“Rather go to bed without dinner than to rise in debt.” Benjamin Franklin
We left off last week in 1900 when gold officially became the only metal redeemable by the US government as money. The silver standard was gone as with it went the inflationary impulses of increased silver finds like the Comstock lode that threatened the supply of government gold. The US had joined England which had been on the gold standard since 1821 and Germany which joined 50 years later. The US was growing and doing more international trade and settling accounts in gold amongst nations made sense.
Gold available reserves grow very slowly and that gets in the way of growth which is limited by perhaps the most important thing in the world- the amount of money in the system. Last week we discussed the Great Bullion Famine and the difficult times that it created in Europe which led to them looking for and finding the New World. Since most all gold ever mined is still available today and the supply tends to grow at about 1-1.5% a year it provides for very stable prices. When the world’s nations pegged their paper to the shiny metal the world was fairly easy to trade with. World War I changed all that with the debt laden countries being forced to sell their gold and they held British pound sterling and the US dollar instead. Since they were both backed by gold, it seemed like a reasonable idea to hold this paper as a proxy.
The Federal Reserve was established in 1913 and they started sticking their beak into the US economy. Roger Garrison, professor of Economics at Auburn University writes, “The Federal Reserve played a leading role in the dramatic boom of the 1920s (and the bust of the 1930s). Artificially cheap credit provided by the Federal Reserve underlays the economic expansion that lasted through mid-1929. This credit expansion, in an economic environment largely devoid of Fed-watchers, drove a wedge between saving and investment. Guided by low rates of interest, investment outstripped saving in aggregate terms, and more importantly investment projects were excessively long-term. As the boom proceeded, low interest rates lured capital into relatively time-consuming production processes. That is, the timing of the output of these production processes was skewed toward the future…” Now let’s think about the Paris Accord of 2050, and being carbon free? Let’s think about the EV revolution, and let’s think about the environment, I’m not talking about saving the rainforest environment, I’m talking about the economic environment in which these policies could be introduced and not laughed out of the room, a no or low-rate environment. Only the technology has changed people, the thoughts and motivations and actions are all the same. I keep bringing up EV and green economic disasters in Looking Backwards Looking Forwards because they projects are ill-suited for a non-zero interest rate environment. Their companies will go broke because their models never anticipated that we could possibly have rates go this high and stay this high. More and more greenies are screaming in environmental rage for Powell to pivot. What if he does? Let’s look back to history… It gets worse in the roaring 20’s came to an end as the Fed continued to interfere with markets.
Scott Sumner writes in EconLib “In 1929 the Fed tried to institute a tight money policy, in order to restrain the stock market boom. At first they failed. But in the fall of 1929, they raised their target rate to 6%, an astoundingly high level for an economy experiencing zero inflation. The monetary base immediately began declining, falling by over 7% between October 1929 and October 1930. By that time, industrial production had already fallen more than 27% below its July 1929 peak. The economy was now in a deep depression. Contrary to popular imagination, there was no financial crisis during the first year of the Great Depression—it was 100% tight money.” Our money supply dropped last year by 3.69%, contracting for the first time since, you guessed it, the 1930s. Now I’m not saying we are walking in the footsteps of the days of yore, but we need to be cognizant of the similarities.
As the depression deepened on President FDR and the world, he pulled a fast one on his people and the world. He outlawed and seized all the gold in the US, remember they were on the gold standard, and then he revalued it less than a year later. From $20.67 to $35, and the gold poured into the US and dollars poured out. We defaulted and had to devalue our money. Gold production soared so that by the time Hitler invaded Poland there was enough gold to replace all global currency in the world. The Asian and European wars took lots of money and by the time that war was over, the US held 75% of the world’s gold and they instituted the Bretton Woods system making the dollar the world’s reserve currency.
Now the war itself was largely a follow up to the first World War. France wanted reparations from the Germany and demanded a lot in the Treaty of Versailles. They wanted energy, at the time it was coal from the Ruhr sections of Germany due to Germans bombing the coal mines of France during the war. They ended up seizing them. Germany was so hamstrung by the high war reparations that they underwent a hyper inflation during the Weimar republic setting the stage for Hitler to assume power right when the other countries in Europe went off the gold standard in 1931 with the default of Austria’s biggest bank Creditanstalt.
