‘“In August 1971”, writes Dan Denning in his “Dollar Report”, “French President Pompidou sent a French destroyer to New Jersey to collect French gold held in custody by the Federal Reserve. This was the end of the post-World War II Bretton Woods system, where the US dollar was the global reserve currency, but backed by gold at a fixed price of $35/ounce.”’
Last week, we looked at the causes of today’s financial turmoil. The worst stock market…worst bond market…worst inflation…worst six months for a standard, 60/40 (bonds/stocks) portfolio ever — how did we get here?
It’s like an archaeological dig…going down…down…down through the layers of mistakes, delusions, and wishful thinking.
Was it because the French destroyer went back empty-handed?
Or because Putin invaded Ukraine? Or because Eve took the apple at the beginning of time?
The problem with digging is knowing where to stop. You keep putting in the spade and you end up in China.
And yes, China is where we’re going today.
Soft dollars
The US switched to a ‘soft’ dollar in 1971. It was a dollar that looked for all the world like the 1969 dollar. But it was different. It was no longer convertible to gold, it was a technocrat’s dollar — flexible, adjustable, and prey to temptation. It was a dollar the French couldn’t redeem for gold at a fixed rate.
New dollars are conceived in the credit market. When banks lend, they don’t actually reach into their vaults to draw down their depositors’ savings. Instead, they just create the money ‘out of thin air’, as a bookkeeping transaction. It doesn’t matter if there are any savings or not.
Conception is the most popular part of the human life cycle. Money is no different; everybody smiles when a new dollar is born. Thus, as borrowing grew, 1971–2022, the money supply grew…and aged. As we saw on Friday, from 1971 to today, federal debt grew three times faster than GDP. And soon there was a big pile of grumpy, old debt that needed to be repaid.
As long as the dollar was tied to gold, there were limits. Ultimately, dollars were redeemable for gold. And there was only so much gold. But without the link, the sky was the limit.
In addition to normal bank lending, the Fed could also ‘print’ dollars and use them to buy bonds. This ‘quantitative easing’, QE, had the effect of putting whole legions of new dollars into service…and driving down interest rates so that even more people wanted to borrow.
Ben Bernanke would crow that he had had ‘the courage to act’ when he used QE to stop a financial correction in 2009. But the result was a US$30 trillion (total new debt 2009–22) increase.
It was a circus of imbeciles — who thought you really could get rich by printing money. And the imbeciles were right.
Inglorious elites
It was no coincidence that most financial assets are owned by the elite — the richest segment of the population. These were the people who run the Fed, dominate both houses of Congress, and the White House too. No wonder they were happy with the new money program. Between 1971 and 2022, it boosted their wealth — real estate, stocks, bonds, private businesses — by an estimated US$72 trillion.
But with all this money printing going on, how come consumer prices didn’t go up alongside asset prices? And what about the 80–90% of the population that didn’t own stocks and bonds?
That’s where the Chinese come in. One of the elite doctrines of the late 20th century was the ideal of ‘globalisation’. New York Times columnist Tom Friedman wrote a book celebrating it — The Earth Is Flat.
In 1979, China decided it was time to join the world economy. ‘To get rich is glorious’, said Deng Xiaoping. Soon, China was covered in glory. Almost overnight, factories sprouted like bamboo shoots…and some 300 million peasants made their way to urban centres to work in them. With so many very cheap Chinese on the assembly lines, who needed to pay American wage earners more money; who needed them at all? And as Chinese factories turned out gadgets by the millions, why should prices go up?
A life of its own
And so, the great trans-pacific trade routes grew crowded. Ships from China rode low in the water, freighted with TVs, toaster ovens, and refrigerators bound for American consumers. The ships going the other way were almost empty. The Chinese made valuable goods. Americans printed up the money to buy them. And by December of 2021, the trade deficit with China had soared to more than US$94 billion for the single month.
That trend appears to have peaked. May 2022’s trade deficit with China fell to only US$78 billion. Why? There are few peasants left to exploit. And Chinese factories are paying more for their copper and zinc and oil and other raw materials.
So now, with its own labour and raw materials costs rising, China is no longer enabling US money printers. Consumer prices are rising everywhere. And inflation takes on a life of its own.
Stay tuned…
Regards,
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Bill Bonner,
For The Daily Reckoning Australia