A Look At This Weeks Show:
- Central bankers worldwide see a “phase out” of the U.S. Dollar reserve currency status.
- The history of central banks in America—Or, the third time’s a charm (actually a curse).
- Hamilton and Jefferson: Two founders competing views of U.S. Money that impact us still today.
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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, yesterday in the Financial Times, a respected publication, the central bankers in Europe were polled, and they see, pretty much as a whole, that over the next 25 years the dollar will be replaced as the reserve currency. The article goes on to say that they see more accumulation of gold and less accumulation of dollars.
David: Kevin, I was in Boston the tail end of this last week, and over the weekend, and made my way into a used bookstore, and found a gem. It is a dialogue amongst economic and financial academics.
Kevin: It sounds like it is right up your alley.
Kevin: A dialogue… Not everybody thinks that sounds like a real treasure find.
David: I know, well, more than just the cover was golden. That was golden, but the content and the conversation were about what was happening in the world monetary system in 1967. That is when the book was published. You had Triffin, you had Mundell, you had Jacques Rouffe – you had some of the leading economists and bankers of the day discussing what role gold needed to play, or should play, with the current crisis.
The current crisis centered on the two other reserve assets that central bankers were collecting, and gold was one of them, but the other two were the pound sterling and U.S. dollars. People looked at the sterling, and they looked at the dollar, and they were looking at account deficits, they were looking at budgets that are crazy, they were looking at devaluation on the paper side, and wondering what needs to happen to gold in the mix, because you still had what they called the gold exchange standard, where you had these three reserve assets held by central banks, and you have two weak sisters, and one bastion of strength, and they were trying to make sense of how to make this stuff work.
Kevin: Well, Dave, there were two weak sisters, but one of them was stronger than the other, because the dollar, at that time, was still gold-backed. The Bretton Woods system set it up so that the dollar would be redeemable in gold, and it still was in 1967, but it looked like it was waning.
David: And that is what we have called the “fool’s gold” standard. (laughter) It was apparently a gold standard.
Kevin: So this was a very appropriate time for these guys to be talking. If I remember right, that is the time that Jacques Rouffe was telling de Gaulle, in France, “Go ahead and cash your dollars in for gold, because they ain’t gonna be tradin’ it for long.”
David: Right. Today we want to look at the monetary system as it exists today, and look at some of the pressures that are in Europe at present. We have Robert Zoellick, as you mentioned, in this Financial Times article, who is suggesting that even now, gold should take on a more prominent position in the world monetary system. He mentioned this maybe two or three months ago, in a Financial Times op-ed piece, and was raked over the coals for the next two weeks by academics all across the world, accusing him of being irresponsible in his position of leadership. How could someone of his position still hold to these sorts of arcane and archaic views? And furthermore, who was going to be responsible for punishing him for saying something so foolish, so stupid, so irrelevant? Because, again, in the post-1971 period, we are on a completely free-floating currency system.
We just want to get a grasp of how we got here, and make some sense of what is happening today in Europe, with the Chinese visit, Wen Jiabao going around making sort of a charity tour in Europe, if you will.
Kevin: Well, he says he is going to bail Greece out, or at least, help with that.
David: And they certainly did bail out, or help with, the Portuguese just a few weeks ago. So let’s look at that Kevin, but starting with the U.S. system, and giving some history to it.
Kevin: Well, Dave, let’s just go back to that, because, really, even before the U.S. system, there have been two competing views for most of history as to whether you give the power of the money into the hands of the people, or you leave it in government hands and let them create money. They are two competing schools of thought that predate even the American Revolution, aren’t there?
David: Well, there are, and if you want to go back into political dialogues and the history of thought, this goes back to Ancient Greece and Rome – the idea that there is centralized power and control, on the one hand, and decentralized power in the hands of the people, on the other. These two toggle back and forth. The advantages of one outweigh the advantages of the other, and then the other school of thought will carry the day and argument, and you will see a move toward decentralization, and then back to centralization. This is sort of a dialogue through several thousands of years. In the U.S., it was epitomized by two people: Alexander Hamilton and Thomas Jefferson. Alexander Hamilton was the first Secretary of the Treasury, the very first person whose shoes are today filled by Timothy Geithner.
Kevin: What is interesting, though, is that they had just fought the American Revolution, but Hamilton actually represented more of a London kind of banker than he really did an American, didn’t he?
David: He did. He had a fascination with the old school. He really was sort of a high-brow guy, with the idea that all culture was emanating from Europe, and particularly, from Britain. He definitely wanted to be considered one of the sophisticates of the day, and that included having a strong central government, as well as a strong central bank, and a strong tax regime.
