Gold, Oil, and Dollars

My efforts at maintaining this blog have flagged lately. I keep very busy with family and professional activities, which generally consist of advising SMEs on business strategy and funding. I have a lot to share here, but I don’t often take the time to do it. So, I’ll make some comments on what I see happening afar. 

Recently, Donald Trump cancelled his planned trip to North Korea, and it appears that onerous sanctions are being re-imposed on the North Koreans. It’s got to be a hard place in which Kim Jong-un finds himself. He cannot do anything that could lead to a significantly reduced military because his generals who probably dispose of him. At the same time, he probably would like to better the lot of his people, if for no other reason than to avoid insurrection. Yes, dictators are sometimes overthrown, and sometimes they are not treated very nicely. So, he remains unpredictable to throw his enemies off balance.

Countries that are under USA sanctions find themselves cut off from the SWIFT system. They are without normal avenues for obtaining U.S. dollars. They can do it, but through intermediaries who do not want to be discovered, so there are high transaction costs. Dollars are important. They are the denomination of 70% of world trade, including pretty much 100% of the oil trade. 

Russia, China, Iran, and Turkey, all not so friendly with America, have been stockpiling gold. A lot of it. It may be that along with Iran and North Korea, these nations will endeavor to establish gold as a means of settling transactions among themselves and others in an effort to displace the dollar as the world’s reserve currency. It is this reserve status that gives the dollar its strength. And in part, it is the strength of the dollar that allows America to keep spending. 

Nations have tried to displace the dollar as the King of Cash and have all failed. Maybe Iran came the closest when they insisted on payment in something other than dollars for their oil. What they found is that their customers complained about the costs of turning their dollars into Iran’s preferred currency, and insisted on passing these costs (estimated at 2%) on to Iran. This persuaded Iran to go back to accepting dollars. This doesn’t mean that nobody will ever unseat the dollar as the world’s reserve currency, but frankly, there is no currency that could do it. The Euro is a currency with more of a past than a future, just like Europe. Demographics have ensured that. But gold may do the job. Time will tell.

Diverging Classes

If you have 3 minutes, here's a thought provoking and informative video about USA class structure: https://www.theatlantic.com/video/index/560222/america-class-problem/?utm_source=newsletter&utm_medium=email&utm_campaign=atlantic-daily-newsletter&utm_content=20180516&silverid=MzM0ODI3MzU3NzEwS0

Catching Up

Lots of interesting news the past couple of weeks.

I see Israel is expecting an Iranian sponsored missile attack, probably not directly from Iran, but from proxies within Syria. News programs in Israel have been reporting warnings from defense officials concerning imminent missile attacks. I expect that such an event would precipitate a full-scale attack by Israel on the source of the missiles. Total demolition. We’ll see.

There have been huge snowfalls in mountainous places in Europe this month. I don’t mean inches. I mean meters. Military personnel are reported to have have been dispatched to find and rescue campers and hikers in the Pyrenees. The Alps between Italy and Switzerland are a problem too. It’s reminiscent of the Little Ice Age. I think we lose sight of the fact that during the Little Ice Age, there were many warm years in northern latitudes.  Weather was very fickle….given to extremes.

I’ve noticed in my 25 years of living in Victoria that our weather has gotten more extreme. It seemed in those earlier years that the daily high was at least zero (32 to you Americans) every day of the year, and it was unusual to have days where the temperature was over 30. Now I find that we have days where the high is well below freezing, and it is not rare to have summer days topping out in the mid-thirties. Sometimes the weather suggests global warming, while at other times an ice age seems more consistent with what is happening.

The Fall of the Bretton Woods Agreement and its Aftermath

Hammes and Willis (2005, 503-504) tell us the basic history of The Bretton Woods Agreement: “The Bretton Woods Agreement takes its name from the international conference held in the New Hampshire town of that name in July 1944…. The arrangement provided for fixed exchange rates, with each member country fixing its currency value to the U.S. dollar. The price of gold, fixed at U.S.$35 per ounce, applied to official transactions between national central banks.”

Preparata (2009, 23) identifies a significant aspect of this agreement and an outcome of it. “The potential for deflation…was reversed by a policy of steady inflationary pressure, built into the system by the provisions of the Bretton Woods Conference of July 1944. As known, the new world standard of The Pax Americana was a gold-dollar-exchange anchored on the promise to redeem the greenback at $35 per fine ounce of gold. The United States went on to inflate massively the money supply providing 1) the international means of payment, and banking reserves, to their newly-annexed western satellites – money which these could spend on 2) America’s market, the largest in the world.”