America had most of the world’s gold, most of the world’s manufacturing, and had just won two wars in two theaters, and had officially became the world’s reserve currency. They also had sound money, and their soldiers went home to make babies and boy did they. The baby boomers came along and by the time they reached an age to be influenced by JFK, Martin Luther King, and LBJ, they demanded social programs in the 1960s, marched in protest of the Vietnam War, and caused our once productive nation to hemorrhage gold out of the US and to Europe. Europe saw that we were not the nation of 20 years before and that our government was spending waaaay too much money and we were writing checks our country couldn’t cash. By 1971, Nixon temporarily closed the gold window meaning other nations could no longer redeem their dollars for gold. That window is still temporarily closed… We defaulted on our obligations again. If there is one common theme in this narrative, it is don’t trust the word of the US government, if you don’t believe me, ask the American Indian, but I digress.
That was it. That was the end of the gold standard. The foolishness of the 1960s politicians and their inability to spend within their means drove the US off the gold standard and into a fiat system. Paper currency which is backed by nothing but the full faith and credit of the United States. A nation that defaulted, devalued, and broke its word more times than I can count. That government would begin being populated by the baby boomers… here is how the dollar has fared. In 1971, one US dollar would buy 17 oranges, in 1997 it would buy 4 grapefruits, and in 2020 it would buy one cup of coffee at McDonald’s. In 2020 Covid hit and since the baby boomers saw their housing prices start to fall and their stock portfolios drop 35%, their government of boomers nuked $10 trillion of government debt into the system and now that cup of coffee costs $2.
Now if I may quote one Kim Mather’s son “Now this is the part where the rap breaks down. It gets real intense, no one makes a sound.” That lack of sound is what is happening at Treasury auctions when the world is being asked to buy the debt of the US government. “It’s funny but it fits perfectly well right here, this song is called the dance.” That right, we are entering the dance. Let’s bring back an oldie, this week’s word of the week is dance-
Dance- to move in a quick and lively way.
Well before dance meant such a weird and lonely thing, a dance was performed by a man and a woman following a set sequence of steps to music. A man would lead, and a woman would follow. That is what the bond market is going to do. The US is broke without being able to borrow more money OR and this is a big OR unless we want to go to bed without dinner and stop spending. Since that seems highly unlikely in our current profligate society, the dance with the bond market will continue. The buyers of our debt see our trillion-dollar deficits and will be like Europe in the 1960’s. Europe sees that we were not the nation of 75 years before and that our government is spending waaaay too much money and we were writing checks our country couldn’t cash. The problem is so does China and Russia and Japan and Brazil etc…. This dance will ebb and flow like the music, the yields will rise and fall with the energy of the band and the energy prices of the world.
Lest we forget the petro dollar which was our pseudo replacement for the gold standard via Henry Kissinger in 1974. This week Saudi Arabia is denouncing the actions of Israel and siding with the other Arab countries in the Middle East like Iran. Their energy which is priced in dollars, paper with presidents’ pictures, and we think they will continue taking that for their energy. They see how vital energy is to the world and they will need money for that, not paper. It seems they have switched dance partners to the Global South for now. We are peddling debt, Russia and the Middle East are peddling energy, and China is peddling manufacturing. I wonder who will be left without a dance partner? Until we find out, the music will continue to play, and the bond market will reveal just how much people trust the United States dollar when it isn’t backed by gold. If we learned anything from Dirty Dancing it is that nobody puts our Biden baby in the corner.
Sincerely Yours,
C Thomas Printer
On this date in history… 258 years ago to be exact, The Stamp Act went into effect allowing the British to directly tax the Colonialists’ commercial and legal papers.
US federal tax revenues are now paying 72% of our spending, leaving a deficit this year of $1.7 trillion. US Debt to GDP stands at 124%, not even after World War II was it this high.
Also born on this date….as elegant a writer as there ever has been, Grantland Rice, “The Dean of American Sportswriters.”
https://www.investopedia.com/ask/answers/09/gold-standard.asp
https://www.visualcapitalist.com/purchasing-power-of-the-u-s-dollar-over-time/
Thank you for listening today and you can find all of our articles and more on our website cthomasprinter.com.