Kevin: And guys like Thomas Jefferson and Adams were saying, “Wait a second, this is exactly what we fought against. This is what we just cut our ties with.”
David: Right. Thomas Jefferson had nothing to do with the Treasury at that point. While Hamilton was the Secretary of the Treasury, Thomas Jefferson was the very first Secretary of State.
Kevin: Like Hillary Clinton is now.
David: (laughter) Very different than Hillary Clinton!
Kevin: Oh, if we could have Thomas back!
David: Oh, if only. Not only a greater appreciation for wine in this country, maybe even better architecture, even better laws, etc., etc. Yes, he was the first Secretary of State, and then, of course, he went on to be the third President of the United States. He was regarded, going back to that centralized versus de-centralized theme, as the people’s president.
Kevin: He did not trust central banks.
David: No, no, no. He had an inherent distrust of the political and financial elites. He was quoted, famously, as saying, “I believe that banking institutions are more dangerous to our liberties than standing armies.”
Kevin: That is what is playing itself out right now in the value of the dollar.
David: Leading into the American Revolution, there was the issue of taxes, of course. I just got back from Boston, as I mentioned, and we went on a tall ship, took the boys out, and we re-enacted throwing tea into the bay. It was fantastic.
Kevin: (laughter) You’re training them up right.
David: But the only disappointment is that the boys were expecting to be able to dress up like Mohawk Indians, and they didn’t get to. They were wondering where their hatchets were. “Where’s our headdresses?” We did still get to throw the tea, and that was quite a hoot.
But this was the issue. You had taxation and increased payments to the British Treasury, and there was no political voice.
Kevin: Does that sound familiar today?
David: It’s not that they didn’t have a political voice, it’s not that they didn’t have a representative in Parliament, but it was appointed to them. They didn’t get to vote the guy in, so yes, they had representation in Parliament, but it wasn’t their representation, it was sort of a stooge chosen for them, if that makes sense, and you can understand how frustrating that would be – paying into the treasury and really not have a voice.
Hamilton’s actions as the first Treasury secretary, as you mentioned, Kevin, reflected the old power structure, and really felt like the old British tax franchise was being reborn.
Kevin: He could not imagine a new system, and again, I keep bringing it back to today. We have a system right now that is failing miserably and we have had guests on recently that have said, “Go ahead and kiss it goodbye, because it ain’t gonna look the same in the future.”
David: Well, Hamilton’s views were based on the legacies of the Swedish and British systems. They had worked. The Swedish system, the oldest central bank around, followed by the British system – you are talking about two systems that, arguably, were working, so why do something different than what was working?
Kevin: Albeit, they were working at a deficit. These were banking systems, even back then, that were utilizing a government deficit system to stay alive.
David: Well, I think you can also point, at least in the British case, to gold being a part of the confidence built into the banking system.
Kevin: That’s true. People really understood physical ownership of gold as a type of money back then, more than they do today.
Well, David, history shows that Hamilton won, at least in the beginning, in having a central bank. There was a first central bank that was created right after the Constitution.
David: Yes. It wasn’t called the Fed at that point. It was called the First Bank of the United States. He modeled it after the British Central Bank, 1694. This was interesting, because the First Central Bank was part-owned by foreigners, and it was seen by Jefferson as an engine of financial manipulation, as a source of speculation, and as something that fostered corruption. He was looking at it from a very skeptical viewpoint. It went along for 20 years, and after 20 years the charter was allowed to expire, so by 1811 that popular opinion epitomized by Jefferson’s suspicion was there, and it was seen as a bank that was self-serving and corrupt.
Kevin: Sure. It showed its true colors right away. In fact, I have heard many people say that the War of 1812 was very much fostered by the English because of the loss of this central bank.
David: Well, the Second Bank of the United States, the second run at this – the first one’s charter ended in 1911 – and the copy of the first was founded in 1816. Andrew Jackson became President in 1828, and he fought the bank. He fought it because he saw it as a source of political corruption and of market manipulation. If you fast-forward to today, and we will talk a little bit about today’s Fed, that is the criticism that you can level against the Fed, and this is not sort of an outlandish, from left field, fringe comment on the Fed. Who is supporting the financial markets? We have talked about them having a dual mandate, and we will spend a little bit of time today looking at their third mandate, as well, which is direct intervention in the financial markets.
Kevin: Right, which we have seen, for the last three years, very radically.
