On August 15, 1971, President Richard Nixon declared that the United States would no longer honour its promise to exchange US dollars held by foreign central banks for gold at a fixed price of $35 an ounce. The innocuous term ‘Nixon closed the gold window’ that is now widely used to describe this act does not quite convey its significance. (Was something to be stopped from going out or from coming in through the window? Can the window be reopened again?)
What Nixon did was cut the last remaining official link between the world’s leading reserve currency and gold and thus remove the last constraint on fiat money creation.
Was this a big deal? – It was very big deal. In fact, we are only now beginning to realize the full consequences of it. In fact, the present crisis is nothing but the endgame of this system, or non-system — of this, mankind’s latest and so far most ambitious, experiment with unrestricted fiat money. The first truly global paper standard.
Nixon knew that it was big. On TV that day he felt compelled to reassure the American public that this was only temporary and that the purchasing power of the dollar was secure. Forty-one years later we are still on the same system (or non-system), and the dollar has lost eighty percent of its purchasing power.
But the mainstream economists, who weren’t even involved in designing this system (or non-system) — as nobody designed it, it was simply the result of political opportunism — these economists today tell us that this system is great, it is to our advantage. We should be grateful for it.
Because the eighty percent drop in purchasing power isn’t the whole story, that is only CPI, the consumer price index. For the past thirty years, a lot of the newly created money was channelled predominantly not into the markets for consumer goods but into the stock market, the bond market, the real estate market, and again the bond market. This created illusions of wealth. It also created a lot of debt, overstretched banks, a gigantic financial industry, various bubbles, and yet more debt. It did so around the world. And whenever this house of cards looks like it could come crashing down on us – we print more money!
Simple. What can go wrong?
Of course, there was also real economic progress over those forty-one years. Entrepreneurship, trade, innovation, saving, and all that old fashioned stuff that modern, enlightened economists don’t talk about any more. But on top of that real prosperity an ever thicker layer of make-believe prosperity accumulated. And our economists have adapted to this new reality – a reality created not by them, or their theories, but simply borne out of cynical political expediency – and become experts in the various techniques of governments to create illusionary prosperity and short-term growth spurts. Stimulus. Growth through low interest rates. Growth through more debt. Growth through currency debasement. Growth through fiscal policy. Growth through monetary policy.
Modern economists don’t know capitalism. They certainly don’t care about it. If the economy grows it is because of good policy, which means low interest rates and stimulus. If the economy doesn’t grow, it is because of bad policy, which means interest rates are too high (even if they are zero) or the central bank does not print enough money. Since Nixon ‘closed the gold window’, we have progressively replaced savings with cheap credit, the market with policy, and entrepreneurs and innovation with the FOMC and the G20.
Since 1971, the number and intensity of banking crises around the world has gone up markedly, according to Carmen Reinhart and Kenneth Rogoff, hardly anti-establishment economists. Debt levels exploded. The ten years up to the start of this crisis in July 2007 have seen house prices in the US rise ten times faster than over the previous one hundred years.
Look around the world today. Is it a coincidence that all major central banks are at zero interest rates to support bankrupt banks and bankrupt governments the world over?
Bizarrely, it is today the advocates of sound and hard money who are made to explain their atavistic ideas. — Gold standard? To establishment figures like Lord Skidelsky, the advocates of a gold anchor are like druids who dress in strange clothes and worship ancient gods – rather than, as befits the enlightened modern economist, worship at the altar of Keynes, the IMF, and big government. And ex-central banker DeAnne Julius simply knows that it would be foolish to return to a gold standard. All power to the bureaucracy!
What I find fascinating is how many intelligent people are willing, even feel urged, to provide intellectual support for a system that is not the result of intellectual discourse but came about – rather non-intellectually – through sheer power politics, opportunism and hubris, and that is evidently failing. Our financial system (or non-system) offers a great example of Nietzsche’s dictum that investigating the true origin and the true motivation behind things most often leads to surprising results. The purpose and the clever design that most people later believe to be behind various institutions are often only projected onto them with hindsight.
Even more bizarre is the willingness to absolve the political class of their responsibility for the disaster they have inflicted on us, and to even look to the political class to now save us from this ever-growing mess. There is something disturbing and sickening about the pathetic reverence of commentators, analysts and economists for the policy bureaucracy, the central bankers, the G20, the finance ministers; how every word they say is scrutinized for any hint of another clever scheme, another policy initiative that could make all our past mistakes go away and that could make the status quo operable again. “The weak labour market could force the Fed into action,” as if the Fed had the key to the solution in some drawer, as if all that was needed now was another round of QE, another rate cut, another twisty price manipulation.
