Great Depression Online Archive Issue:

A Prescription for Disaster

Great Depression Online
Long Beach, CA
June 15, 2010

Inside This Issue You Will Discover…

*** Yin Yang
*** Keynesian Endpoint
*** A Prescription for Disaster
*** And More

Yin Yang

“To every action there is always an equal and opposite reaction,” says Newton’s third law of motion.  While Newton was describing how the physical world works, he may have also been describing how the world works in a general sense too.

What happens today shapes tomorrow…and what happened yesterday shapes today.  There’s cause and there’s effect.  There are decisions and there are consequences.  There’s yin and there’s yang.  Bad things happen to good people who do bad things.

Some of us have to learn these simple lessons through the school of hard knocks – that’s us – while others somehow have these key insights from birth.  Regardless, there are no exceptions, exemptions, or exclusions.  Everything under the sun must conform to these natural laws, whether they like it or not…including economists.

~~~~~~Why Gold?~~~~~~

Despite gold’s 350% trip up the profit ladder, the yellow metal still has legs to run – and those legs are long.  Even though fortunes have already been made in the gold market over the last nine years, the biggest profits have not yet been realized.

Why Gold? 

~~~~~~~~~~~~~~~~~~~~~~~~~

Over the last 100-years or so there’s been a group of economic thought, namely Keynesian economics, which believes it’s exempt from the consequences of the world.  That government spending can bring wealth to the world and that somehow you can pyramid debt from a paper foundation up to the stars forever and ever.  Finally, after a long and destructive run, Keynesian economics has bankrupted itself along with the nations of the world.

Keynesian Endpoint

The notion that you can solve a problem caused by too much debt by piling on more debt is absurd.  But that’s precisely what Keynesian economics is all about. 

Last week Tony Crescenzi of PIMCO wrote “…dark days have returned to some nations and are threatening to return to the world at large because the solutions themselves are being seen as a magic elixir that has morphed into poison.  Nations have reached, in other words, the Keynesian Endpoint, where there are no more balance sheets left to support either economic activity or the financial system.”

For every dawn there is dusk.  For every endpoint there is a starting point.  So what was the Keynesian starting point that sent us down this road to crisis?

To answer this question, today’s guest essay by Lew Rockwell traces the origins of today’s paper monetary system back to Bretton Woods, New Hampshire, in July of 1944.  This is an excerpt of Lew’s column, Hazlitt’s Battle With Bretton Woods.

Enjoy,

M.N. Gordon
Great Depression Online

---

A Prescription for Disaster

At the end of World War II, the monetary condition of all nations was deplorable.  The U.S. faced a massive debt overhang from the war and yet this country was still a creditor nation to the world.  The U.S. also had huge stockpiles of gold.  Most everyone else was flat-out bankrupt, as only a gargantuan government program can accomplish.  The main currencies had been wrecked and the main economies along with them.

As was the fashion, world elites assembled to plan some gigantic coordinated solution.  They met from July 1 to July 22, 1944, at the Mount Washington Hotel in Bretton Woods, NH, and drafted the Articles of Agreement.  It was nearly a year and a half later, in December 1945, that the agreement was ratified.  On March 1947, one of the monstrosities created during the event, the International Monetary Fund, began operations.

What was the goal of the plan?  It was the same goal as at the founding of the Federal Reserve and the same goal that has guided every monetary plan in modern history.  The stated idea was to promote economic growth, encourage macroeconomic stability, and, most absurdly, tame inflation. Of course, it did none of these things.

There are other analogies to the Fed.  In the same way that the Fed was to serve as a lender of last resort, a provider of liquidity in times of instability, so too the Bretton Woods Agreement obligated all member nations to make their currencies available to be loaned to other countries to prevent temporary balance-of-payment problems.

There was to be no talk at all about what created these balance-of-payment problems.  The assumption was that they were like bad weather or earthquakes or floods, just something that happens to countries from time to time.  The unspoken truth was that monetary problems and the related problems with balance of payment are created by bad policies: governments that inflate, spend too much, run high debts, control their economies, impose trade protections, create gigantic welfare states, fight world wars, and otherwise undermine property rights.