David: The second bank’s charter was allowed to expire in 1836. The public did not support that bank at all. It was viewed as both self-serving, and actually, the dialogue of the day centered on it being constitutionally illegal, which is interesting, because they were looking at it as an issue of Congress being responsible for the issue of our currency, and not a private organization.
Kevin: Andrew Jackson was hailed a hero because he got rid of that bank. Most people saw the corruption the second time and they said, “Never, ever, again.”
David: Well, some time passed before the third version of the central bank came into being, and it was sold as a means of preventing crisis. It was sold as the antidote and the answer to what had occurred in 1907. “We did’t have to go through this, guys. We told you before, if you had just given us the keys to the kingdom, we would have managed this differently, and we could have all avoided all of the pain and catastrophe, the losses, the distress, that the markets have been through in these recent years,” again, centering on 1907.
Kevin: In 1906 through about 1912-1913, a representative period of time that feels very much like the crisis time that we have now. There were institutions failing, there were banks coming in and bailing out other banks. J.P. Morgan comes to mind. Can you outline a little bit of that period of time? It was 100 years ago, but it was almost an exact replay, 100 years ago.
David: Sure. Now, I don’t think Dodd-Frank has the same sort of significance as the Federal Reserve act does today, except that it does go to fostering corruption in the system, and establishing the frailties that we have today, creating legacies of frailties into the future.
Kevin: And it was passed based on the fear that we have of losing our security.
David: Right. But I think if you look at the Federal Reserve Act, passed December 22, 1913, what came before it is very telling. There was the passage of the Hepburn act in 1906, which caused the panic in rails because it essentially controlled the freight rates, and made that a centrally determined thing, not a market-determined thing. So you had a panic in the rails, and if you look at the significance of the railroad industry then, they were more significant than the industrials were at that time.
Kevin: And there was the disaster of the San Francisco fire that came right on the heels of that, so you have a panic, then you have a major tragedy.
David: Right. It cost 350 million. (laughter) It doesn’t seem like much money today, we have bankers making that much in their short tenure as a CEO today, but it cost 350 million to rebuild San Francisco. It was a four-square-mile disaster. At the same time there was a shrinkage of international trade in 1907, as London was tightening credit as a consequence of the Hepburn act, and again, panic in the rails.
Then there was the Morse-Heinze duo and the failed short-squeeze of United Copper. Essentially, as the large share-holders of the company, they saw this growing short position in the company and they tried to prop up the shares. It went from $60 a share down to $10 a share. It drove them to insolvency, which had sort of a domino effect because they didn’t just own United Copper, they also owned a number of banks in the State of Montana, and those banks subsequently failed. Then the whole issue of, “Oh, well isn’t there a connection between Morse and Heinze and the Knickerbocker Trust?” Of course there was no connection at all, but that didn’t matter. The market panic ensued and it was a rumor leading to “Goodness, yes, sell today and ask questions tomorrow.”
Kevin: So it’s like Bear-Stearns, to Lehman, to AIG, to City Group. It’s like what we saw back in 2008.
David: Right, so we ended up with the panic of 1907. Subsequent to that was the creation of the National Monetary Commission in 1908. What went wrong? “Congress has got to explore this, we have got to figure out how we came off the rails.” Well, they could have looked, and perhaps with some degree of reflection, said, “We caused it! Go back to the Hepburn Act. What came off the rails is the fact that we inserted the state into the equation. We should have let the market set the rates.”
So the National Monetary Commission was their attempt to say, “Obviously we weren’t responsible for this, but we need to find who was responsible for this.”
Kevin: Speaking of rails. There was a midnight sort of secret cloak and dagger kind of meeting that actually used the rails. These guys went on rail, top bankers, quietly, with name changes, they didn’t even use each others names, in the middle of the night, down to Georgia, a place call Jekyll Island.
David: It was sort of a hunting enclave, a country club for the wealthiest of the wealthy at the time. Today it is a National Park. You can go there and see massive mansions and what you might call a hunting shack – a little different than a hunting shack that might come to mind, but yes, the billionaires of the day…
Kevin: They were not there to hunt that time, though.
David: No, they were drafting what became known as the Federal Reserve Act. That was circa 1910. They tried to pass it a number of times under a different name and they couldn’t get it to gain any traction. It took them, actually, three years, up until December 22, 1913, before the Federal Reserve Act was passed.
Kevin: A lot of Congress was away for Christmas vacation, and they just basically stood on the floor and got it passed – something that Americans back in the 1840s swore would never occur again.
