By John Law
To fully understand today’s economic crisis and where we are heading, one must find the origin of this crisis — the event or the culmination of events that put us down this path. The event leading us to the current crisis isn’t the high unemployment — currently 9.7% — and avalanche of foreclosures or the bailout of all the major banks as a result of the housing boom and subsequent crash of the 2000s. It wasn’t the preceeding tech bubble of the late 1990s and early 2000, or all the years of the Fed’s easy monetary policy. Which lead to the high — arguably understated — inflation of the last three decades. No one of these events put us down this path. When one searches for the origins of the current crisis, they will find all of these events are rather the symptoms of the same illness — the same illness that has steadily worsened and accelerated us down the path upon which we are now traveling. A path that leads us over a cliff into which we fall into the abyss.
The origins of today’s crisis can be traced all the way back to the 1944 Bretton Woods agreement. In 1944, world leaders and economists met to form a new world monetary system for the post war era. With the Bretton Woods agreement, America became the reserve currency of the world, promising other nations they could redeem any dollars they had for gold. While the dollar’s value was set in gold, the other countries’ currency valuations were fixed to the dollar. The value of the dollar was set at FDR’s 1934 revaluation of $35 per ounce of gold. Before FDR’s revaluation, the dollar was stronger and was valued at $20.67 per ounce of gold.
However, this was not a true gold standard and it heavily favored the United States. In a true gold standard the currency is convertible by any one — private citizen, foreign central bank etc. — whereas under the Bretton Woods agreement, only foreign central banks could convert their dollars to gold. It favored the United States because the US could settle its foreign payments in dollars. Whereas other nations had to settle their foreign payments — including any with the US — in gold, so the US could simply print dollars and send them overseas and keep doing this until when/if foreign central banks started demanding gold for their dollars. Under a true gold standard, all foreign payments by any country would be settled in gold. Thus putting a limit on the number of dollars the Federal Reserve could print. Forcing balance of payments and trade responsibility, so as to the outflow of gold is not greater than the inflow of gold.
After World War II, it didn’t take the US long to find itself in war again, this time in Korea. War broke out on June 25, 1950. The Korean War escalated the Cold War between the US and the Soviet Union; and as what would have been a civil war, turned into a proxy war between the two powers, with the US vowing to defeat communism at all costs. The war ended on July 27, 1953 with an armistice, but the stage was set for the further escalation of the Cold War and the international currency crisis that would engulf the world in the late 60s and in 1971, bring the collapse of the Bretton Woods agreement and the ensuing run on the dollar that pushed it to the brink of collapse and hyperinflation.
The three year Korean War set the stage for these events by the financial cost of the war and the actions — which are still repeated this day — taken to pay for the costs. Although the US had a trade surplus, it had a balance of payments deficit which was due mainly to government spending on overseas expenditures, including military and foreign aid to help rebuild Europe. The US Treasury issued new bonds which were then bought by The Federal Reserve with money printed out of thin air. By the year 1951, The Federal Reserve had more US Treasury bonds on its balance sheet than it had in gold reserves. By 1958 these dollars were being exchanged for gold by foreign central banks at an alarming rate. By the end of 1958 US gold reserves had fallen 9%.
By October 1960, the outflow of gold from the United States was beginning to put upward pressure on the price of gold. Gold had just reached $40 per ounce in trading on The London Gold Exchange that October, while the official price was still at $35 per ounce. In an effort to suppress the price of gold, the US, Great Britain, Germany, France, and other western central banks, formed the London Gold Pool in 1961. If the price of gold neared $35.20, the group would dump gold onto the market in an effort to get gold back to the official $35 price and if the price fell below $35, the group would buy gold to bring the price of gold back to $35.
By 1965 the outflow of gold was accelerating even more as the balance of payments deficit grew ever larger. Large tax cuts proposed by President Kennedy and passed after his death by President Johnson in 1964 had taken effect. A massive full escalation of the Vietnam War had started, the space race with the Soviet Union was in full swing, and huge, new entitlement spending on President Johnson’s Great Society also had taken effect. As a result of the massive increase in government outlays, in 1967 total US foreign liabilities had soared to $36 billion, while the US only had $12 billion in gold reserves — only one third of total obligations.
With the acceleration in the outflow of gold, the US increasingly attempted to forcefully control the outflow. In 1959 President Eisenhower made it illegal for Americans to buy gold overseas. Before his death, President Kennedy proposed The Equalization Tax, which was passed after his death in 1964. The act was a new tax on foreign currency deposits to prevent Americans from investing overseas. President Lyndon Johnson went as far as to discourage Americans from traveling. He stated “We may need to forgo the pleasures of Europe for a while.” And also, “I am asking the American people to defer, for the next two years, all non-essential travel outside the western hemisphere.” And as a Time magazine article from February 12, 1965 noted:
“Martin, Douglas Dillon and Budget Director Kermit Gordon are lobbying for measures that would drastically affect the nation’s foreign and domestic policies. Among the proposals that one or all three of them have forwarded: an exit tag of $50 or $100 per person to discourage tourism abroad, direct controls on U.S. investments abroad…”
Beginning in 1965, French President General Charles de Gaulle– who by that time had made France an economic power house through austerity programs in which built up France’s gold reserves after he returned to power in 1958– started demanding a reform of the international monetary system, a move back to the gold standard. As this February 12, 1965 Time article explains:
“Perhaps never before had a chief of state launched such an open assault on the monetary power of a friendly nation. Nor had anyone of such stature made so sweeping a criticism of the international monetary system since its founding in 1944. There was Charles de Gaulle last week proclaiming that the primacy of the dollar in international dealings was finished, calling for an eventual return to the gold standard —which the world’s nations scrapped 50 years ago — and practically inviting other countries to follow France’s lead and cash in their dollars for gold. It was a particularly nettling irritant just as the U.S. was deeply involved in making some hard decisions about its monetary policy.”
