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Journal of a Wayward Philosopher
Monetary History in Ten Minutes
August 23, 2016
Hot Springs, VA
"Money, moreover is the economic area most encrusted and entangled with centuries of government meddling. Many people - many economists - usually devoted to the free market stop short at money. Money, they insist, is different; it must be supplied by government and regulated by government. They never think of state control of money as interference in the free market... If we favor the free market in other directions, if we wish to eliminate government invasion of person and property, we have no more important task than to explore the ways and means of a free market in money." - Murray Rothbard
The S&P closed out Tuesday at $2,183. Gold closed at $1,343 per ounce. Crude Oil closed at $46.81 per barrel, and the 10-year Treasury rate closed at 1.58%. Bitcoin is trading around $585 per BTC today.
Little Maddie is rapidly approaching her second birthday, and I swear she is going on twelve. Like her mother, Madison is quite adept at the art of talking, and she communicates with us very well. This makes life so much easier when she tells us exactly what she wants for dinner; it makes life just a touch more difficult when she wakes up in the wee hours of the morning and tells us she wants to watch Mickey Mouse.
While this seems terribly inconvenient to her parents now, I can only imagine how immaterial it will seem when Maddie is a teenager and we just hope she comes home before the wee hours of the morning. Nevertheless, it all makes perfect sense when she looks up at us with her blue eyes shining bright and says I love you sooo much!
Moving on to finance...
Today's journal entry is actually an excerpt from The Individual is Rising. Along with watching Mickey Mouse episodes at 5:00 in the morning, I have been working to complete the third edition of the book which will be published this Autumn. I am excited about how this edition has shaped up because it is loaded with practical philosophy, opportunities, and actionable financial strategies; more-so than the first two editions.
We will be offering an advanced digital copy of the book absolutely free to members of the Zenconomics Report before it hits the shelves at Amazon. Simply enter your name and email address into the form at the end of this entry to join our network and receive an advanced copy.
What's so important to understand about the evolution of the monetary system is the fact that it has directly shaped the very world in which we live. Money is half of every transaction thus half of the entire economy, and most people spend most of their time working for money. Like it or not, this dynamic makes money one of the single most important items in everyone's life. As such, we would be wise to know its story. Here's a brief monetary history:
Prior to the rise of central planning, most of the world operated on the gold standard through which international trades were settled in gold.
While not perfect, the classical gold standard kept nations mostly honest in their financial dealings with each other. It also forced nations to live within their means because large trade deficits had to be settled in gold which drained gold from the nation’s reserves. Conversely, when a nation ran a trade surplus it received additional gold to add to its reserves. Such a system placed limits on national debt and encouraged sound finance because the incentives were properly aligned.
World War I effectively put an end to the classical gold standard. To finance the war effort, the countries involved looked to currency inflation to expand their money supply and they suspended trade settlement in gold. Most of these nations attempted to go back to the gold standard once the war was over, but the excessive money-printing distorted valuations and the necessary economic corrections were not politically desirable, so the classical gold standard was never re-implemented.
During the same time period, the shift towards central planning in America led to the creation of the Federal Reserve System in 1913. It is important to note here that the Federal Reserve (the Fed) is not a government agency, but rather a quasi-private central bank (actually a consortium of banks that act as one unit) exclusively chartered by the U.S. government to centrally manage the banking system.
Not coincidently, two centralizing amendments to the U.S. Constitution were passed in that same year. The 16th Amendment created the national income tax which brought the IRS to power. The 17th Amendment established the direct election of U.S. Senators whom were previously elected by state legislatures. This effectively snuffed out any remaining sparks of States’ rights that had survived President Lincoln’s water hose.
Though the foundation had already been set, the year Nineteen Hundred and Thirteen ramped up the centralization process and set the stage for the greatest economic boom ever witnessed. As we have seen throughout history, centralization can lead to a tremendous boom in the short term, but it is always followed by either an epic bust or a long march down the road to serfdom.
Upon opening its doors, the Federal Reserve monopolized control over the currency supply and it functioned as a banker’s bank - as the lender of last resort. Naturally this created moral hazard within the banking system as the banks were free to pyramid large amounts of debt on top of capital reserves with the Fed ready to step in and provide them with liquidity should their increasingly riskier financial bets go bad.
With the Fed’s banking cartel established, member banks could lever up their balance sheets for outsized profits with the knowledge that the Fed would print money for them to prevent bank runs. This was sold as a progressive feature of the system, but in reality it incentivized unsound lending practices and credit expansion en masse. We are still living with the effects of this moral hazard today, and we saw in 2008 that significant losses within the banking sector will be socialized to perpetuate the system.
The Fed quickly took on additional functions as America moved further towards coerced collectivism in 1933 with the onslaught of the New Deal. To support the myriad of New Deal welfare programs, Franklin Delano Roosevelt (FDR) issued an executive order that closed the domestic gold window and criminalized the private ownership of gold by American citizens. This was done because the domestic gold window limited inflation since Americans could redeem paper dollars for gold at any time. This direct redemption of dollars for gold served to contract, or deflate, the money supply which limited the Fed's ability to monetize government debt.
With Americans no longer free to redeem their dollars for gold, the Fed could backstop the New Deal programs by inflating the currency supply with little resistance. Foreign central banks were still allowed to redeem dollars for gold, however, which served as a partial constraint to the inflationary regime.
In 1944, representatives from 44 nations of the world met in Bretton Woods, New Hampshire to discuss a new international monetary system needed to replace the classical gold standard which had been dismantled by the world wars. The agreed upon ‘Bretton Woods System’ established the U.S. dollar as the international reserve currency.