David: Let’s start with the third mandate of the Fed today, Kevin, because nothing has really changed. There have been things that have been added in terms of the list of responsibilities to the Fed, and the Fed is certainly being asked to take on more of a “regulatory position,” which is very, very curious, but the unofficial third mandate, and we will work back to the second and first, is that the Fed is now responsible for creating and providing liquidity to the market, and maintaining asset inflation.
What is the effect of that? The effect of creating asset inflation within financial assets, whether that is housing, or stocks, or what have you, is that there is a hope that the wealth effect will keep the consumer in the marketplace, consuming. That wealth effect is, of course, when you have your personal balance sheet, which continues to grow and show bigger and bigger numbers through time, and you say, “Well, I can afford the vacation, I can afford the extra house on the beach, I can afford a third car, I can afford the boat. Granted, I am only going to use it three times a year and it is going to cost me an arm and a leg to maintain, but that doesn’t matter.”
Kevin: “I bought my house for 100,000, now it’s worth a million. Why wouldn’t I have a boat? In fact, why wouldn’t I have a second mortgage? With interest rates as low as they are, why wouldn’t I just continue to enjoy the ride?”
David: And the Fed is trying to prop up this asset inflation. It’s not working in the housing market, there is an overhang. We had Case-Shiller this week, year-on-year, the numbers were pretty bad, again, down 4% from last year. Month-on-month there seems to be an improvement. Actually, it was not an improvement, it was still a decline, but not as much of a decline as expected, and that is considered an improvement.
Kevin: David, do you see this asset inflation that they are trying to promote right now showing up in the stock market? Is this why the stock market is in the 12,000s right now, playing around with 13,000 sometimes? Is it because they are printing so much money?
David: They have tried their best to hold the market together and to prop up sentiment. Whether that can continue, we will see. And it is timely, this week being the end of QE-II. And what comes next? The concerns about inflation are global concerns. The value added from Quantitative Easing II initiated last November and announced at the last conference in Jackson Hole is somewhat suspect. The bond market certainly did not like it, and we saw rates rise in the subsequent months to that announcement.
What will happen? Will we have Quantitative Easing III? Will we not? These things are important, but I want to put it in the context of: What the heck the Fed is doing in the market, manipulating prices, to begin with? They already have two utterly confused mandates, and they have adopted this unofficial third. Now let’s talk about the other two.
Kevin: Yes, let’s go backwards with the other two. We’ll go to price stability as the last one. That is how they were sold originally, from the get-go. But full employment was added as a mandate over the last 20 to 30 years, and it is a compromise, in that it forces the Fed to print more money than they probably ought to. If they pull QE-II and we still have unemployment running close to 10%, that is insanity. Where are the jobs going to come from now that the money is being pulled?
David: This is a part of the reason why Bernanke has said we will continue providing support to the market, as in, we will keep our zero interest rate policy. They are providing accommodation to the market, because, clearly, they have not delivered on their second mandate, which is full employment.
The compromise, really, is this: What it means is that they are more in the political fray than they should be. They are subject to political pressures, and certainly, coming into a 2012 election period, you are going to see people howling over the fact that unemployment has increased.
Just this last week, Kevin – Absurd! What is the Obama administration doing drawing down our strategic oil reserve at a time when oil is already in decline? The next thing that you could assume is that he may, in fact, be handing out Chevy Volts if you will vote for him. There was one commentator who suggested that this last week. How much closer can you get to just outright buying votes coming into the 2012 election? You, the consumer, need a little extra help. We are going to manipulate prices lower. This is the president of the United States manipulating the oil price. And we have the CFTC chasing after some guy in Sweden who owns a shipping company for making an extra 50 million dollars “manipulating the market.” How about going after the President?
Kevin: David, you said you were going to go into the monetary history of the United States. You are getting political here, and you are mad, I understand that you are mad, but let’s go to the first mandate.
David: The first mandate is price stability, and the goal was to manage price inflation at an “acceptable level.” What that has become is inflation targeting, wherein some range between 1-3% is an acceptable inflation target.
Kevin: Since the early 1970s, the dollar has lost 85-90% of its buying power.
David: That is an acceptable devaluation of the dollar.
Kevin: (laughter) Okay, so that is price stability.
David: (laughter) Well, if you assume a 2% or 3% rate of inflation, if that is an “acceptable level,” then yes, you are ultimately, over a longer period of time, going to destroy your currency.
Kevin: So there is an acceptable level of bleeding, let’s say. Rather than put a Band-Aid on, if you can just acceptably bleed a little bit each day, that’s okay?