I wonder if forty years of paper money have made the politicians bolder and the economists dumber. But maybe at this stage they are both simply getting more desperate.
And nothing is more dangerous to your personal and material well-being, and your liberty, than desperate politicians. Desperate politicians think that the end justifies the means. No constraints on their ad hoc decision-making can be tolerated. Laws must be changed if they stand in the way.
On October 27, 2010, Chancellor Angela Merkel promised the German parliament that the bailout fund EFSF (European Financial Stability Facility – you couldn’t make this stuff up!) was a temporary thing. As temporary as Nixon’s closed window, one assumes. In February of 2010, Greece had already been bailed out the first time – in contravention of the no-bailout clause in European treaties. Now a bailout fund was needed. But not to worry. This is only temporary. And we know what we are doing.
Of course, as more bailouts were needed, the EFSF grew bigger. It will now be replaced with the ESM – the European Stability Mechanism, no sniggering please. And this thing is, of course, permanent. (The German Constitutional Court will rubber-stamp it soon. Not to worry.)
What do our commentators and mainstream economists have to say about it? – Great! We need a big bazooka! Merkel should do more!
EVERY law, regulation and restriction that was part of the original set-up of EMU has now been broken.
The limits on budget deficits and overall public debt limits (Maastricht Criteria)? –Ignored.
The no-bail out provision? – Ignored.
The ban on ECB buying sovereign bonds to support fiscal policy? – Circumvented with the flimsiest of excuses.
Let’s face it. There is no master plan here. The political class is losing control. There is not even a conspiracy. There is a lack of control, of direction and of design. One quick-fix after another, and every one brings us a step closer to a very nasty endgame.
For the final option is always the same, not only in the Euro Zone, where new ‘hope’ just arrived in the form of Mario Draghi’s apparent willingness to buy more government debt, but also in the US, the UK, Japan, and China: print more money.
If you have no (or little) debt, if you are a productive citizen and if you have saved a bit, you are already in the crosshairs of the policy bureaucracy. Either your property will get taxed away or inflated away. Probably both.
The biggest threat to your property and to your individual liberty does not come from markets and not even from the bankers. It comes from politics.
This article was previously published at Paper Money Collapse.
In theory it would be possible to return to gold.
What the government would have to do is to divide the gold it actually owns by the number of Dollars (in NOTE and COIN form – see later on for why it must be limited to this) it produces and then declare “the Dollar is worth X amount of gold”.
When a Dollar (in note or coin form) was handed in to the government for the gold, the paper (or token coin) Dollar would be destroyed, and thus the ratio of Dollars to gold would be maintained.
However, this could not include bank credit (“broad money” – M3 and so on) as the government does not directly control how much of this there is, and it can expand and contract (by huge amounts) very quickely.
Sadly even before 1913 (the introduction of the Federal Reserve system) banks were not allowed (under the National Banking Acts) to discount the debt paper of the major Wall Street “National Banks”.
Thus the only effective limit on credit expansion (i.e. the production of credit “cheap money” in order to offer loans without giving savers the interest rates they would have demanded to give up that amount of money for loans) was the, inevitable, “bust”.
Although it must be formally stated that, prior to the creation of the Federal Reserve system, boom-busts could not put the entire economy in danger of total collapse – as banks would have gone bankrupt long before credit bubble finance reached the size needed to totally destroy the economy.
Nor could bankers produce long term grand inflation (i.e. increase in the money supply – let us leave aside Irving Fisher “price level” sillyness) as the “bust” liquidated the malinvestments of the credit bubble “boom” and sent broad money (bank credit) back down towards the monetary base.
So the bankers (no matter how bad) COULD NOT either destroy the economy (not totally) in the pre Federal Reserve system days, nor create a long term grand inflation.
In a system where politics was taken out of money – i.e. an end to the Fed and each Dollar produced by the government (in either note or coin form) representing a specific weight of gold of a certain purity (and this gold ACTUALLY EXISTING – and being in the possession of the government, not some book keeping trick) then the bankers would indeed be powerless to destroy everything.
In the end, yes, it is politics (NOT banking – not even banking of the credit bubble form) that makes the survival of our civilisation uncertain.
Bankers, on their own, can only deny physical reality to a certain level and for a certain amount of time (eventually the bust comes – and the insanity of the boom is liquidated). Only with POLITICAL (government) support can the credit bubble “boom” reach such a size that the existence of civilisation is put under threat.
Bankers CAN NOT do this on their own.
Almost needless to say…..
All the above would remain true if silver (or some other commodity) was chosen as money by buyers and sellers – rather than gold.
Paul, this emphasizes the only practical solution to avoid systemic bust : stop underwriting systemic risk with taxpayer money !
Stop that and the risk becomes unsustainable far earlier than it takes to reach systemic proportions.
