It remains one of those instances when you see something for the first time, truly take in the thing, you can never unsee it. Explanations for the seventies Great Inflation to this day are lacking and inconsistent. The venerable Allan H. Meltzer’s work is largely seen as definitive on the subject, and for good reason. He correctly criticizes contemporary authorities for making a shocking variety of critical errors, those which allowed the imbalance to begin unchallenged and then take hold for a period of nearly two decades.
But what’s lacking in Meltzer’s own effort remains far greater. Writing at considerable length in 2005, he notes:
“Economists in the Nixon administration did not neglect money growth. Neglect of money growth contributes to an understanding of the start of the inflation in 1965-66, but neglect cannot explain why inflation continued after 1969.”
Even recognizing how the dastardly affair wasn’t limited to the US boundaries, there is no more attention given to this than what’s filtered through mainstream econometric nonsense. In this standard convention, the Great Inflation is as if several national great inflations just so happened to have taken place at the same time.
And that same time began under the presumably fixed exchange Bretton Woods system. Briefly, according to this view, countries with surplus balance of payments had refused to consider higher exchange rates for their currencies which would threaten their export businesses; the same worldview of outmoded “capital flows” which had indeed perplexed authorities throughout the early sixties.
The solution proposed at the time was to let the dollar’s exchange value devalue; only it didn’t work. Presumed monetary and trade rebalancing didn’t take shape following Bretton Woods’ final termination in August 1971. The BIS’s 1974 Annual Report had revealed, “Contrary to what had frequently been expected, floating exchange rates and the shift of the US balance of payments from deficit to surplus do not seem to have exerted a major drag on the market.”
That “market” referenced in the report was, of course, the eurodollar market. Even by then, it was no simple marketplace, a full-on, self-contained ecosystem displaying all the functions – and more – of any competent reserve structure.
Yet, in Meltzer’s 2005 Origins of the Great Inflation, the famed Economist doesn’t even mention the term “eurodollar” once. Not a single time throughout its twenty-seven overflowing pages clocking in at around 18,000 words (by my unofficial count). Instead, like most, he had spent the overwhelming balance of his examination combing through bank reserves (“even keel”) and grandiose macro theory (with particular focus on Phillips Curves, not money).
It's not as if the clues weren’t available, though scattered around the edges of the academy. One such from the Federal Reserve itself published right near the height (October 1978) of the indignity:
“Expansion of the international activities of U.S. banks has been one of the most remarkable developments in American banking over the past 20 years.' The most "visible" sign of this expansion has been the growth of foreign assets of U.S. banks. From just over $6 billion in 1957, these assets had increased to almost $350 billion at the end of 1977. Less visible but equally remarkable has been the institutional adaptability of banks, which facilitated the expansion.”
One curious vehicle put in use to accomplish, in part, this massive monetary and financial growth was something called an Edge Corporation.
Wishing to involve the country’s banking giants from the very early 20th century up-for-grabs increasingly international trade, the original Federal Reserve Act was quickly amended barely a couple years after in 1916 to allow for special cases to increase foreign business. Anyone with $1 million in spare capital could form what came to be called agreement corporations which were permitted wide regulatory latitude so long as the corporation’s customers weren’t Americans, or in America.
Few chose to put up the initial margin until 1919 when New Jersey Senator Walter Edge sponsored another amendment to the Federal Reserve Act loosening the constraints even more. These came to be known as Edge Act Corporations, or Edges.
It had sparked some modest interest throughout the twenties, and even then only twenty (mostly Edges but also a couple agreement corporations) were ever put together. They then went almost completely silent with the onset of the Great Collapse, only five still being active by 1934.
In fact, between 1934 and 1956, just one additional agreement corporation and two more Edges were chartered. From that point forward, these suddenly found serious banking favor; seven more Edges (and another agreement corporation) were set up from 1957 to 1960, bringing the total to ten. By 1964, a further twenty were created.
The timing here is neither secretive nor coincidental; it might only seem that way if you spend 18,000 words and never once hit upon the term eurodollar. It had been the eurodollar system, not market, which went into full bloom beginning around 1955 or so and taking off (while taking down Bretton Woods) during those late fifties and throughout the early sixties.
Asset growth – meaning liability growth way beyond startup capital for Edges – as the Chicago Fed had reported in 1978 had gone from a stunning $6 billion in 1957 to $350 billion twenty years later (only a fraction of it had been held by Edges, those were merely the most visible symptom of the wider global money adoption in American banking, banks who also used foreign-based direct subsidiaries to participate offshore).
No one then had then, or has since, made a real effort to explain just why US firms became so keen on expanding their presence outside the US.