As with all government plans, Bretton Woods was dealing with symptoms rather than causes, and treating those symptoms in a way that enables and even encourages the disease.  It pegged currencies at unrealistic levels, provided a bailout mechanism for governments and banking establishments to continue to do what they should not be doing, and thereby prolonged the problems and made them worse in the long run.

Governments have been throwing our good money after bad for a very long time.  The plan, just as with the latest round of bailouts in the U.S. or Europe, was to dump money on near-bankrupt countries and thereby encourage them to continue with the very policies and practices that created the problem to begin with.

The core problem of the world monetary system after World War II was essentially that the gold standard had broken down, or rather, government had destroyed what remained of the old-fashioned gold standard through relentless inflation, debt, and devaluation.  Economists in the Keynesian tradition had encouraged this, viewing money creation as some sort of panacea for all that ailed the world economy.

Keynes, the maestro of the Bretton Woods Conference, himself had recommended this and celebrated the results.  To him, a flexible and standard-less currency was the key to macroeconomic manipulation of his beloved aggregates.  In a perverse way, he was right about this.  A government on the gold standard is seriously constrained.  It can’t take a sledgehammer to aggregate supply and aggregate demand.  It can’t spend beyond its means.  It must pay for the programs it creates through taxation, which means having to curb the appetite for welfare and warfare.  There can be no such thing as a Keynesian state on the gold standard, any more than a cocaine addict or compulsive gambler can be on a strict budget.

Keynes’s message at Bretton Woods, in Mises’s summary, was that the world elites could turn stones into bread.  And so under the influence of Keynes, the target at the Bretton Woods meeting was liberalism itself, which was widely assumed to have failed during the Great Depression.  The elites also came out of World War II with a more profound appreciation for the role of central planning.  They had reveled in it.

The Bretton Woods plan for monetary reconstruction did not go as far as Keynes would have liked.  He proposed a full-scale world central bank and a single paper currency for all nations, which he wanted to be called the “bancor,” so there could be no escaping inflation.  That plan is still awaiting implementation.  As it was, the Bretton Woods conferees, under pressure from the U.S. – which wanted the dollar to be the bancor – took a compromise position.  They would create not a gold standard, though it was called that for reasons of credibility.  Instead it was a global gold dollar standard, or, more precisely, a phony gold standard.

The Bretton Woods system established a gold dollar that was fixed at $35 per ounce.  But it was the only currency so fixed. Every other currency could be a fiat currency based on the dollar.  What this obligated the U.S. to do, as the main creditor nation to the world, was ship out dollars to the world while somehow maintaining the dollar's connection to gold.  It was a prescription for disaster, as should be obvious.

To be sure, there is nothing wrong with the gold standard in one country.  The United States could do that now.  But that was not what Bretton Woods established.  The dollar was not convertible into gold at the domestic level.  You could not go into your bank and exchange dollars for gold.  It was only convertible on an international level, and only for governments, so that the U.S. was obligated to ship out gold instead of paper when it was so demanded.  This established some limit on credit expansion at home but not enough of one.  Few were courageous enough to demand gold from the empire.  Yet it is clear just from this description of the plan that the pressure to spend and redeem would eventually lead the U.S. to go back on its word.  It took some twenty years, long after the original crafters of the deal had left the scene, but economic logic could not be gainsaid.

The breakdown really began soon after the plan was implemented.  But most of the effects were disguised through currency controls.  Once the 1960s came, and the expenses of LBJ's welfare-warfare state mounted, the Fed played its traditional role as the financier of big government.  Pressure on the dollar mounted, foreign governments became more interested in the gold than the paper, and the whole cockamamie scheme unraveled under Nixon’s welfare-warfare state.  

Sincerely,

Llewellyn H. Rockwell, Jr., Editor
LewRockwell.com

P.S.  Llewellyn H. Rockwell, Jr. lewrockwell@mac.com, former publications editor to Ludwig von Mises and congressional chief of staff to Ron Paul, is founder and chairman of the Mises Institute http://www.mises.org/, executor for the estate of Murray N. Rothbard, and editor of LewRockwell.com.

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