Thursday, March 22, 2012

Why Did Nixon Take the Dollar Off the Gold Standard?

Every once in a while we get a question that we answer, and then realize that our answer was just so brilliant that we can use it for the daily blog posting. Or maybe we realize that, no matter how obscure our ramblings are, we're in no shape to pound out another piece of writing just to be able to post something.

Whatever the reason, today's posting is a response to something a Faithful Reader sent in, asking "To what extent is this true? Is there a systemic crisis brewing in our system? Could it collapse in the next two years? If so, how and why? If not, why not?", "this" being the following comment on the internet:

"Why did Nixon take the Dollar off the gold standard?

"Because the bankers needed to increase the money supply in order to keep paying for the massive military buildup during the Cold War.

"America 'won' the Cold War because America's Dollar had reserve currency status which afforded America to keep their high cost of living AND to run the most expensive war machine ever. All because the rest of the world was forced to accept the US paper or else.

"Cold War is long over. A few more banking machinations since then and a few stock market crashes. Things are coming to a dead stop now because EVERYONE knows America is lying about it's financial health and EVERYONE knows the DOLLAR IS NOT BACKED BY ANYTHING. Certainly not the trillions in Dollars that are sloshing around the globe.

"Give it a few months, 2 years TOPS."

We responded that the comment appears to be correct in substance (at least as far as the conclusion goes), if somewhat surreal, and gives some wrong impressions. For example, the U.S. dollar has never, except for gold certificates and a legally mandated amount of United States Notes, been backed by gold. Rather, until 1933 (with a hiatus during the Civil War and until the 1870s) the dollar was convertible into gold (or silver) on demand.

Prior to the New Deal, the dollar was backed by private sector bills of exchange representing the present value of existing and future marketable goods and services, and a limited amount of government bills of credit representing the present value of future tax collections — the "faith and credit of the United States." Claiming it was a move against currency speculators (how that is possible with a fixed exchange rate was not clear), Nixon took the United States off the gold standard internationally. Roosevelt had already taken the U.S. off the gold standard domestically in 1933. What Nixon's move meant was that the ability of foreign central banks to convert their dollars into gold at a fixed price ($35.00 per ounce) was suspended — allegedly temporarily.

The reason was not, however, because "the bankers needed to increase the money supply in order to keep paying for the massive military buildup during the Cold War." The exact opposite was the problem. The costs of the Vietnam War and Johnson's "Great Society" had finally caught up with America. Financing both with debt-backed credit instead of taxes had resulted in the U.S. Treasury emitting massive amounts of bills of credit: public sector bills of exchange backed by the present value of future tax collections.

Both welfare and war are government expenditures, not investment in new capital formation, and are thus purely inflationary. Instead of being backed with the present value of private sector hard assets, as intended in the "Indianapolis Plan" of 1900 and the original Federal Reserve Act of 1913, the new money was backed only by the "faith and credit" of the United States government — that is, what the government could be granted and collect in taxes in the future. Debt-backed U.S. dollars were consequently flooding the channels of commerce throughout the world. The problem was not insufficient money to keep the military industrial complex going, but far more money than was needed for private sector uses, and created in the wrong way.

Since the New Deal, the Federal Reserve had virtually ceased rediscounting private sector bills of exchange backed by the present value of future marketable goods and services to supply agriculture, commerce and industry with an "elastic currency" sufficient for the needs of commerce and private sector development. Instead, the country relied then and now on government bills of credit backed only by the government's promise to pay, a promise that has grown increasingly shaky over time.

The Bretton Woods agreement had imposed fixed exchange rates, which required that a world reserve currency such as the U.S. dollar had become, replacing the British pound, be pegged to and convertible into something (such as gold) with a legally fixed price. The massive increase in the money supply, however, put a heavy strain on maintaining the fixed exchange rate. Consequently, various European central banks began intervening in the market, purchasing dollars at a tremendous rate to relieve the pressure by decreasing — not increasing — the supply of dollars. Naturally, not being able to afford holding such vast amounts of dollars, they traded them in for gold, and the U.S. suffered a heavy drain on its gold reserves. In essence and in a very roundabout way, the U.S. was paying for the Vietnam War and the Great Society with undervalued gold exchanged for overvalued paper dollars.

This could not be maintained, and Nixon effectively terminated the Bretton Woods agreement by allowing the U.S. dollar to have a "floating" exchange rate, i.e., be set by the market. The bankers were able to stop purchasing massive quantities of dollars — which could not have been sustained in any event as U.S. gold reserves plummeted — but the stage was set for currency instability that contributed to the "stagflation" of the 1970s. Without the debt-backed dollar being maintained at an artificially high value by being pegged at a fixed rate to gold, foreign goods (such as oil) rose dramatically in price.

The situation could have been corrected by halting monetization of government debt and returning the Federal Reserve to its original purpose of providing liquidity to the private sector and supplying the country with an elastic and asset-backed currency. Investment in new capital would have been financed not by restricting consumption, as the Keynesians, Monetarists and Austrians erroneously assume is essential (see Moulton, The Formation of Capital, 1935, especially the CESJ foreword), but by increasing production, that is, by monetizing the present value of marketable goods and services to be produced in the future by discounting and rediscounting bills of exchange.

There would have been an adequate supply of money, and the dollar would have had a stable value naturally, instead of being imposed or manipulated by State fiat. Because of the increase in production that would have resulted in increasing private sector investment and decreasing non-productive government spending, "supply" (production) would have increased, lowering the prices of American goods overseas. Had Nixon adopted a program of widespread capital ownership at the same time, effective demand would have increased domestically as well, optimizing the chance that the new capital formed would be financially feasible.

While the analysis in the passage is thus somewhat superficial, we agree with the conclusion. The present system cannot be sustained, and is almost custom designed to collapse. The repeal of Glass-Steagall removed even the minimal internal (systemic) controls needed to restrain private sector greed and monopolizing tendencies, and tried to substitute external, government control through increasing regulation — misusing the State's monopoly over the instruments of coercion to maintain a private sector monopoly over the instruments of greed and corruption. (This is contrary to sound principles of system design, as a regulatory agency can only enforce, not replace internal controls.) This has allowed the financial services industry to "reset" the economy to 1929 with a vengeance, when, e.g., the private sector was creating massive amounts of money for both capital investment and speculation.

The situation is worse today, because not only has the industrial base eroded (almost fully intact in 1929 — even having excess capacity), and increasing numbers of jobs eliminated by advancing technology and shifts to lower wage areas, money creation has shifted from the private sector to government. Virtually ensuring disaster is the fact that the new money creation is not tied in any way directly to increased production — government produces nothing — and when it enters the economy is channeled into the stock market, inflating speculative prices, not being invested in new plant and equipment or jobs. The so-called "recovery" is almost pure illusion, fueled by debt and speculation, not production of marketable goods and services in which every child, woman and man can participate through ownership of labor, capital, or (preferably) both.

The situation could be reversed virtually overnight, and the economy restored to a modicum of sanity within 12 to 18 months by implementing "Capital Homesteading." The announcement that Capital Homesteading would be implemented would itself help restore confidence and bridge the gap between the current situation and full implementation, much as the Federal Reserve averted a threatened financial panic in 1919/1920 merely by announcing that it stood ready to supply credit if needed. It wasn't necessary, because the announcement itself restored confidence in the system. Obviously something more than a mere restoration of confidence is needed today, but that is essential, or the economy will continue to flounder.

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