Flashback November 1971
John Connally, President Nixon’s Treasury Secretary, bluntly told a group of European finance minsters “The dollar is our currency, but it’s your problem.”
Nixon Shock
Connally’s statement is part of what’s now labeled as “Nixon Shock“.
The Nixon shock was a series of economic measures undertaken by United States President Richard Nixon in 1971, in response to increasing inflation, the most significant of which were wage and price freezes, surcharges on imports, and the unilateral cancellation of the direct international convertibility of the United States dollar to gold.
Nixon said the move to end gold convertibility was temporary. It wasn’t. But it’s important to understand the background history following the end of WWII.
Background
In 1944, representatives from 44 nations met in Bretton Woods, New Hampshire, to develop a new international monetary system that came to be known as the Bretton Woods system. Conference attendees had hoped that this new system would “ensure exchange rate stability, prevent competitive devaluations, and promote economic growth”.
It was not until 1958 that the Bretton Woods system became fully operational. Countries now settled their international accounts in dollars that could be converted to gold at a fixed exchange rate of $35 per ounce, which was redeemable by the U.S. government. Thus, the United States was committed to backing every dollar overseas with gold, and other currencies were pegged to the dollar.
For the first years after World War II, the Bretton Woods system worked well. With the Marshall Plan, Japan and Europe were rebuilding from the war, and countries outside the US wanted dollars to spend on American goods—cars, steel, machinery, etc. Because the U.S. owned over half the world’s official gold reserves—574 million ounces at the end of World War II—the system appeared secure.
However, from 1950 to 1969, as Germany and Japan recovered, the US share of the world’s economic output dropped significantly, from 35% to 27%. Furthermore, a negative balance of payments, growing public debt incurred by the Vietnam War, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s.
In France, the Bretton Woods system was called “America’s exorbitant privilege” as it resulted in an “asymmetric financial system” where non-US citizens “see themselves supporting American living standards and subsidizing American multinationals”. As American economist Barry Eichengreen summarized: “It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one”. In February 1965 President Charles de Gaulle announced his intention to exchange its U.S. dollar reserves for gold at the official exchange rate.
By 1966, non-US central banks held $14 billion, while the United States had only $13.2 billion in gold reserve. Of those reserves, only $3.2 billion was able to cover foreign holdings as the rest was covering domestic holdings.
Nixon did not want to hike interest rates for his guns and butter policies (War in Vietnam and social spending), and as a result the US was rapidly losing its supply of gold.
Charles’ de Gaulle’s announcement that France would redeem its trade balance in dollars was the end of Bretton Woods.
Stock Market Cheered
The stock market cheered the “temporary” suspension of gold redemption and so did governments around the globe.
A direct consequence of Nixon Shock was governments could and did spend at will with no checks and balances.
The US consumer then became the global buyer of last resort
It’s Our Dollar 2022 Style
The dollar is soaring not plunging and the Fed, unlike under Nixon, is gleefully hiking rates.
Bloomberg reports Yuan at 2008 Low Fuels Speculation Monetary Easing to Slow
The yuan’s slump to the weakest since the global financial crisis in 2008 has fueled speculation China’s central bank will slow the pace of monetary easing to avoid adding further pressure on the currency.
The People’s Bank of China will probably delay any major stimulus moves, like lowering interest rates and the reserve requirement ratio for banks, according to analysts including from Australia & New Zealand Banking Group Ltd. and Tianfeng Securities Co.
Emerging markets who borrowed dollars expecting them to get cheaper, are in a crisis mode.
Japan is using currency intervention while the Bank of England took emergency to shore up its bond market.
For discussion, please see Bank of England to Buy Bonds on Whatever Scale Necessary to Halt Crisis
Also note Strong Dollar Fatigue: Japan’s Yen Intervention Will Not Work. How Can It?
Ever since Nixon killed convertibility of gold there has been no checks on fiscal deficits. Countries could spend at will and did. The Fed was finally forced to hike rates, the dollar has soared in response.
Total dollar credit is now over $90 trillion and the Debt Clock shows US national debt at close to $31 trillion. There are no constraints on debt or government spending anywhere.
Meanwhile, mainstream media is devoid of any discussion of the root cause of the current problems. Nor is there any end in sight to reckless fiscal policies.
The root cause is no brake on unrestrained spending that a gold standard provided.
Gold provided a brake on recklessness. Guns and butter policies with low interest rates led to losing your gold.
This post originated at MishTalk.Com.
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Mish
Why is the
Dollar strong now?
Only major
economy which is energy independent.
The major
economy with the lowest exposure to international trade vs GDP (Trade to GDP
Ratio)
Is the currency
of the country that has the largest and best military in the world.
The only major
economy whose interest rates has the best chance of becoming real positive
interest rates.
The only
major economy which has a positive demographic profile.
The major
economy that will be touched the least by the worldwide recession.
The major
economy with a unique financial-industrial ecosystem much larger than any other
that facilitates startups and attracts talent and investment money from the
whole world.
There are
many other advantages but those I noted are the major ones. They only real problem is the trade deficit but as a percentage of GDP it is not too much of a worry.
Come to Carousel and renew!
Summers, who’s been a vocal critic of the Fed, said it took too long for the institution to react to rising inflation.
“The Fed allowed itself to get way behind the curve for a long time in 2021 and early ’22, and in the process, sacrificed a reasonable amount of credibility,” he said.
When asked what he would do if he were on Fed to determine when to stop raising rates, Summers told the Journal that he’d watch what’s happening in the labor market.
“I’d be looking for evidence that signs of an overwhelmingly tight labor market were giving way to signs of a labor market with more slack,” he said.
Despite his earlier criticism of the Fed, Summers says the Fed is doing what it needs to.
on fiscal deficits. Countries could spend at will and did. The Fed was
finally forced to hike rates, the dollar has soared in response.”
The monetization and sterilization of LSAPs suppresses the real
rate of interest. It makes real growth more expensive than holding
existing assets. I.e., lending by the banks is inflationary, whereas
lending by the nonbanks is noninflationary.
There’s a lack of investment opportunities (secular stagnation).
Asset valuation prices are driven from the
appraisal of loan collateral, and loanable funds, which depends upon Gresham’s
law: “a statement of the least cost “principle of substitution” as applied
to money: that a commodity (or service) will be devoted to those uses which are
the most profitable (most widely viewed as promising), that a statement of the
principle of substitution: “the bad money drives out good”.
The only solution is to sell higher quantities, of higher
quality, and lower unit costs of production, relative to our trading partners.
The Chinese first did this with cheap labor. Looking to the
future the Chinese will ultimately replace their labor advantage with a machine
tool advantage. We need much more gov’t incentivized investment in AI and
robots.
robots.”