David: As long as you have healthy bone marrow and you are cranking out the white blood cells, and the red blood cells, and there is a faster replication. Looking at inflation, and assuming 2-3% is acceptable is like accepting the old medicine, wherein leeching is the best way to treat any ailment. Just a little less blood in the system and you will feel much, much better.
Kevin: David, let’s go back to a time when people were actually not being bled dry, when inflation wasn’t necessarily an acceptable standard. There was a period when the United States and Europe were on a gold standard. In fact, it could be argued that we really were on a one-world kind of currency, and it actually worked.
David: Before we move on to that, and we have probably mentioned this ad nauseam, but the acceptable level of 2-3%? If that is the target, they have lied about the statistic. They have overstated GDP. They have understated real-world inflation. MIT’s Billion Prices Project puts it closer to 6%. If you use the old Bureau of Labor Statistics numbers you are between 6-11%.
Kevin: Go back. Explain MIT’s number. That is something any of our listeners can go look at any time.
David: Google it – MIT Billion Prices Project. What you will find is that they sample, not a billion prices, but awfully close to it, in terms of prices of real goods and services, and what the price trends are. Coca-Cola, this week, announced a 3-5% increase in prices, and the question is, for our Coca-Cola executives who may be listening: Is this a transitory increase? Is this a temporary increase in prices, as Ben Bernanke has promised all inflation to be? I think not.
This is the problem. We have systemic inflation. We have structural inflation, and we have lying that is occurring on a regular basis, about what that inflation is. It is not 3%. It is not 2%. It is not what is targeted. We have closer to 6-10%.
Kevin: My wife and I go to the farmer’s market here in Durango on Saturday mornings. In fact, your wife does too. They have a lemonade stand, a fresh-squeezed lemonade stand. We have our pattern, we go through the farmer’s market, we get to the lemonade stand…
David: Tom does a great job. If you happen to be passing through Durango, Tom makes a great glass of lemonade.
Kevin: You are such a name-dropper, but nonetheless, I was talking to Tom, and I had just made a comment about Ben Bernanke, and Tom said, “Yeah, you need to talk to Ben Bernanke. My cup prices have gone up 10% (and there is a play on words here) and the lemonade stand really is getting squeezed.” He told me he hasn’t raised his prices in four years, but he is getting to the point where he says he cannot continue to operate at those prices, and he is already charging $3 for a lemonade. It just goes to show you that inflation is affecting the farmer’s market, it is affecting the oil markets, it is affecting the labor markets, but it is definitely not affecting the government. We went to Washington, D.C. last year, Dave, and we really did not sense that they had felt any kind of pain.
David: Kevin, this does come back to a more philosophical argument. In recent weeks we have talked about discussions that need to take place, not second-order discussions, but conversations relating to first-order issues, philosophical underpinnings to a broader conversation. If you aren’t clear on what the basis is for certain political views, for certain economic views, you need to get back to the bedrock, you need to get back to the foundations, and be asking those assumption-oriented questions.
Kevin, for us, looking back in time, you do see this conflict between centralized government and decentralized government, and different people, maybe even different personalities, that feel more comfortable with other people making decisions, versus the market and individuals making those decisions, as an alternative. Kevin, if we look back to what you were suggesting earlier, our U.S. gold standard era. 1879 is when it began for us, and it moved from there to 1914. This was a unique period in time wherein we didn’t have a centralized brain trust making monetary decisions. It was on autopilot, and it functioned very well. This was a global trend, really starting from the 1860s and moving forward, wherein currencies were backed with gold, and what they were modeling this after, was the British success, beginning in 1717.
Kevin: Which was a gold-backed, very firmly supported system.
David: And Kevin, with your great love of science: Who put the British on the gold standard in 1717?
Kevin: Well, let’s see, it was a guy who, just in three laws, figured out how we could later go to the moon. It was Sir Isaac Newton.
David: (laughter) He was brought in to manage the money because the money had been mismanaged by a centralized brain trust. It was, actually, literally, a money guild who had been in charge of the money supply for hundreds of years, and then the British crown figured out that they were getting (sorry, for lack of a better term) screwed by the money guild.
Kevin: Isaac Newton was a believer, literally, in equal weights and measures, and he actually laid that out and it is amazing what happened to modern economics starting with Isaac Newton.
David: It is interesting what happens when you put a tremendous amount of trust in man. What you end up with is a totally different set of solutions compared to there being an appeal to something like natural law. What you had with the gold standard was all foreign trade imbalances being settled automatically by gold flowing from the debtor to the creditor nation. It happened on an automatic basis. It didn’t need someone pulling levers, pulling switches, clicking with the mouse to create “x” number of trillions of dollars in liquidity.
