Main Culprit of Our Financial Disaster, with Special Attention to Euro Crisis

Naveen Alle International Finance - Assignment MMS II Roll No: F - 04

Monetary policy is the most recondite yet most pervasive and powerful of economic forces. Keynes, in The Economic Consequences of the Peace, wrote,
There is no subtler, no surer means of overturning the existing basis of society than to debauch the curren cy. The process engage s all the hidden forces of econo mic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

The converse also is true. Restoring real monetary integrity engages all the hidden forces of economic law on the side of prosperity. And forces for monetary reform are very much in motion. The dollar has fallen in value by more than 80 percent from the day when Richard Nixon took the world off the tattered remnants of the gold standard. August 15 marks the 40th anniversary of the avowedly "temporary" abandonment of the gold standard by President Richard Nixon. "Closing the gold window" was part of a series of dramatic but shocking and destructive tactics by Washington, including wage-price controls, a tariff barrier, and other measures, all leading to economic and financialmarkets hell. All such measures save one stand discredited. The only piece of the Nixon Shock still in force was the piece most ostentatiously designated as temporary. Nixon: "I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold ." Suspending convertibility was no trivial matter. Nixon speechwriter William Safire recalled, On the helicopter headed for Camp David, I was seated between [Herb] Stein and a Treasury official. When the Treasury man asked me what was up, I said it struck me as no big deal, that we would probably close the gold window. He leaned forward, put his face in his hands, and whispered, 'My God!' Watching this reaction, it occurred to me that this could be a bigger deal than I thought .

It proved to be a very big deal. How ironic that the most staunch defenders of a pure paper standard, the sole remnant of Nixonomics, are a few influential "progressives" such as Paul Krugman, Joseph Stiglitz and Thomas Frank. Call them "the Nixonians." The poor jobs growth and stagnation of today's "world dollar standard" are not, unsurprisingly, dissimilar from the results of the Nixon Shock. There is ample evidence that restoring gold convertibility would put the world back on the path to jobs, growth, and a balanced federal budget. Politicians do not like messing around with monetary policy. But gold, recently rediscovered by the tea party, has an impressive technical, economic, and political pedigree of gold convertibility and a very well established track record of job creation, properly applied, during many eras. The silver lining to the whipsawing Dow is that it makes politicians open to new ideas, even new old ideas. Monetary statesmen from Alexander Hamilton forward have faced circumstances far more dire than those of today and turned things around. Modern example? The German economic miracle, the Wirtschaftswunder. That miracle was founded in currency reform. On the very day when Ludwig Erhard's currency reform was put into place the economic paralysis ended. The "rightest" economist of the 20th century, Jacques Rueff, wrote (with Andr Piettre) about the turnaround beginning on the very day of the reform: Shop windows were full of goods; factory chimneys were smoking and the streets swarmed with lorries. Everywhere the noise of new buildings going up replaced the deathly silence of the ruins. If the state of recovery was a surprise, its swiftness was even more so. In all sectors of economic life it began as the clocks struck on the day of currency reform. Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them.

One day apathy was mirrored in their faces while on the next a whole nation looked hopefully into the future. Rueff took a similar approach, including a dramatic currency reform, to reviving the French economy. As economist and Lehrman Institute senior advisor John Mueller summarizes, Despite the unanimous opposition of his cabinet, de Gaulle adopted the entire Rueff plan, which required sweeping measures to balance the budget and make the franc convertible after 17.5% devaluation though not without qualms. 'All your recommendations are excellent,' de Gaulle told Rueff. 'But if I apply them all and nothing happens, have you considered how much real pain it will cause across this country?' Rueff replied, "I give you my word, mon General, that the plan, if completely adopted, will re-establish equilibrium in our balance of payments within a few weeks. Of this I am absolutely sure; I accept that your opinion of me will depend entirely on the result.' (It did: ten years later, de Gaulle awarded Rueff the medal of the Legion of Honor.) Today on this the 40th anniversary of the closing of the gold window a group of Americans issued a statement stating, in its conclusion, We support a 21st century international gold standard. America should lead by unilateral resumption of the gold standard. The U.S. dollar should be defined by law as convertible into a weight unit of gold, and Americans should be free to use gold itself as money without restriction or taxation. The U.S. should make an official proposal at an international monetary conference that major nations should use gold rather than the dollar or other national currencies to settle payments imbalances between one another. A new international monetary system, based on gold, without official reserve currencies, should emerge from the deliberations of the conference. Many of the signers are associated with the American Principles Project, chaired by Sean Fieler, and the Lehrman Institute (with both of which this writer is professionally associated), chaired by Lewis E. Lehrman. Signers also include such important thought leaders as Atlas Foundation's Dr. Judy Shelton and Forbes Opinions editor John Tamny.