Preparata states that “a policy of steady inflationary pressure” was “built into the system by the provisions of the Bretton Woods Conference”, but I am not convinced.  “Policy” implies that it was deliberately planned. Perhaps it is more accurate to use the word potential instead of policy.  Either way, inflation is what happened and it is what ruined the effectiveness of the Bretton Woods Agreement.

Hammes and Willis (2005, 504) add: “In the late 1960s, several countries argued that U.S. fiscal and monetary profligacy, resulting from the financing of the Great Society programs and the Vietnam War and from the Federal Reserve's monetization of the government's deficits, contributed to their accumulating dollar reserves and their rising rates of domestic price inflation. These dollar reserves accumulated and inflationary pressures grew as those countries supplied more of their own currencies to the foreign-exchange markets in order to keep their currencies pegged to the dollar at the fixed rates. Therefore, they accused the United States of "exporting" inflation.”

Back to Preparata:

During post-war reconstruction, the United States accumulated significant trade surpluses vis-à-vis the rest of the world. These surpluses, however, were systematically exceeded by substantial flows of US economic and military investment overseas, which consolidated American hegemony by way of industrial and financial acquisitions. Conventionally stated, America printed dollars and bought the world.

So long as there existed a 'dollar shortage' - i.e. a commercial dependence on US exports, which manifested itself through a strong demand for the American currency - such capital outflows were sustainable: in other words, they did not foment an immediately detectable bout of inflation. But as soon as the european countries had achieved reconstruction and an industrial (exporting) capability of their own, they found their reserves to be such that the 'dollar gap' was finally being closed. This occurred in 1958. America's outgoing dollar flows, however, kept increasing dramatically throughout the 1960s, and its persistent trade surpluses offered little offsetting relief against this steady transfer of dollars earmarked for strategic placement.

It so happened that the central banks of the recipient countries found themselves flooded with dollar balances (presented to them by resident businesses and private citizens) against which they had to issue the equivalent value expressed in the domestic currency. The tricky dimension to this business was that such capitals denominated in dollars thus surrendered by European payees to their central banks, were eventually re-placed ('invested') by the latter in the American market itself. Therefore, America perpetrated two economic injustices at once. First, owing to its hegemonic position, the United States fuelled a ceaseless generation of world inflation, as funds earmarked for foreign investment originally issued by the Federal Reserve found themselves duplicated: once as converted balances in Europe and twice as capital disposable anew on Wall Street. Second, the dollar, as the currency vested with the role of internationally recognised reserve, permitted the United States the luxury to score chronic capital account deficits, by which it managed, in fact, to 'expropriate' - as French president Charles de Gaulle polemically put it - key industrial assets in Europe, paid for with freely-printed dollars. De Gaulle's economic advisor, Jacques Rueff, referred to the dollar's bullying privilege as that 'marvelous secret of the tearless deficit' (le déficit sans pleurs). (Rueff, 1971, 24, 92)

From America's viewpoint, however, the adherence to a tempered gold regime entailed an annoying constraint, namely, that creditor countries could actually squeeze a tear or two from the US giant by demanding sooner or later the redemption of their dollar gluts in gold. This, they eventually did. Chronologically, the point at which America's debts to foreign central banks exceeded the value of the US Treasury's gold stock was reached in 1964, 'by which time the US payments stemmed entirely from foreign military spending, mainly for the Vietnam War.' (Hudson, 2002, 16). In 1967, France finally resolved to spearhead a run on the dollar by demanding conversion of dollar balances into gold; in March 1968, as President Johnson avowed failure in Vietnam by announcing his withdrawal from American politics, the US gold stock had been so depleted that American strategists awoke to the reality, lamenting bitterly how european financiers had 'forced peace' (Hudson, 2002, 307) upon them and caused, indeed, an American president to be ousted. (Preparata, 2009, 23-24)

Preparata, drawing on sources such as Hudson (2002, 18, 22, 340, 351)  then gets us to the end of the Bretton Woods Agreement. “… America… wrought yet another momentous modification on the modern capitalist engine with a view, of course, always to maintain hegemonic control. It was done in 1971, under Nixon. The alteration was straightforward: sever the link to gold (i.e., suspend gold payments), and upgrade to a full-fledged US Treasury Bill Standard which, with the addition of further refinements, is the regime under which the world economy has been operating to this day. It was a critical transition - the end of Bretton Woods. The scheme has been deemed Machiavellian in that it cleverly shifted the burden of US external deficits squarely and definitively onto the creditor countries by raising the spectre of dramatic dollar devaluation (Nixon had already driven down the dollar by 30% in the aftermath of the 1971 break). In other words, europeans would be forced to continue to absorb dollars for fear 1) of suffering crippling losses on their dollar reserves, and 2) of seeing their exports to the United States irremediably undercut by protectionism and rival American merchandise boosted by a low dollar. One by one die western allies, including France, fell back into line. (Preparata, 2009, 24-25)