Kevin: They didn’t need credit default swaps. They didn’t need all these fancy financial products guaranteeing that something would be paid, because that something actually existed.
David: There was a natural balance, and if things got out of balance, there was a shift between inflation to deflation within the international context. The first great period of globalization, at least in the modern era, was this gold standard period. You could look at changes in technology, freight, the steam engine – there were a number of technological innovations that made it happen, but as an underpinning, there was a trust in the settlement of trade, in the unit of account, and that trust did not center on a brain trust, like the Federal Reserve, like the British central bank, like the Swedish central bank. It was something that settled on an automatic basis.
Kevin: But that trust, that gold trust, was broken with the crisis of 1914, World War I. At that point, the justification for governments to go into debt, which had been used many, many times before throughout the centuries, was to go slowly, and then quickly, away from the gold standard. Is that not correct?
David: Yes. And it happened during the Napoleonic Wars. It was very common for countries that had adopted the gold standard to, under duress, have to finance more than they could with the current stock of money. So they would suspend convertibility. They would suspend the gold standard for a period of time, and the people in the marketplace, with great angst and ire, would say, “We expect it. You must come back to a discipline, because we don’t think that money in your hands is going to be spent well. We have to have something that is supra- or trans-monetary, and that means, simply, not in the hands of a central bank.”
Kevin: What you are saying is, to pay for war, sometimes you have to print more money than you actually have, with the hope that afterward you are going to be able to go back and pay that off.
David: Right. It was from that point forward that we began to see ivory tower solutions come into a very common sense approach to money, and the ivory tower solutions introduced in 1922 at the Conference of Genoa (the world’s central bankers’ gathering) suggested, “We just don’t need physical gold, we’ve got dollars. Granted, it’s useful. Granted, it should be in the mix. But it certainly is more convenient to settle trade in U.S. dollars and pounds sterling.” And it was pounds sterling, primarily, and U.S. dollars, secondarily, there at the Conference of Genoa, along with gold. The real significance was that they were using a monetary unit that was more “convenient” to settle foreign trade, and they just didn’t want to deal with physical metals and what that required, the labor and the risk involved in transport, etc., etc.
Kevin: How many times have you heard a little voice in the background saying, “You can trust us. We’ll do this right.”
David: And the banking community has always appreciated the opportunity to shuffle a little bit more paper, and that is what happened at the Conference of Genoa, and that is what happened in warp speed as we went through 1933, 1944, 1971, and up to our modern monetary system.
Kevin: Let’s move to 1933, because actually, this 1922 agreement in Genoa obviously didn’t work, because they printed too much money, and the redeemability of dollars for gold, ultimately – the dollar had to be devalued, didn’t it?
David: And it was. In 1933 it was devalued by 65%. Prior to the devaluation, there were 20-dollar gold pieces trading for 30 dollars in France. This is the brilliance of the market. This is people thousands of miles away saying, “You know what? Something is not right in the United States, and…”
Kevin: “We’ll go ahead and take our gold.”
David: Exactly. That 20-dollar gold piece, in paper currency terms, is not worth 20 dollars, it is worth 30. So the market had already anticipated, in 1931 and 1932, a devaluation, and that, I think, is very, very telling. In response to the pressures from the Federal Reserve Bank, in an effort to liquefy the system, Roosevelt restricted the domestic gold trade, and required U.S. citizens to hand in their gold. You can look at the Trading with the Enemy Act, if you want to look at what happened in 1933, but, essentially, the government was still able to settle foreign trade in gold terms, but U.S. citizens could not, from 1933 until 1971, own the physical metals.
Kevin: It may be a misnomer to call that the gold confiscation. Yes, it was a gold confiscation in the United States, but it was more of a devaluation, was it not?
David: It was. And the reason I say it is a devaluation, and one of the reasons why I am not particularly concerned about a confiscation, certainly not at $1500 an ounce, maybe at $25,000 an ounce (laughter), that’s a difference kettle of fish, but at $1500 an ounce, it is really not an issue. Confiscation was not an issue here. Only 10 percent of the outstanding gold stock was handed in. The rest of the red-blooded Americans said to the government, “Go pound sand. Our gold is our gold. What you want to do, in terms of a monetary devaluation, will not affect us. We see what you are doing.” 90% of the population were not patsies. 90% of the population held onto their gold. And in all fairness, I don’t know what percentage, exactly, of the population was involved, I just know that 90% of the gold was not handed in. Only 10% was.
Kevin: With that being said, though, at some point, and we don’t know what price level that will be, if a currency actually has to be devalued against something, that something will probably be gold. So restrictions in the future may come with actual bullion gold.