Politicians may have forgotten the power that real money, money of integrity such as currency convertible into gold, has to reverse an economic crisis. But the people have not. Earlier this year, the government of Utah restored, to international attention, the recognition of gold and silver coins as legal money. Now news emerges that the largest and most respected political party in Switzerland is supporting the work of the Goldfranc Association, led by citizen Thomas Jacob, to introduce a gold-convertible Swiss franc as a parallel currency. Proponents are using the Swiss political process to put the creation of a gold franc in the Swiss Constitution. Jacob finds himself in the very distinguished company of Rueff and Erhard. While London burns, Switzerland thrusts gold-based currency reform toward the center of the international debate on how to rescue the euro, end the debt crisis, and turbocharge economic growth and job creation with integrity, not Nixonian manipulation. Will a world Wirtschaftswunder an economic miracle follow a restoration of gold convertibility? History shows how practical such a miracle can be. When the euro was first introduced, people were aware of this very danger. That's why the Maastricht Treaty contained rules on countries wishing to join the euro currency union. Specifically, government budget deficits were not to exceed 3 percent of GDP, and total government debt was not to exceed 60 percent of GDP. Obviously the Maastricht Treaty's rules were as binding as the Bill of Rights in the United States. Partly aided by shenanigans involving currency swaps designed by Goldman Sachs, the Greek government flouted the limits of deficits for years. Thus here we are, in the very nightmare scenario about which some economists (such as Milton Friedman) warned at the euro's inception. Lost in all the analysis of the theory of "optimal currency area," the possibilities for a structured default, the consequences of a collapse of the euro, etc., are two simple questions: Why does the behavior of the Greek government have anything to do with taxpayers in Germany?

Why did the original Maastricht Treaty have rules about fiscal policy as part of the criteria for monetary union? The answer is that the euro is a fiat currency, and as such it will always provide rulers with the temptation to monetize fiscal deficits. That's why the citizens of traditionally hawkish Germany who grew up with horror stories of hyperinflation would be very wary of joining a currency union with people who elect spendthrift governments and have central bankers who are doves on inflation. I tried to illustrate the point to my Slovakian audiences with a thought experiment: Suppose that instead of the fiat approach, the euro from day one had been backed 100 percent by gold reserves. In this arrangement, an organization in Brussels would have a printing press and a giant vault. Anybody around the world whether private citizens or foreign central banks could order up euros, so long as they deposited the fixed weight of gold in the vault. Thus, at any given time, every single euro in circulation would be backed up by the corresponding gold in the vault in Brussels. In this scenario, the people issuing the euros wouldn't have to run a background credit check on the people applying for new notes. So long as the requests were made with genuine gold, the people printing euros wouldn't care if the applicant were the German government or Bernie Madoff. Even if some other country had adopted the (gold-backed) euro as its own currency, and then that government defaulted on its bonds, there would be no repercussions for the other regions using the euro as money. People would know that their own euros were backed 100 percent by gold in the vault in Brussels, just as always. For an American audience, I have another way of illustrating the point. Right now, there is a decent chance that states such as California and Illinois will default on their bonds. Yet this currently doesn't pose problems for other states, nor does it make investors worry about the "fate of the dollarzone." This is because few people expect that the Fed will provide massive intervention to prevent state-level defaults. However, suppose that the Fed does step in and start buying up massive quantities of bonds issued by California, Illinois, Michigan, etc.

At that point once it became clear that state-level deficits would influence Federal Reserve policy you very well might see something analogous to the current crisis in Europe. You might see the exchange rate of the dollar against other currencies vary in response to changing reports about the fiscal condition of American state governments. Conclusion Since the world left the last vestiges of the gold standard in 1971, the global economy has been set adrift. The technocrats keep assuring us that they can steer the economy much more efficiently than the "obsolete" gold standard, and yet a continual series of crises suggest otherwise. We can achieve the dream of the euro an integrated monetary union where people and businesses can plan their activities spanning several countries without fear of exchange-rate risk without its attendant pitfalls, but only if people go back to using genuine commodity money.