August 15, 2012 marked the 41st anniversary of the "temporary suspension" of the gold standard by President Richard Nixon. It is of interest to read the reminiscences of Paul Volcker, who, as under-secretary of the Treasury for international monetary affairs under Mr. Nixon, was at Camp David and participated in the deliberations and execution of the closing of the gold window.
In 2000 Paul Volcker spoke to an interviewer for PBS's Commanding Heights:
INTERVIEWER: Were you at Camp David the weekend when gold convertibility was suspended?
PAUL VOLCKER: Yes, I indeed was.
INTERVIEWER: What was the atmosphere like?
PAUL VOLCKER: It was a little bit mixed. Arthur Burns, who was then chairman of the Federal Reserve Board, argued strenuously enough to suspend gold convertibility. He was really the only one who vigorously took that view. I think most of the rest of us who were involved thought the time had come and some approach had to be taken, and that the only practical move internationally was to suspend gold convertibility, which would lead to a depreciation of the dollar. It was not a permanent solution, in my mind, but it was a necessary transitional step. The president, I think, had become pretty well convinced before he was up there. The surprise to me was the way it was politically shaped, with Mr. Nixon and Mr. Connally presenting it to the world as a great triumph. This was America exhibiting its strength and power, dealing with speculative pressures in an appropriate way and seizing the moment to deal with the price question at home, and at the same time there was actually a tax reduction on there. The economy responded favorably; the stock market responded favorably. There had been very ominous predictions of what would happen to the stock market. The stock market went up instead of down.
INTERVIEWER: You led the charge against the gold standard. Do you feel that some sort of fixed exchange rate should be used?
PAUL VOLCKER: I certainly agree with more stable exchange rates. What we are seeing and will see is that some economies will search for some way to get some stability and they will be driven a bit to abandon their own currency. You already see that going on with half a dozen or a dozen countries around the world that are either adopting the dollar or adopting the euro or adopting a currency board which comes close to the same thing other countries are talking about. It's not so easy for countries sitting out there in Asia that have no natural anchor, so to speak. They have very diversified trade. It's a fairly easy question for Mexico. It's got big political questions that are very heavily [reliant] upon the United States anyway, and a lot of feeling in Mexico [is] they'd be better off using the dollar. There's some merit to that, and we're being pushed in that direction. The big countries are relatively self-satisfied. You may see the world breaking up into regional currency zones. I don't think we're going to go to a gold standard.
Rep. Ron Paul remembers the day he was transformed from a mild-mannered physician into the feisty political Nostradamus of the Republican Party.
It was the evening of Aug. 15, 1971. President Nixon announced that he was taking the United States off the gold standard, which had anchored the dollar based on a fixed amount of the precious metal.
"He just, by executive order, ended the gold standard, put on wage and price controls, put on tariffs," Paul, R-Texas, recalled in an interview with McClatchy Newspapers. "And I thought that was bad news for America and it was going to usher in an age of rampant inflation and financial bubbles and, finally, bankruptcy.
"Nixon’s actions launched Paul’s four-decade political career. At times it’s been a lonely journey. Paul has predicted a coming U.S. economic Armageddon, with hell to pay for overly aggressive American military and foreign policies. He also has called for a strict interpretation of the Constitution. At times his views were greeted with derision and laughter, even within his own party.
When Richard Nixon signed the so-called Economic Stabilization Act of 1970 into law, the hope was that wage and price controls would put a halt to rising price inflation. The program was a reaction to the spendthrift ways of the federal government in the 1960s that attempted to finance both the Vietnam War and Lyndon Johnson’s so-called Great Society.
Nixon’s plan to impose his will on the economy ended in utter failure. For instance, his price ceiling on red meat did not stabilize the price of beef, it kept rising. What it did do was put many small plants out of business because they found themselves selling on smaller and smaller margins. No amount of price controls could remedy the overall price inflation of the 1970s. It wasn’t until the double-digit interest rates of the early 1980s that it finally subsided.
The President’s economic advisors should have known better. Besides many instances throughout history where price controls have caused much more harm than good, all they had to do was study rent control effects in New York City since World War II. Again, the effects of price controls have been an utter failure. While stabilizing prices at the proscribed government level, rent price controls negatively affect the very low-income renters they are meant to help. Because landlords are required to rent their properties at below market prices, they provide inferior dwellings in short supplies. While a 7 percent vacancy rate is considered normal and non-rent control cities like Dallas, Houston, and Phoenix often have vacancy rates about 15 percent, New York City has not had a vacancy rate above 5 percent since World War II. Any way you look at it, government price controls distort the market and cause much more harm than good.
The reason is because they abrogate the important relationship between supply and demand. Economics 101 tells us when government mandates a price for a product that is above market value a surplus results. Since the 1920s, government farm price supports have caused prolonged surpluses in agricultural goods. Conversely, when government mandates a price below market value shortages arise because consumers are willing to buy more than what suppliers are willing to provide. At the end of the day, price supports always disrupts the link between supply and demand that the market relies upon to run efficiently.