David: If you want to count up the amount of gold that even the U.S. has as the largest holder of gold in the world today, it is a pittance compared with even the amount of debt that Greece has, for instance. You could liquidate every ounce of gold held in Fort Knox, at today’s prices, and ours is the largest stock of gold in the world, 8,000 tons, and we could just about pay off the Greek debt. That is how small the gold market is compared to the paper asset world, as it has exploded over the last 50-75 years.
Kevin: It is unbelievable. Unless they made it illegal and then revalued it at whatever they needed to, to make it payable, $10,000 an ounce, $50,000 an ounce.
David: I don’t mean to sound seditious, and it wouldn’t be, because that rule doesn’t exist today, but I have confidence in the mind of the average American to, at that point, say as they did in 1933, to the tune of 90% of the gold outstanding, “Go pound sand.”
Kevin: The fact that they did leave the dollar backed by gold, at least internationally, led to the power of the Bretton Woods Conference.
David: You are right. Moving forward to what happened in the White Mountains of New Hampshire, the Bretton Woods Conference brought all of the currencies into relationship with the dollar, and that is what we were talking about earlier – the fool’s gold standard. The reason I mentioned the book, published in 1967, this dialogue between academics, when we started our conversation today, Kevin, is that in the U.S., things were deteriorating in the early 1960s, and it was not lost on the French. Keep in mind how brilliant they have been through time in looking at monetary dysfunctionality.
It is no wonder that it is Sarkozy who is proposing how to patch together the current situation, the equivalent of today’s Brady bonds, the plan that is to bail out the Greek debt issue in its present incarnation today. The French have always been sensitive to being number 1, if not number 2, in the world monetary scene. Even if they never are, they still want to be. And that has them keenly insightful as to what is wrong with the situation so that they can insert themselves into a position of prominence as things begin to play to their favor. That would be the theoretical framework that they are operating on the basis of.
1968 rolls around, the U.S. authorities were reminding their trade partners that “friends of America” should take greenbacks, will take greenbacks, and if you want gold instead of greenbacks, it will be on a permission-granted basis. You submit a request, and we will let you know when it is accepted, which was very different than what had been agreed to in 1944, which was an automatic transference. “You want gold? Take gold. You want dollars? Take dollars.”
Kevin: That is why they accepted it in the first place, because the dollar was to be as good as gold – period.
David: It was a gold proxy, as far as the international markets were concerned. It was fascinating to me, Kevin, on the plane back, reading this dialogue between Triffin and Mundell, between Mundell and Jacques Rouffe, and John Exeter, who was a classical gold bug. These guys were battling it out.
Kevin: He was a New York Federal Reserve president before that.
David: That is exactly right, that was John Exeter. What is fascinating is that all of them recognized in 1967 the importance of gold. The question was: How important? It was a question of degrees, not a question of utter irrelevance, and that is what I find particularly interesting today. We have somebody like Robert Zoellick at the World Bank who says that gold needs to be a part of our current monetary system, and he is laughed at, and these guys don’t realize that, as recently as 1967, everyone and their brother said, “Well, of course it is important.” Because guess what? You lose public confidence. What they didn’t realize is that financiers and bankers could step in, and through great Houdini-ism, great smoke and mirrors, create a perception of stability in the paper currency markets …
Kevin: For 40 years.
David: … that would create the sense, and the impression, and the perception, that gold is irrelevant to any monetary system. That is why Robert Zoellick is laughed off the stage today.
Kevin: Speaking of 40 years, we are coming up to the 40-year anniversary, in 1971, of Nixon closing the gold window completely, and these guys that you are talking about, like Jacques Rouffe, especially, in 1967 and 1968 were saying, “Look, you had better cash your dollars in for gold. Do it as quickly as you can, because the United States will not honor this forever.”
David: We just finished our most recent DVD and it is going to be available here in the next two weeks, for either a download on the Internet, or if you want a physical copy, feel free to request a physical copy. We will be making tens of thousands of those available. But if you want to just view it immediately online, that will be available here in the next week or two. The reason I mention it is because we have the footage of Nixon talking about the suspension of convertibility, and he uses the same word that Ben Bernanke has become very comfortable with – the word “temporary.”
Kevin: Temporary, or transient.
David: “We are temporarily suspending convertibility in the interest of the stability of the world monetary system.” It is amazing! It is amazing to see him say it, with all sincerity, and to realize that sincerity is worth what you pay for it – not more than about the cost of a cup of coffee.
