Thursday, December 11, 2014

A Tale of Two Countries

Suppose there is a world consisting of only two countries, one rich and powerful and the other relatively poor and not very powerful, but with many natural resources. The powerful country has been calling the shots for some time due to its power and wealth. All trading has been done in the currency of the powerful country, but most of the consumer goods produced are made in the poor country where they can be produced much more cheaply. The rich country also has a sizeable gold hoard which used to back its currency, but not longer does. The poor country has accumulated a lot of the currency of the rich country, which it has used to buy bonds issued by the rich country in their currency. Along with the consumer goods purchased from the poor country is a sizeable quantity of natural resources needed to support the lifestyles of the people in the rich country.

Things seem to be working out okay, the poor country is prospering from the trade and the interest on the bonds and slowly getting richer, while the rich country enjoys the cheap goods manufactured by the poor county and its natural resources power the lavish lifestyle in the rich country. But, then the bottom drops out of the interest on the rich country’s bonds. So the poor country decides to take the payments for its resources and goods in gold rather than currency, gold being a very thin market, but nevertheless required for some critical manufacturing processes and is highly sought after by affluent people in the rich country for jewelry and art objects. All of a sudden gold becomes the medium of exchange (indirectly, see how below) rather than the currency of the rich country. The demand for the rich country’s currency tanks relative to the demand for gold. Over time the gold hoard in the rich country diminishes and piles up in the poor country. So how does this scenario end? Is war the only alternative for the rich country? Maybe the rich country only slaps sanctions on the poor country. Or do the countries stop trading with each other and become isolated? Or do they develop a mutual respect for each other and work something out?

Now consider that the rich country is the West and the poor country is the BRICS, led by Russia and China. So how could this happen? The US will only pay for what it buys in its own currency. So that’s what the BRICS accept. But they turn around and buy gold with it on the open market, driving up the price of gold and driving down the price of the dollar. China has already said they’re not going to buy any more US bonds. The BRICS have already come to some agreements to trade in their own currencies, possibly using their values in gold to arrive at an equitable exchange rate. Russia is already replacing purchases of Western goods with purchases from other BRICS countries. China has worked out an agreement to buy oil and gas from Russia. If the West were to refuse to buy oil and gas from Russia the price of these commodities would skyrocket since the Russian supply is absolutely needed to meet world demand.

So, in the long run, who is in the drivers seat here, the countries with the natural resources and a pile of gold or the consuming West with their paper currency. This is already happening. See the link below. I’ve posted or sent this link before, but no one in the West seems to get it. Or, they do get it and keep quiet about it, realizing their jeopardy, hence their sabre rattling and attempts to destabilize Russia and eventually China and the rest of the BRICs.