Even most mainstream economists agree that government price controls are bad because they cause dislocations in the economy. However, what’s funny is they don’t see how the actions of the Federal Reserve Bank are essentially price controls of our money that also cause much more harm than good. When the Fed sets interest rates, buys and sell assets, monetizes federal debt, or simply creates money or credit out of thin air it is setting a price level for the cost of money either directly (interest rates) or through the supply of money in circulation. In other words, mortal men and women are fixing the price of money not the market.
The result of monetary price fixing by the Fed has been no less damaging than government’s price fixing of goods. It is responsible for a continuous cycle of booms and busts in our economy. The scenario that is repeated time and again is as follows: usually in response to a downturn, a sluggish economy, or a crisis, the Fed sets interest rates artificially low; a cheap and abundant money supply promotes mal-investment into unproven enterprises like the dot.com bubble of the 1990s; a cheap and abundant money supply also promotes irresponsible investment and speculation like the housing bubble of the 2000s. The fake boom ends when bank credit expansion ends. That is to say, the bust begins when adequate returns on investments can no longer be found at prevailing interest rates. What is then needed is a liquidation of all the mal-investments made during the boom. This is referred to as a recession. The ensuing recession starts the cycle over again with the Fed lowering interest rates to stimulate growth.
The booms and busts caused by Fed price fixing of the dollar have serious consequences. Besides the up and down economy, savings rates remain low because it doesn’t pay to put your money in a low-interest bearing bank account. This in turn denies start-up capital to the markets. The Fed then prints more money and its member institutions use fractional reserve banking to increase the money supply. This accelerates general price inflation. To put it in perspective, the dollar has lost over 95 percent of its value since the Fed began operations in 1914. Much of that erosion has taken place since Nixon closed the gold window to foreign redemption in 1971. The result has been a declining standard of living for most Americans and an ever widening gap between rich and poor.
from Wall Street Journal's REVIEW & OUTLOOK, September 7, 2011
Central banking in a currency crisis.
It's not fashionable these days for central bankers to worry too much about the external value of their currencies. Since the collapse of the Bretton Woods exchange-rate system in the 1970s, policy makers have grown fond of saying that markets should set exchange rates. But markets can't set the value of a commodity whose sole supplier is the central bank, and this pseudo-laissez-faire is an abdication of central banks' duty to control the supply of their currency, both internally and externally. Full marks to the Swiss for breaking with this mistaken central-bank orthodoxy.
Full marks to the Wall Street Journal for making such a clear distinction, in the wreckage of the collapse of Bretton Woods, between true free market processes and the "pseudo-laissez-faire" of a "commodity whose sole supplier is the central bank."
Warren Coats, retired from the International Monetary Fund in 2003 as assistant director of the Monetary and Financial Systems Department, where he led technical assistance missions to central banks in more than 20 countries, reviewed Inside the Nixon Administration: The Secret Diary of Arthur Burns, 1969-1974.
If the Tea Party wants evidence for why as little as possible should be trusted to government, here is a bundle. In addition to Nixon’s constant eye on the next election as he formulated policies, Burns observed in his 12 February 1969 entry:
“As I watch our Cabinet in action, I wonder more & more whether or how they differ from the LBJ people. They push for their departments, care not about money, rely on LBJ’s people, and talk like them. If this continues, people over the country will be asking what promises for change we are fulfilling. Fascinating to watch cabinet officers becoming so quickly the prisoners of the career civil servants.” (page 7)
It took Burns a long time to see Nixon for what he was, a duplicitous, insecure man, more interested in re-election than the nation’s well being. Nixon launched a campaign of leaked threats to curtail Federal Reserve independence to pressure Burns, who Nixon did not trust, to ease monetary policy (faster monetary growth and lower interest rates) well ahead of the 1972 elections in order to reduce relatively high unemployment rates (6 per cent). The contrast between Burn’s diary as he attempts to uncover Nixon’s true feels and involvement in these le(a)ks and the White House tapes, in which Nixon plots against Burns behind his back is pathetic and shocking.
Photo courtesy of the National Archives
Burns correctly understood the bigger picture. Lowering interest rates (monetary stimulus) in 1970 and 71 would worsen the international pressure on the dollar and accelerate the drain of US gold under the terms of the gold exchange standard. It would destroy the international monetary system established in Bretton Woods, which was probably doomed anyway as a result of macro policy mismanagement by the reserve currency country, the United States.
Burns said the right things, tighter fiscal and monetary policy, but like Nixon seemed at times to be on all sides of the issues. While arguing with Nixon against lowering interest rates, he pushed for them at the Fed2. In October 1971, the White House tapes recorded this telephone exchange between Nixon and Burns: Nixon: “As a safeguard, I will ask the Congress [for standby controls on interest rates]. Now, that doesn’t bother ya?
Burns: “No, no. Mr President, I don’t think you have much of a choice.”