the standard slip, however, might prove just as popular abroad, too.

In 1926, hollowed out by post-war debts that ate half the national budget each year, Britain opted to put the Pound Sterling back on the Gold Standard at its pre-war exchange rate. The move, widely blamed for Britain suffering the '30s Depression ahead of time, came "partly out of fear that the Dominions would switch to the Dollar if the Pound were devalued," says Ferguson.

But in 1931, when Britain finally quit the Gold Standard for good, "it turned out that the Pound could be devalued and the Dominions would gladly follow. Overnight, the Sterling Bloc became the world's largest system of fixed exchange rates, but a system freed from its gold mooring."

By the eve of the Second World War, the share of British exports going to other members of the Empire rose from 44% to 48%. The share of imports coming to Britain from the Empire rose from 30% to 39%.

Devaluing the world standard, in short, could prolong monetary dominance even as military might wanes. Perhaps the capital city named after George Washington doesn't need to spend so much on guns, bombs, tanks and grunts.

Not if it's going to let the Dollar slide anyway.

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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