Kevin: In 1971, something significant happened. For the first time ever, in the history of the world, the entire world economy was just based on paper.
David: That’s right, a completely fiat system, backed by nothing. This is where you have just a banker’s guarantee or promise to pay. What that means is there is no limitation of the quantity of money and credit that can be created. We saw an inflation bias, an inflation crisis, in the 1970s, and arguably, we see that in the pipeline for today, whether that is this year, next year, over the next 3 to 5 years. The dollar has maintained its status as the world’s reserve currency, following 1922, following 1933, following 1944, following the end of convertibility to gold in 1971, and that is the question: Can the dollar remain the world’s reserve currency today?
We have Wen Jiabao traveling throughout Europe today, promising support. Not being specific in what he will support, but the Chinese see the significance of the dollar taking, at least, a step down. Not necessarily a step toward irrelevance. Not necessarily a step toward oblivion. I don’t think anyone is assuming that the dollar is going away completely, but the fact that the Chinese are the new champions of the euro, a monetary unit which is fraught with internal problems, we don’t need to explore that anymore than we have in recent weeks, but the fact that they are champions of this means that they are unwilling to allow the world to go back to a unipolar monetary system centered on the U.S. dollar.
Kevin: Within the last month we interviewed the author of Exorbitant Privilege. One of the things that he was saying was that, really, we are probably going to lose that exorbitant privilege. The reserve currency status that has been so sweet to America, that has just really encouraged consumption as a form of GDP, that lifestyle has to change.
David: The reason we had Eichengreen on the program is not because we are necessarily champions of every one of his ideas, or even any of his ideas, but when he wrote an article in Foreign Affairs more than a year ago, which was an introduction, essentially, to his book, Exorbitant Privilege, I knew at the time that the Council on Foreign Relations and the mucky-mucks in Washington, and globally, would be looking at this and saying, “You know, I think he has a point.”
Kevin, today you brought this article to my attention: “Dollar seen losing global currency reserve status.” This is a sampling of opinions by UBS, the Swiss bank, of the global central bankers, who control roughly 8 trillion dollars’ worth of assets. Some of those are dollar deposits, some of them are non-dollar deposits.
Kevin: That is 8 thousand billion, or 8 million million, dollars. That is a huge chunk.
David: They surveyed 80 central bank reserve managers, sovereign wealth funds, and multilateral institutions, and the conclusion was, “Nope, the dollar cannot keep its status as the world’s reserve currency.” How long does that take? Is that a crisis event? Is that something that evolves over a period of time? I can tell you that there is money on the table and a guarantee that the Chinese will not allow this to occur. They will not allow an implosion in Europe to occur. It seems inevitable, and this is sort of point and counterpoint to our conversation with Bill King in the last week, in which it was said that yes, this is the death of Western socialism, the collapse of Western socialism.
You see that in Europe today. Better than socialism is communism and a command economy that says, “Yeah, but we don’t want to go back to being at the end of a U.S. whip. We don’t want to be completely dependent on a consumer base in the United States. We realize we need to expand our market share, and in fact, have expanded our market share. Europe is one of our largest trade partners next to the United States and we are not about to see that impaired. We want to see stability in the Eurozone, we want to see stability in the euro, and we are willing to put money on it.” That is their guarantee.
Kevin: It is amazing, they are swinging a big, big bat. They have a huge amount of money, as we know, in reserves. If you go back to the 1950s – the late 1940s, 1950s, 1960s, the fear was that a communist country, and in this case it was Russia, would swing a big bat internationally. What is interesting is that we have sold, basically, our soul away, by going off of the gold standard, printing all this money, creating this incredible debt, not just here in the United States, but in Europe, and now you have a country, a communist country, a command-controlled country, that is coming in, and actually, the borrower truly is the servant to the lender.
David: Kevin, it is fascinating. The question I started the interview with last week, with Bill King, was: “What is being birthed in Europe?” And he said, without skipping a beat, “A gold standard.”
Kevin: Yes, it was like you caught him off guard, he didn’t expect that question, so it just came right out of his instinct.
David: What is he talking about? I don’t know, we didn’t explore it fully in the conversation last week, but Kevin, I think we are moving toward a period of monetary crisis, not just with the dollar, but a global monetary crisis, in which the only means of bringing stability into the system is to go back to what was regarded as axiomatic as recently as 1967, 1968, 1970, leading into 1971 and the suspension of convertibility, what was axiomatic prior to 1922, prior to 1914, what was considered to be absolutely true, by Jefferson – not necessarily by Hamilton – that you can never trust a central banker with your money.