IVIV (8): Nixonizing U.S. Currency

[kelber at mindspring.com]

Thanks for this, Kevin.  It's damned complicated stuff for people like myself who never studied econ (outside of selected excerpts from Das Kapital).  You're worth every Troy ounce.  And kudos for working in a Laugh In phrase -- very Nixon-esque.

Laura

-----Original Message-----
>From: Kevin Troy <kevin.troy at gmail.com>

>
>"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...
>