As the world’s sole reserve currency, the dollar replaced gold as the medium for international trade settlement. This meant that all international goods would be bought and sold in U.S. dollars no matter which nations were doing the buying and selling. The dollar would remain pegged to gold at $35 per ounce and other nations could redeem their dollars for gold through the ‘gold window’.
The dollar’s convertibility into gold on demand was to serve as a ‘check’ on the United States to prevent excessive currency inflation. This greatly accelerated the adoption of the Bretton Woods System as the gold window served as a promise to the international community that the U.S. would maintain the value of the dollar.
The Bretton Woods System bestowed an enormous privilege upon the United States as it created a global demand for dollars. Since all international trades would be settled in dollars, all nations would need to hold U.S. dollars to facilitate foreign trade.
This dynamic rendered trade deficits irrelevant for the U.S. Under the gold standard, trade deficits necessitated an outflow of gold from reserves. Under Bretton Woods, trade deficits necessitated an outflow of paper dollars created from nothing. In other words, the U.S. was in the advantageous position of swapping fiat scrip for tangible foreign goods and electronics.
This artificial global demand for dollars is what powered the United States’ “guns and butter” campaign which ramped up in the 1950's.
The Great Society programs expanded upon the domestic welfare state and the undeclared wars in Korea and Vietnam launched the warfare state and the rise of the military-industrial complex. As you can imagine, a policy of welfare and warfare is not cheap and it must be financed.
The United States financed its guns and butter by selling Treasury Bonds and inflating the currency supply. Under Bretton Woods, other nations were happy to buy U.S. debt because they needed to increase their dollar holdings. And the United States was able to run trade deficits with other nations without hindrance because they could send newly created dollars overseas rather than gold from reserves.
The Federal Reserve began to function more and more as a big government financier during this time period as it ramped up the currency inflation to support the welfare/warfare state. The United States did not experience drastic price increases domestically, however, as most of the inflation was in effect exported overseas due to the international demand for dollars.
As the undeclared war in Vietnam continued and the Great Society programs expanded, other nations began to fear that excessive currency inflation in the United States would lead to a re-valuation of the dollar to gold. They recognized that the dollar was now overvalued at $35 per ounce of gold because of the Fed's activities so foreign nations began to increasingly exchange dollars for gold through the gold window. Here's former French President Charles de Gaulle in 1965:
"The fact that many countries accept as principle, dollars being as good as gold, for the payment of the differences existing to their advantage in the American balance of trade... this fact leads Americans to get into debt and to get into debt for free at the expense of other countries... We consider necessary that international trade be established as it was the case before the great misfortunes of the world, on an indisputable monetary base, and one that does not bear the mark of any particular country. Which base? In truth no one sees how one could really have any standard criterion other than gold!"
As a result of this run on the dollar, the United States’ total foreign reserve gold coverage had diminished to 22% by 1971.
On August 15, 1971, President Richard Nixon closed the international gold window and implemented domestic wage and price controls in the United States. Nixon assured the world that the gold window would only be closed temporarily and that the dollar would be redeemable in gold again at some point in the near future.
“Your dollar will be worth just as much tomorrow as it is today.” Nixon proclaimed on television with a straight face. “The effect of this action, in other words, will be to stabilize the dollar.”
Prior to closing the gold window, Nixon and his Secretary of State Henry Kissinger struck a deal with the Saudi Royal Family. The agreement was that the Saudis would price all international oil sales exclusively in U.S. dollars and they would refuse settlement in all other currencies. In return the United States would provide military protection for Saudi Arabia and supply the Saudis with military-grade weapons. By 1975 all OPEC nations, not just the Saudis, had agreed to settle oil trades exclusively in dollars.
This deal effectively kept the U.S. dollar as the world’s reserve currency, even with the breakdown of the Bretton Woods System, as all other countries needed to obtain dollars in order to purchase oil from the largest oil producing nations in the world. Of course the gold window was never re-opened, and the United States’ welfare/warfare state has exploded with the removal of the last honest restraint on money-printing.
So this is where we stand today – in the midst of a global fiat monetary experiment.
Since 1971 the U.S. dollar and all other currencies have been fiat currencies backed by nothing and created from nothing. With all ties to gold removed, the U.S. and many other nations have been ferociously inflating their currency supply which has resulted in the explosion of prices across the board. This is why you could purchase a hamburger for a quarter in 1971, but you are lucky if you can purchase a cheap gumball for a quarter today.
The deliberately obscured fact is that this is not a case of rising prices, but rather of your dollars becoming worth less and less, thus requiring more dollars to buy the same item of value. We have been conditioned to believe rising prices are a good thing, or at least normal. But prices do not naturally rise year after year; especially as increased productivity, automation, and mass production lower the costs of manufacturing and distribution. Price inflation is ultimately an artificial monetary event and not a natural process.
To come full circle, the U.S. dollar has lost 98% of its value since the adoption of central planning and the creation of the Federal Reserve System in 1913. Stated another way, the dollar could purchase on average 50 times more goods and services back in 1913 than it can today. Despite Nixon’s proclamation on national television, the value of the U.S. dollar fell off a cliff.
While incomes in general have also risen during the last 100 years, their rise has not kept pace with the dollar’s loss of value. This is the primary reason households now require two wage earners to make financial ends meet.
The rise of economic central planning and the global fiat monetary system has also led to an explosion of debt, especially in the Western economies and Japan. Without hard money restraint, nations have been able to finance deficits and run up enormous debt that can never possibly be paid back...
More to come,
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