August 15, 1971: President Nixon's Golden Error
Writing in the New York Times, [John Brooks] voiced "a suspicion that the president and his advisers, in making their Draconian move, did not understand what they were doing." Robert Bartley, The Seven Fat Years, p. 33.
Today marks the 40th anniversary of President Richard M. Nixon's decision to sever the dollar's link to gold. Though private markets had begun to price in a floating dollar well before August of 1971, it was on August 15th forty years ago that Nixon committed this most colossal of blunders.
In allowing the dollar to float the president pursued what former Wall Street Journal editorial page columnist George Melloan has referred as an "absence" of currency policy whereby the value of the dollar, lacking definition, began to bounce around.
That's problematic because, far from a commodity, money is merely a measuring rod that facilitates the exchange of actual goods. As the late Warren Brookes once observed, "if we were to destroy every piece of paper currency in the world, and every bank account entry, we would not have destroyed one shred of economic wealth. Indeed, our ‘real' economy might quickly recover if it were released from what economists now call the whole ‘money illusion.'"
What Brookes meant was that real wealth lies in our labor and production, and money is simply a way of assigning value to it so that we can exchange our work done each day for the surplus goods produced by others. Ultimately we trade products for products. Since most producers don't have in their immediate possession what other producers desire, quality money plays the role of middle man.
When we produce we're demanding money, and the money we accept in exchange for our labor is accepted as payment for the goods we don't produce. Money's sole purpose is equivalent to that of a ruler; a foot being a foot and a dollar a dollar. When the dollar had a gold definition of 1/35th of an ounce, the dollar's value was stable. Trade between individuals was harmonious because the value of the products we exchanged was expressed in terms of a medium defined by a commodity known for being most stable. We got back what we gave; the stable dollar a guarantee of that beautiful trade harmony.
In delinking the dollar from gold, Nixon deprived the dollar of its most important property. It no longer existed as an effective measure of value. And with the floating dollar the rule over the next 40 years, it's fair to say that the economic path of the United States has been altered in a profoundly negative way.
How little some things have changed. The most notable change occurred with the value of dollar-denominated assets. Gold has served as money for thousands of years precisely because it has a constancy of value to it but, unhinged from the "golden constant," the dollar went into free fall.
As is well known now, though the dollar bought roughly 1/35th of an ounce of gold in 1971, today it buys less than 1/1750th. It gets interesting, however, when we notice just how little some things have changed in the last forty years.
Indeed, as Brookes calculated in his essential book The Economy In Mind, "In 1970 an ounce of gold ($35) would buy 15 barrels of OPEC oil ($2.30/bbl). In May 1981 an ounce of gold ($480) still bought 15 barrels of Saudi oil ($32/bbl)." Fast forward to the present, and an ounce of gold ($1750) buys roughly 20 barrels of oil ($85), but given the historical reversion to a 1/15 gold/oil ratio, it's not a reach to suggest that oil is due for a spike upward to roughly $116/bbl assuming gold remains where it is.
The late Robert Bartley put quotation marks around "oil shocks" in The Seven Fat Years, and he did so with this ratio in mind. What we have suffered are not truly oil shocks in the U.S. since 1971, but dollar shocks that drove up the nominal price of the commodity.
So while prices to some degree remain stable measured in gold terms, the fluctuations in the dollar prices of the commodities most sensitive to monetary error have wrought profoundly negative implications. Brookes referenced the "money illusion," and while it can't be quantified, policy is distorted by price signals falsely transmitted through the weak dollar, particularly during periods of monetary debasement.
Economic implications of the undefined dollar. Nowhere have the economic consequences of the undefined dollar created more turbulence and confusion than in the market for oil. Absent our departure from currency stability in the 1970s, it's not unrealistic to suggest that OPEC would have remained the sleepy non-entity that it was in the 1960s. If we'd maintained the dollar's fix at $35 a gold ounce, oil would still be nominally cheap at roughly $2.30/bbl.
That's not to mention the economically crippling notion of "energy independence" that captivates the minds of so many voters, commentators and politicians. With so many fooled by the money illusion that is nominally expensive oil, the economy suffers growing government subsidization of alternative energies. Comparative advantage is the origin of economic progress for individuals doing what they're comparatively best at, but energy independence calls for Americans to commit limited financial, human and mechanical capital to the extraction of a commodity that is plentiful around the globe at a market price that in gold terms has remained quite stable since 1971.
American Enterprise Institute economist Mark Perry calculates that the "Major Integrated Oil and Gas" sector ranks 112 among industries when it comes to profit margins, yet thanks to oil that is only expensive insofar as our floating dollar is cheap, there's an ongoing desire within the electorate to source all of our oil in the US. Not asked enough is what economic productivity would be lost chasing this most monetary of illusions.
Looking at housing, in his 1981 book, Wealth and Poverty, George Gilder (Classical School) referenced a late 1970s housing mania that to the uninitiated reader would sound quite a lot like the one experienced in the decade just passed. Of course, as has been explained with great regularity in this column through references to books by Benjamin Anderson (Austrian School), Liaquat Ahamad (Keynesian School) and Adam Fergusson (When Money Dies - ideology unknown), during periods of monetary debasement there's often a reorientation of investment into the hard assets least vulnerable to currency devaluation.
In the 1970s gold rose amid the dollar's fall, and much the same has occurred in the U.S. since 2001. That another housing boom resulted shouldn't surprise those with the most basic knowledge of economic history. To put it plainly, periods of currency weakness regularly coincide with heavy investment in commodities, art, rare stamps, land and housing, thus rendering the recessionary housing mania of recent vintage wholly unsurprising.