Hammes and Willis (2005, 504) present these events with a bit more abridgement: “Once countries began to redeem these reserve dollars for gold, it became clear the United States could no longer support a gold price of $35 per ounce. By early 1971, U.S. dollar liabilities exceeded $70 billion, backed by only $12 billion of gold (Yarbrough and Yarbrough 1994, 641). To staunch the outflow of gold, the United States suspended its obligation to buy dollars from foreign central banks at $35 per ounce of gold. On August 15, 1971, the United States unilaterally and without consulting allies or the IMF closed the "gold window." With this "floating" of gold, the world moved from a fixed to a flexible exchange-rate system as countries followed West Germany's lead and stopped interventions in the foreign-exchange markets once the United States stopped buying dollars with gold (James 1996, 220).”

An interesting detail about a French warship is added is by Sinn (2012, 12) in this account:

“As my colleague Wilhelm Kohler has pointed out, these problems of the eurozone are similar to, but much more extreme than, those of the Bretton Woods system, the fixed exchange rate system that lasted until 1973. At the time, the U.S. Federal Reserve System had printed many more dollars than were needed for internal U.S. circulation. These dollars were used, for example, to buy cheap goods and assets in Europe, including German and French firms that had attracted the interest of American investors. By virtue of the fixed exchange rate regime, the dollars arriving in Europe had to be converted into national currencies by the Bundesbank and the Bank of France, and the converted "dollar-deutschmarks" and "dollar-francs" then crowded out the refinancing deutschmarks and francs that usually constituted the respective currency stocks. The dollars (or U.S. Treasury Bills to which they were converted) accumulating with the European national banks were the analogue of today's Target claims, and in both cases there were sizable public credit flows through the central bank systems. It was said that Europe financed the Vietnam war that way.

General De Gaulle did not like this public credit flow. In 1968, he asked the United States to convert the dollars that had piled up with the Banque de France into gold, and he sent a warship to protect the gold transport back home. This was the beginning of the end of the Bretton Woods system, as the United States was forced to end the gold convertibility of the dollar.” (Sinn, 2012, 78)

General De Gaulle seems to have been a man who didn’t march to anyone’s drum.  The year before, when Canada was celebrating the 100^th year of Quebec’s union with Canada, he had visited the Province of Quebec, and had made a speech in which he shouted “Vivre Quebec libre!” --- a rallying cry of freedom for Quebec from Canada.  He was sent packing quietly and quickly.  This speech is captured at http://www.youtube.com/watch?v=C0LQBcygNew

The aftermath of the collapse of the Bretton Woods Agreement saw commodities prices escalate. Hammes and Willis (2005, 504-505) recount this.

Gold was initially revalued to $38 per ounce, then to $42, and shortly thereafter it was allowed to float freely. By mid-1973, the dollar price of gold had risen to $90.50 per ounce, and by the end of the decade it had risen to more than $455--an increase of 1,200 percent in less than a decade.

As the world adjusted to a new international trading arrangement, currency markets experienced turmoil. From early 1971 to mid-1973, the U.S. dollar fell dramatically relative to all Western currencies except the pound sterling. It fell more than 30 percent against the Deutschmark and the Swiss franc, and more than 20 percent against the currencies of Japan, France, Belgium, Holland, and Sweden. On average, by mid-1973 the U.S. dollar had fallen by 25 percent relative to the major Western currencies. Given that oil contracts were stipulated in U.S. dollars, this decline meant that oil revenues per unit from these countries fell to OPEC.

In addition, the average annual inflation rate in Western countries rose to more than 5 percent during the early 1970s and averaged approximately 9 percent for the entire decade across the Western countries (Economic Report of the President 1992, 418, table B-105). Prices of nearly all commodities, not just gold, rose dramatically during the decade: aluminum by 165 percent, pig iron by 200 percent, lead by 170 percent, potash by 269 percent, silver by 1,065 percent, and tin by 219 percent…”

They discuss “The Oil Price of Gold”. “When the price of oil is analyzed in terms of gold, instead of in terms of U.S. dollars, the 1970s look quite different. The U.S. dollar price of oil hardly changed from the end of World War II to the late 1960s: from 1947 to 1967, it rose by less than 2 percent annually on average (from $2.07 to $3.07 per barrel), not even keeping up with U.S. price inflation. Thus, given the Bretton Woods system, the oil/gold price was also nearly fixed. Throughout this entire period, through to the end of Bretton Woods in late 1971, 10-15 barrels of oil would buy an ounce of gold.” (Hammes & Willis, 2005, 505)

The Bretton Woods Agreement brought some predictability to planning for commodities prices and currency exchange rates, but was defeated by market forces.  Even governments eventually have to cave to the market.

