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Today is a period when we are building the foundation for the monetary
systems of the future – what former Fed chief Paul Volcker recently called “the
need to develop an international monetary system worthy of our time.”
This “foundation” consists mainly
of ideas – the ideas that are later implemented in real-world systems.
Without the ideas, you can’t make the system. It’s as simple as that.
I think there is a lot of trauma remaining today regarding the last “system”
we had, the Bretton Woods arrangement of 1944-1971. This was a prosperous
time worldwide – the best era, I would say, of the last century since
1914. Not the sort of thing that anyone would want to come to an end.
So, you can see why its accidental and premature death was a bit traumatic. I
think we need to review this today, and get over it.
Bretton Woods blew up, in the midst of peace and prosperity, for two basic
reasons as I see it: first, because governments wanted to fool around with
Mercantilist money-jiggering notions; and second, because they really had no
idea how to manage the system that existed, or even what it was for.
The proximate cause for the demise of Bretton Woods was that president
Richard Nixon installed his good buddy Arthur Burns as the head of the
Federal Reserve in February 1970. Burns, along with the other Nixonites,
advised Nixon that the minor recession of the time could be resolved with a
certain amount of money-printing. Their target was an increase in nominal GDP
of 9% in 1972, putting everyone in a good mood for Nixon’s re-election that
year. They called this the “game plan.”
Well, you can’t just go print money woohoo and also maintain the dollar’s
Bretton Woods gold parity at $35/oz. To do that correctly requires currency-board-like
techniques, as establishment
economists have finally learned after a few decades of blowing up countries
right and left. Currency-board-like techniques require the abandonment of
a “discretionary, domestic monetary policy” aimed at Mercantilist economic
management.
You might assume that, at some point, the Nixonites got together, and had a
careful discussion about whether to stick with the Bretton Woods gold standard
arrangement, or to have a little adventure with the printing press in service
to political expediency, with floating fiat currencies the inevitable
outcome.
But, that didn’t happen. As John Butler recalls in his recent book The Golden
Revolution, the Nixonites got together a few days before Nixon publicly ended
the U.S. dollar-gold parity policy on August 15, 1971. Paul Volcker, then
Under-Secretary for the Treasury for International Affairs, was there. Arthur
Burns, then head of the Fed, was there.
Apparently, the biggest advocate at that meeting for maintaining the Bretton
Woods dollar/gold parity at $35/oz. (i.e., the gold standard policy) was:
Arthur Burns!
The head of the Fed, and lifelong monetary economist, had no idea – no idea!
– that his money-printing strategy was having a head-on collision with the
existing gold standard policy.
No idea. The degree of ignorance implied, among the world’s supposed top
experts, is even now difficult to fully grasp.
Wow.
I’ve called it: “The
Mind-Bending Ignorance of the Bretton Woods Years.” My mind bends even
today.
Oddly enough, the little narrative I just presented is actually completely
different than what you might hear from mainstream academics today, who are
actually repeating the view that was conventional during the 1960s as well.
They tell a story something like this:
“The U.S. dollar’s reserve currency status, in the Bretton
Woods system, caused a persistent U.S. current account deficit. This current
account deficit was exacerbated by heavy deficit spending by the U.S.
government, to fund both president Johnson’s Great Society welfare programs,
and the Vietnam War. The huge Balance of Payments imbalances eventually led
to the demise of the system.”
Here’s a version
of that story, from the IMF’s own website. Another typical
mainstream account can be found at Wikipedia, similar to what you’d find
in college textbooks.
I want to emphasize that this was not one guy’s idiosyncratic notion, but a
widely-held, mainstream view, and remains so today.
I’m not going to get into the nitty-gritty details of these issues in a short
op-ed. But, we should at least be able to see whether this description had
any relation to reality.
First: The U.S. supposedly had a chronic current-account deficit of
world-monetary-system-destroying proportions. Did this exist?
 
No, it did not. The U.S. ran a current account surplus every single year of
the 1960s, averaging about 0.5% of GDP.
A surplus. Not a deficit. A surplus – with an “S.”
Second: Did the U.S. Federal government have a large deficit,
supposedly funded by the “exorbitant privilege” of selling Treasury bonds to
foreign central banks for use as reserve assets?
Nope. During the entire decade of the 1960s, the average Federal deficit was
-0.7% of GDP. Less than 1%. Which doesn’t seem all that disastrous to me. The
largest deficit was -2.7% of GDP in 1968.
As you might imagine, if deficits are small and GDP was growing smartly,
debt/GDP ratios were steadily coming down to very manageable levels.
Nothing very disastrous there either. When the Bretton Woods era ended in
1971, U.S. Federal debt/GDP was about 35%.
How about the yield on the ten-year Treasury bond? Was there any evidence of
some “exorbitant privilege” enjoyed by the reserve-currency issuer, such as
unusually low interest rates?
Treasury yields were rather high during the 1960s, among the highest in U.S.
history up to that point.
Let’s take a big-picture look at the Bretton Woods era as a whole. Is there
evidence of major “balance of payments imbalances” worldwide that suggests
some kind of impending catastrophe?
Actually, the entire Bretton Woods period had some of the lowest “balance of
payments imbalances” of the last 150 years. (This was due in part to capital
controls common at that time.) Not only that, the very large “balance of payments
imbalances” of the pre-1914 era actually were no problem at all. The
“Classical Gold Standard” era ended due to printing-press finance related to
World War I, not because of any issue related to international capital flows.
In short, the common narrative is hooey. A fairy tale!
What actually happened is so simple, Adam Smith had it figured out in 1776:
“Should the circulating paper at any time exceed
[the appropriate amount within the context of the gold parity system], it
must return immediately upon the banks to be exchanged for gold and silver.”
Or, to summarize in three words: Too Many
Dollars.
That’s all it was.
I want you to try to imagine the world’s top monetary experts traipsing from
one five-star hotel to another, having Weighty Discussions about the
implications of a fairy tale which did not actually exist.
For ten years, roughly 1960-1971.
It’s kinda funny, in a vaguely sickening way.
If you want to know why we don’t have a gold standard system today … that’s
why.
If we are going to become able to build great monetary systems in the future,
we need to be able to correctly diagnose past errors – especially when those
errors can be summarized in three words. Otherwise, how would we avoid doing
the same stupid thing again? Sometimes I wonder if the human species is
capable of this; and yet, in the past, it did happen. Adam Smith figured it
out. So did David Ricardo, John Stuart Mill and others.
We are fortunate that the process of deterioration of the present monetary
arrangements, though well underway, has been moderated recently. There is
still a lot of foundation-building to do, in the realm of ideas, before we
are ready to actually create new real-world institutions with the capability
of lasting for centuries.
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