Be it gold, oil or housing, we must then consider the economic implications of all three. As evidenced by their relatively good performance during inflationary diversions, it's apparent that all three are defensive assets meant to protect savings denominated in dollars from devaluation of same.
In short, when money lacks definition, and worse, when monetary authorities lean toward currency weakness, the economy suffers a painful detour into assets of the past that already exist, and away from stocks and bonds that represent income streams from assets that don't yet exist. Adam Smith himself observed that stationary economies are declining ones, and in periods of inflation economies are worse than stationary for so much investment migrating back to the prosaic commercial ideas of the past.
Conversely, during periods of relative currency stability and strength (the '80s and '90s stand out here), investment flows to the ideas and income streams of the future. Brookes referred to this as investment in the metaphysical, or the "economy of the mind." Considering the technology explosion that occurred in the '80s and '90s, what happened was not surprising in the least. Strong, stable money equals investment in the future.
Though the dollar still lacked a gold definition in the '80s and '90s, policy leaned in favor of strength such that the investment returns of intrepid investors seeking to fund the next big intellectual concepts were protected. When investors buy shares of companies, they're buying future dollar income streams, and because they are, a stable currency is a tautological necessity if we want to ensure robust investment. What then needs to be asked is how many incredible innovators of the Microsoft, Intel and Google variety never saw the light of day over the last 40 years thanks to investment policies that became more defensive thanks to the dollar's gyrations.
After that, it should be said that the unwitting genius of locales such as Hong Kong and Switzerland has a great deal to do with the fact that both lack the natural resources or wealth that bubbles up from the ground. Hong Kong and Switzerland are "dependent" for nearly every commodity that Earth has provided us, and the citizens of both trade the product of their more metaphysical pursuits for assets that exist, and which are plentiful.
As a result, neither the Swiss nor Hong Kongers owe their wealth to the land on which they stand; rather their wealth is a creation of their fecund minds. In short, taxes in Hong Kong and Switzerland could never be onerous for the simple reason that citizens themselves in both are the assets, and they can move their intellectual wealth away should governments in either place ever become too greedy.
The above must be considered when we think of what severing of the gold-dollar link has wrought. With inflation an ever-present fear thanks to the dollar's lack of definition, investment to varying degrees must always flow to the hard, less mobile and easily taxable wealth of the earth, and away from the highly mobile, less easily taxable wealth of the mind.
Professional implications. Particularly in the aftermath of the 2008 financial crisis, many in the electorate and commentariat lamented the proliferation of hedge funds given the incorrect belief that these unregulated investment partnerships had somehow authored the meltdown. In truth, hedge funds were heaven sent for their investment success (and failure) signaling to the markets where capital was most and least needed.
To lament hedge funds is to bemoan symptoms as opposed to causes. While hedge funds would have to be invented if they didn't already exist, it's essential to point out that the floating dollar and its inevitable distortion of the money prices of everything made hedge funds ever more necessary. Though hedge funds employ myriad investing styles, one of the most prominent involves taking investment positions based on unrealistic prices.
Considering the various commodities exchanges in Chicago alone, they were largely sleepy institutions until 1971 when a volatile dollar tautologically fostered volatile commodity prices, and made derivatives meant to smooth out that volatility a necessity. Needless to say, absent President Nixon's mistaken decision to float the dollar, commodities would be far more stable, and the investment infrastructure needed to cope with their movements would be a great deal smaller. The derivatives strategies that so unnerve politicians and commentators who should know better would be so much less relevant today as to most likely not merit comment were the dollar's value stable.
The global currency market tallies roughly $3.2 trillion worth of transactions per day, and commodity transactions can claim similarly nosebleed numbers. A lot of the trading and the hedge funds that exist to profit from currency and commodity volatility is a direct result of a dollar that has been left to float without definition. In this case, we must ask what hedge fund legends George Soros, John Paulson and Paul Tudor Jones might be doing in a stable currency world.
Floating money has foisted a great deal of chaos on the U.S. and global economy, and individuals like Soros, Paulson and Tudor Jones, lured by the gargantuan profits to be earned from trading the chaos, have taken on facilitator roles in the global economy. This isn't meant to diminish their brilliance, but it is to say that hedge funds arguably wouldn't be as lucrative a profession were the dollar's value tied to gold.
Back to what they might be doing, it's not an unrealistic speculation to suggest that if the historical norm of stable money values prevailed at present, all three would be doing something else. Rather than facilitating economic activity through successful capital allocation, each might be crafting innovative communications advances, curing cancer, and developing the next software concept that drives impressive productivity enhancements.
Not only do floating money values drive limited capital into the tangible sinks of wealth of yesterday, they also author the migration of some of the world's greatest minds into facilitator roles over production. When Soros noted in 1989 that "exchange rates have found a way of influencing the fundamentals," he knew well of what he spoke.
Conclusion. Looking back on the forty years since policymakers unlinked the dollar from gold, though we've made astounding economic progress, it's important that we consider the unseen in this equation. While it's our nature to evolve and innovate, what will forever remain unknown is just how much more advanced we'd be if the dollar's stability had remained policy.
Floating money values have fostered ever more frequent recessions, financial crises, and faulty investment decisions that have hampered our advancement. Worse, they've forced the term "inflation hedge" into the investment discussion such that capital flows toward the immobile asset classes of yesterday, and away from the less taxable intellectual concepts of tomorrow.
Ever-enterprising individuals can thrive no matter the chaos foisted on them by feckless monetary authorities. But the question is how much more successful we'd all be if money had maintained its simple purpose as the facilitator of trade and investment. Floating money values, though not a policy of the past, will, if allowed, author our descent into it. To reverse a needless decline, it's essential that we revert to the historical norm of stable, gold-defined money values that are so essential to a thriving, evolving economy.