41 years since we all became Keynesians

Rumour has it that this little beauty of an op-ed piece was written by someone over at JP Morgan, you’ll see why we’re so surprised when you’ve read it. It’s an interesting read, with some interesting references as to just why we ended up where we are. This is an excellent introduction to the history of our historically unique and screwed up financial system.

It’s just too good to share it with you all in one day so we’ve decided to hold back the second half until tomorrow. Hope you enjoy!

Landon Lowdown: “Brother, Can You Spare $1.37”?

As we await the latest developments out of the Eurozone and Washington, I take a moment to look back on this very important day in history. If you want to understand current events, then you first have to understand history. How did we get here? More specifically for financial markets, how did we end up in this mess — this economic purgatory? The answer boils down to a simple proposition on the philosophical level, which I will leave to the reader to identify because my doing so would likely ruffle a few too many feathers. So I will keep the discussion on the concrete-bound level. However, I am willing to say that the political philosophy that drove us to the current state of affairs was responsible for the respective concrete measures implemented over the years. The crisis in confidence that we observe today resulted from cumulative effects of those measures. 

This being August 15, 2012, students of the history of monetary economics no doubt are aware that this is the 41th Anniversary of the breakdown of Bretton Woods. It was on this day 41 years ago that President Nixon defaulted on the promise to exchange gold for paper dollars presented for exchange by foreign central banks. Aug 15th marks the anniversary of the collapse of Bretton Woods and the gold-exchange standard that was established after WW II. (Notice that dollar debasement has been bipartisan over the years: Republicans Nixon and Bush and Democrats Carter and Obama have all presided over major declines in the value of U.S. money.)

The current crisis in the global monetary system pales in magnitude to the sundering of gold from central banks’ fiat paper currencies in 1971. That is, we are not witnessing the wholesale dismantling of an entire monetary system. What we are witnessing is a loss of confidence in the current monetary system, which, of course, is equivalent to a loss of confidence in central banks’ ability to restore stability. However, the decision to renege on the gold-exchange standard that was made 41 years ago is still reverberating today. In *fact*, many or most of the problems observed today are the direct result of wrong-headed discretionary monetary policies.

What was it that made the current morass inevitable once the paper dollar was severed from gold?

 The answer is simple: fiat paper money that is not grounded in any objective standard can be manipulated at the whim of the issuer. Without the requirement to exchange fiat money for gold or some other commodity, the central bank can issue unlimited amounts, thus making its value subject to extreme volatility and, as we have seen, perpetual debasement.

Chart 1 (above) shows the extent of debasement of the value of U.S. money since 1913 when the Fed was established. To summarize in simple terms, a child with 4 cents in his pocket could buy the same amount of candy in 1913 as his descendant could with $1 in 2012. Today, it takes a quarter to buy what a penny did in 1913. The dollar has lost 96% of its purchasing power since 1913! (using CPI statistics) Once the dollar lost all linkage to gold, its value plummeted at an accelerated rate. Since 1971 when Bretton Woods was intentionally dismantled, the dollar has lost 82% of its purchasing power. 82%! Because Nixon sabotaged the last vestige of honest money, a child in 2012 would need $1 to buy the same amount of candy purchased by children for just 18 cents in 1971.

Monetary debasement has rendered obsolete the expression “brother, can you spare a dime?”, which was the title of a 1930’s Depression-era song that became a common refrain of panhandlers in those days. In 2012, the equivalent would be “brother, can you spare $1.37?”

Come back tomorrow for part II…

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