IVIV (8): Nixonizing U.S. Currency

[Kevin Troy]

"Have you ever looked at a dollar bill -- _on weed_?"
--_Half-Baked_

I am not an economist, nor do I play one on TV.

But I sure have taken enough international relations courses to take a
stab at explaining the BRETTON WOODS SYSTEM and its collapse in 1971.

If you'd rather not, the simple answer is that David Morris's
explanation (quoted at the end) is sufficient for most Pynchon fans to
riff on without being Wrong About How Economics Works:  the U.S. spent
too much money on the war in Vietnam, so its currency regime collapsed
underneath it.

Our story so far:

At the end of and right after WWII, the Western nations got together
and determined some ground rules for how international trade and
development would be conducted in the post-war world.  The reasoning
was that WWII had been caused, in some ways, by the Depression, so
what the world needed was economic recovery and no more Depressions.
And since failures of international trading regimes -- for example,
the tarrif wars that went on during the early 30s -- had been a major
cause of the Depression, the road to economic recovery and stability
lay (at least partly) through what today the kids are calling
globalization of the economy.

Lots of formal and informal institutions and arrangements came out of
those meetings, including GATT (the precursor to the World Trade
Organization), the World Bank, and, most important to our Nixon
fixation, a system of fixed exchange rates that was backed by the
International Monetary Fund (IMF).

Quotation below is from Lairson and Skidmore, _International Political
Economy:  The Struggle for Power and Wealth_, 3rd edition, Thomson
Wadsworth, 2003.

"The desire for fixed exchange rates was the result of a deeply felt
need for stability in international transactions....  The U.S.
possessed the vast majority of the world's gold in 1945, and this was
used as the basis for establishing fixed rates.  ... [O]ther
governments fixed their currencies to the dollar and pledged to
intervene in foreign exchange markets to keep values within a narrow
band around the fixed rate."

So, for example, the Yen was for many years pegged to the dollar at a
360:1 ratio.  And gold was fixed at a price of $35 per troy ounce.

(If it's not clear to anyone why fixed exchange rates were beneficial
at this time, I can give it another go.  But let's move on for now.)

Now, the fixed exchange rates that came out of Bretton Woods were
backed by U.S. gold.  And the system worked well when the U.S. had
enough gold to back it.  But as dollars (and therefore claims against
U.S. gold) flowed out of the U.S., the U.S. ability to back the system
diminished.  Some of these outflows were for reasons that economists
would consider good:  the U.S. started importing things from countries
like Germany and Japan, which made those countries richer and
therefore less likely to slide back into the Bad Old Days.  But some
of these outflows were because the U.S. was spending too much money on
its military adventures in Southeast Asia.

Those of you who have read those three insufferably long Neal
Stephenson books about the 17th century might remember the business
where the English keep secreting their gold bullion reserves out of
the Tower of London so they can pay for Spanish materiel to fight
their war against the Dutch -- until there is no more gold.  The
situation by 1970 was like that, except instead of gold actually being
moved physically out of the U.S., it was just pieces of paper (or even
entries in ledgers) that gave people the right to demand gold.
Because of that, the U.S. was able to get away with having more
dollars in circulation outside the U.S. than it actually had gold to
support.  All it _needed_ to have at any one time was enough gold to
satisfy that day's claimants, much as a bank only needs to have enough
cash in its vault to satisfy the withdrawals for the day.  But the
trick was that if everyone cashed in their dollars at once (or in
rapid succession), the U.S. would never be able to provide a troy
ounce of gold for every $35.  They would have to drastically increase
the price of gold (or conversely, decrease the price of dollars in
gold).

By 1971, the ratio of dollars outside the U.S. to gold inside the U.S.
had gotten so far out of hand, however, that international confidence
in the system was weakening.  And if you remember what happened to
Bear Stearns, you know that confidence is everything in a financial
system.  Let's say one participant "chickens out" and cashes in his or
her $35  for an ounce of gold.  That actually further weakens the U.S.
dollars outside to gold inside ratio, increasing the likelihood that
it will have to stop honoring the $35 price in the future (and
increasing the number of $$ you will have to provide for an ounce of
gold once the system does collapse).  So more people will follow the
lead of the first "chicken," further weakening the system, and so on
in a vicious cycle.  This is a run on the nation's central bank.

In a vicious cycle like that, the central bank will have to either
revalue its currency against its gold standard (to much more than $35
per troy ounce), or cut its currency loose and let it "float" in value
against other currencies.  Nixon chose the latter option.

Now, for those of you who have read this far, a Proverb for Paranoids:
 any time a politician blames "speculators" for recent economic
distress, you can bet your sweet bippy that there's a humongous crack
in the foundations of your nation's economy.  The run on the central
bank won't happen if everyone's confident in the bank's ability to
maintain its pledges, and no one would doubt the bank's ability to
maintain its pledges if you weren't spending God-knows-how-much money
on a foreign war, while simultaneously importing luxury goods such as
steak knives and T.V. sets.

I'm going to leave off there for now.  If this is interesting to you
folks, I can post more on Friday or Saturday.  Or better yet, you can
read an actual economist on this stuff -- this stuff gets even deeper
when you compare what happened in 1971 to what's been happening since
2001.  Paul Krugman is good on this stuff.




On Wed, Sep 30, 2009 at 12:37 PM, pynchon-l-digest
<owner-pynchon-l-digest at waste.org> wrote:
> From: David Morris <fqmorris at gmail.com>
> Subject: Re: IVIV (8): Nixonizing U.S. Currency
>
> Yeah.  We need a couple, three economists to give us the low-down on
> this Nixon dollar action.  All I could glean was that it was in
> response to inflation resulting from Vietnam war spending.  This could
> be a big clue from TRP...