References

Hammes, D., & Willis, D. (2005). Black gold: The end of Bretton Woods and the oil price shocks of the 1970s. Independent Review, 9(4), 501+. Retrieved from http://www.questia.com

Hudson, M. (2002). Superimperialism. The origin and fundamentals of US world dominance. London: Pluto Press

James, H. (1996). International monetary co-operation since Bretton Woods. Washington, D.C. and New York: IMF and Oxford University Press.

Preparata, G. G. (2009). Of Money, Heresy, and Surrender: Part I: The Ways of Our System, an Outline, from Bretton Woods to the Financial Slump of 2008. Anarchist Studies, 17(1), 18+. Retrieved from http://www.questia.com

Rueff, J. (1971). Le péché monétaire de l’occident. Paris: Plon

Sinn, H. (2012, Winter). European End Game: The Striking Similarity between Today's Eurozone Situation and the End of Bretton Woods. The International Economy, 26(1), 10+. Retrieved from http://www.questia.com 

Yarbrough, B. V., & R. M. Yarbrough. 1994. The World Economy (3rd ed.) Orlando, FLA.: Dryden Press.

May is Jewish Heritage Month

From HFT:

Trump urges all Americans to celebrate the heritage and contributions of American Jews during the month of May.

"During Jewish American Heritage Month, we celebrate the profound contributions that the Jewish faith and its traditions have had on our Nation. Two hundred years ago, in April 1818, Mordecai Noah delivered his famous discourse before the members of America's first synagogue, Congregation Shearith Israel, upon the consecration of their new house of worship.

Reflecting on Jewish history as well as on the unique rights and privileges afforded to American Jews, Noah proclaimed that, 'for the first time in eighteen centuries, it may be said that the Jew feels he was born equal, and is entitled to equal protection; he can now breathe freely,'" Trump said in a statement.

"Jewish Americans have helped guide the moral character of our Nation. They have maintained a strong commitment to engage deeply in American society while also preserving their historic values and traditions. Their passion for social justice and showing kindness to strangers is rooted in the beliefs that God created all people in his image and that we all deserve dignity and peace.

These beliefs have inspired Jewish Americans to build mutual-support societies, hospitals, and educational institutions that have enabled them and their fellow Americans to advance American society. Jewish Americans marched for civil rights in Selma and fought for the freedom of their brethren behind the Iron Curtain. Through their actions, they have made the world a better place," he continued.

"The contributions of the Jewish people to American society are innumerable, strengthening our Nation and making it more prosperous. American Jews have proudly served our country in all branches of government, from local to Federal, and they have defended our freedom while serving in the United States Armed Forces. The indelible marks that American Jews have left on literature, music, cinema, and the arts have enriched the American soul.

In their enduring tradition of generosity, Jewish Americans have established some of the largest philanthropic and volunteer networks in the Nation, providing humanitarian aid and social services to those in need at home and abroad, acting as a 'light unto the nations.' Universities and other institutions around the country proudly display Nobel prizes won by Jewish Americans in the fields of medicine, chemistry, physics, and economics."

"In reaction to Mordecai Noah's 1818 discourse, Thomas Jefferson wrote that American laws protect 'our religious as they do our civil rights by putting all on an equal footing.' The American Jewish community is a shining example of how enshrining freedom of religion and protecting the rights of minorities can strengthen a nation.

Through their rich culture and heritage, the Jewish people have triumphed over adversity and enhanced our country. For this and many other reasons, the American Jewish community is deserving of our respect, recognition, and gratitude."

Trump called on Americans "to celebrate the heritage and contributions of American Jews and to observe this month with appropriate programs, activities, and ceremonies."

Former President George W. Bush first proclaimed the month of May to be Jewish American Heritage Month on April 20, 2006. Since then, annual proclamations have been made by Presidents Bush, Barack Obama and Trump.

The Canadian Parliament recently approved similar legislation which makes every May Canadian Jewish Heritage Month.

North Korean Goodwill

North Korea appears amenable to the idea of stalling their nuclear testing. A goodwill gesture to the rest of the world?  Maybe. Or maybe it’s because the mountain in which they were running the tests collapsed. See https://gordon-feil-economics.blogspot.ca/2017/11/cultures-in-collision.html and http://www.scmp.com/news/china/diplomacy-defence/article/2143171/north-koreas-nuclear-test-site-has-collapsed-and-may-be-why-kim-jong-un.

The bottom picture is the mountain before the collapse, and the top one is after.