To achieve this you only need to repeal one set of laws , the Legal Tender laws forcing people to use the currency that is in turn being used to underwrite the risk.
Throw open the market and let people choose the currency they wish to transact in and in which one they chose to save. These may turn out to be two different mediums, the currency may even inflate but the saved one, or store of value, will be sound. As long as the the inflating currency inflates gradually enough to be expediently cleared for the store of value , then people may be willing to use it for convenience and pay the small price.
Two systems facilitating this come to mind, the Freegold system of Rome and Greece and the Real Bills system of the 19th century.
Gary – well under Roman law (under both the Republic and the Empire) fractional reserve banking was not even possible, due to how a “deposit” was treated in law.
On legal tender laws – of course even without them governments would still declare what they wanted their taxes paid in. And what they choose would have a major effect.
I broadly agree, but would it not also be valid to divide the number of notes in circulation by ALL the precious metals, if a metal standard was what we were wanting to achieve?
This isn’t an original situation, it’s come up many times in the past. Septimius Severus debased Roman coinage in order to increase government spending because he had taxed all he could from the population and no one had come up with the idea of selling sovereign bonds. Bonds gave government the impression that it was possible to postpone debt repayment into a future that might not even arrive, that political promises could be kept while the costs could be passed on to generations yet to be born. It might have worked, too, on a reasonable scale, but the figures are currently simply too massive.
In reality, government can’t be trusted with the administration of money. Money should be issued by private concerns, under competitive conditions, which means money tied to a commodity.
abolishincometax (I take it you changed your name to that by deedpoll – still no matter).
Even trying to run a monetary system on two metals at the same time (gold and silver) does not work if there is a fixed (RIGGED) exchange rate.
With a fixed exchange rate either gold drives out sliver or silver drives out gold.
So one must declare what the notes are going to be paid in – and it must be ONE commodity.
That does NOT mean there can not be competing currencies (for example gold and silver without any fixed exchange rate – as was the practice in the Kingdom of Hannover in the early 19th century), but each currency must represent one (and only one) commodity.
F.A. Hayek came up (very late in his life) with the idea of “index money” – i.e. one would take the price index (he had forgotten what he understood in his youth – i.e. that no price index is really a picture of reality over time) and make money the money somehow represent that.
However, it turned out the notes would be “nonconvertable”(i.e. one would not really get X per cent of such a commodity and Y per cent of another commodity – and on and on, when one went to try and redeem the note) in short the scheme was nonsense.
The product of an old man (and we all get old – as I know only too well) DESPERATE to find some politically acceptable alternative to the out of control fiat money system he observed with despair.
Mmmm – any relation to the famous Charles Martel?
You are quite correct about the Emperor Severus.
He increased military pay, but he had no extra tax revenue to pay for it.
So he tried to square the circle by debasement. A little at first – but then other Emperors…..
There is a physical limit to debasement – the copper coin just “washed in silver” or whatever.
It is also rather obvious.
You are quite right that paper money is the key.
Terrible experience in China led the Ming rulers to abandon it, although Tim Congdon holds that anyone who is against fiat money inflation must also be in favour of the Ming policy of banning overseas trade (with is nonsense – but then Banker Friends like Congdon tend to come out with a lot of nonsense).
Would the policy have worked if conducted on a more limited scale?
There I disagree – it would not have worked, as money that is borrowed (or printed, or created by computer) to be spent on the Welfate State, is resources denined for productive investment.
Not in the time of future generations – in THIS ERA.
There is no way that monetary policy tricks can finance anything – not in the long term.
And the long term does not mean future generations – the time span is a lot shorter than that.
“But the present system has lasted for generations” – so it has.
But over that time economic advance has been undermined.
This has not been visible due to the vast improvements in TECHNOLOGY.
So it seems artificial to say “well we are better off than we were a century ago – but we would be vastly better off still, if we had not….”
That is true, but it does not hit people as a strong argument (they did not experience this alternative present, where things are vastly better, so they are not intererted in it).
Only when the undermining gets to the point where living standards DECLINE (as opposed to improve less and more slowly) are most people actually interested.
But that was inevitable also.
One can not be “a little bit pregnant” and one can not have a “limited Welfare State”.
Once the promise to care for people “from cradle to grave” has been made, the explosion of costs over time WILL happen.
Let us say one only printed (or created by computer) one Pound – just one.
And then spent it on fiancing government spending.
That would divert resources away from productice economic activity – it would make things (over time) slightly worse than they otherwise would have been.
There really is “no such thing as a free lunch” – not even a little lunch.
As for those people who say that government spending is economically productive…..
Stop worshipping Frederick the Great and go read Bastiat.
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