Even Meltzer’s “even keel” doesn’t cut it if only as his version of inflation’s original spark. The money, as Stephen Goldfeld put it by 1976, had gone missing. But it wasn’t missing, more had been neglected from the “official” pages of history in favor of convoluted, often-contradictory backdoor presumptions for the alleged cause behind one of macroeconomic history’s most reviled (for good reason) episodes.
And there was still more. The New York Clearinghouse Association (the folks who just so happen to run the biggest offshore US dollar payment system, CHIPS) had proposed yet more international streamlining from July 1978, though it would take until December 1981 before International Banking Facilities (IBF) were allowed via still-another change to the Federal Reserve Act.
An Edge would have to be overseas, therefore what seemed a totally separate bank operating in some far-flung foreign location on behalf of foreigners. This provided officials and ingloriously uncurious researchers their “out”; it wouldn’t have anything to do with American money, they’d rationalize.
It wouldn’t matter that most of the “money” being put to use through them - again, as only a symptom of wider, weightier offshore expansion – was called dollars.
Edges hadn’t really been anything more than a brass plate; some US bank employee sent down to basically vacation in a tropical location (Cayman Islands), among the gorgeous mountains of the Alps (Zurich), or chipping kippers and whatnot having a grand time among the City Boys of London City. A direct phone line to NYC headquarters and a nameplate stuck to a rented office door, this was the bank’s Edge.
These IBFs simply dispensed with all the physical fakery. Overseas operations which had been run domestically anyway could stay domestic, no need for the London or Caribbean brass plate, so long as the accounting was done separately – which is what the money truly is in this eurodollar’s world.
Accounting.
In other words, in that sort of monetary world location really doesn’t matter. Money long ago had become unconstrained by borders and traditional boundaries (real as well as qualitative), and that’s the part which both caused the Great Inflation and confused anyone offering their stab-in-the-dark explanation for it.
The more those “foreign” balance sheets swelled, Edges, IBFs, offshore subs, and way beyond, the more we knew there had been monetary expansion across the world. Dollars would flow in from them, or out to them. The more robust and voluminous the trade back or forth, the more had to have been out there across the entirety of this “missing” money in the global shadows.
Our Treasury Department’s TIC data, for instance, captures some of this back and forth, what gets reported to the government from certain global banks engaged in cross-border money. The figures for foreign subs go back to, of course, 1978, while those for IBFs didn’t appear until 2003.
What you find in each of them is…nothing surprising whatsoever, at least if you are the slightest familiar with the world beyond academia. Rapid growth in the eighties, a redirect of monetary expansion from what had generated consumer prices to what would instead lead to a worldwide globalization and financialization, into the nineties and its parabolic explosion.
Around 1995, TIC records about $300 billion in short-term US bank claims on their foreign subsidiaries. By the start of 2003, a particularly bubbly time around the globe, that balance had swelled three-fold to $900 billion.
Add to that an initial 2003 estimate of $287 billion for US bank claims on their IBFs (remember, offshore in name only), the combined $1.2 trillion quickly became $2.5 trillion in four short years by August 2007 – with so much more behind it hidden out there in the eurodollar’s still-more-vast shadows.
You know where this is going.
Big drop following Bear Stearns in March 2008, the same when those at the Federal Reserve began to celebrate their “successful” operation, from a peak of $2.7 trillion down to $2.2 trillion in a mere matter of months. Those months when, as Ben Bernanke only later quipped, “intense strains in the global dollar funding markets began to spill over to U.S. markets.”
Following an initial rebound up to 2011, the second eurodollar crisis represented the peak not just for bank claims on IBF/foreign subs, but for the entire worldwide monetary apparatus. The amount of deflationary money destruction indicated by this one proxy alone has been truly stunning. In the era of QE and most people’s perceptions of out-of-control money printing at the Fed, an un-even keel, so to speak, TIC tells us combined claims have been cut in half since a May 2011 peak of $3.3 trillion.
A good chunk ($190 billion) of that disappeared (not missing) half came…after May 2021.
The same time when CPIs have accelerated, our historically-validated direct proxy of global monetary sufficiency has been decidedly deflationary; in both the short run of the past few years as well as the bigger picture post-2008.
Just like dramatically higher interest among US-based banking for participation in overseas meaning offshore functions had told us more than enough to really understand the Great Inflation, their absolutely clear post-2007 and after-2011 distaste for the same proposes the opposite from the seventies despite how many people today are absolutely convinced otherwise.
Convinced by a world described in a peculiarly, ironically narrow set of 18,000 words.
The implications are, well, historic. Besides getting the history right, we can also better appreciate what’s wrong about today. And that isn’t inflation; a fact which might already be reverberating through the conference rooms of the historically hawkish Federal Reserve (July 2022 Minutes). They won’t know why, thanks to the unreasonably narrow confines of academic un-discovery, despite this blind spot even they seem to sense what’s coming.
If they’d use just the one more word, officials and the public wouldn’t have to “sense.”