Time also wrote in the article that “past attempts to close the payments gap have been mere palliatives — and that the problem has begun to undermine U.S. influence around the globe.” And:
“Just before De Gaulle spoke, Treasury Secretary Douglas Dillon made the first public admission that the U.S. payments deficit in 1964 moved higher than anyone had expected. It totaled about $3billion, all of which the U.S. is legally committed to exchange for U.S. gold on demand. The Federal Reserve announced that the U.S. gold supply declined last week by $100 million, to a 26-year low of 15.1 billion.
France converted $150 million into gold last month, plans another $150 million conversion soon. Following that lead, Spain has quietly exchanged $60 million of its dollar reserves for U.S. gold—the biggest such transaction of the Franco era. To free more gold to meet rising demand, a congressional committee last week approved President Johnson’s proposal to eliminate the 25% gold backing now legally required for deposits held in the Federal Reserve System. But concern is growing in Washington that nations that have so far refrained from converting dollars out of consideration for the U.S. may cash them in for gold once the extra bullion becomes available—and thus send still more gold-laden truckloads rolling out of Fort Knox.”
Unlike France, Great Britain’s economy was already a disaster and was getting worse. Britain’s external trade balance and general economic conditions were poor and was getting worse. With foreign obligations growing and a shrinking industrial base, fears began to fester the Bretton Woods agreement would be broken at the Pound Sterling link. With fears of a Sterling crisis and a breakdown of the Bretton Woods agreement possible, causing France’s Charles de Gaulle to push for an overhaul of the international monetary system, de Gaulle was the target of several CIA-linked assassination attempts between 1965-1966. After these attempts failed, de Gaulle’s government was then a target of destabilization which later succeeded in 1968.
Economist and historian William Engdahl gives a more detailed account in his 1992 (republished 2004) book, “A Century of War: Anglo-American Oil Politics And The New World Order”:
“After the war [World War II], under Bretton Woods, Britain, through her Sterling Bloc ties with colonies and former colonies, had been able to make the Pound Sterling a strong currency, which in many parts of the world was regarded the equal of the dollar as a stable reserve currency. Member countries in the British Commonwealth were required, among other “courtesies,” to deposit their national gold and foreign exchange reserves in London and to maintain Sterling balances in City of London British banks. Britain’s quota share in the IMF was second only to that of the United States. Therefore, the Pound was disproportionately important to the stability of the Bretton Woods dollar order in the 1960’s, despite the clearly depleted condition of her economy.
During the 1960’s England, like America, was a net exporter of financial funds to the rest of the world, despite the fact that her technologically stagnant industrial base created increasing trade deficits. Continental European economies, through growth of trade within the new Common Market and their productive advantages from strong investment in technology, grew vigorously.
Thus Britain’s deficiencies and lack of new technological investment grew ever larger by comparison. The powerful financial interests of the City of London again preferred to focus single- mindedly on drawing the world’s financial flows into London banks by maintaining the highest interest rates of any major industrial nation throughout the mid-1960’s. Industry went into a slump, unable to borrow for needed technological innovations.
By 1967, the British position was alarming. Despite several large emergency borrowings from the IMF to help stabilize the Pound Sterling, British foreign debts continued to grow, rising another $2 billion, or some 20% in that year alone. In January, 1967, de Gaulle’s principal economic adviser, Jacques Rueff, came to London to deliver a proposal for raising the official price of gold held by the leading industrial nations. The United States and Britain continuously refused to hear such arguments, which would have meant a de facto devaluation of their currencies.
Throughout 1967, the Bank of England’s gold reserves declined. Foreign creditors, sensing the obviously imminent devaluation of the weakening Pound, scrambled to redeem paper for gold, which they calculated must rise in value. By June 1967, de Gaulle’s government announced that France had withdrawn from the American-instigated “Gold Pool.” In 1961, under U.S. pressure, the central banks of ten leading industrial countries had created the Group of Ten as it became known. In addition to the U.S., Britain, France, Germany, and Italy were added Holland, Belgium, Sweden, Canada, and Japan. The Group of Ten had agreed in 1961 to pool reserves into a special fund, the Gold Pool, to be administered in London by the Bank of England. Under the arrangement, a temporary remedy at best, as events revealed, the U.S. “central bank contributed only half the costs of continuing to maintain the world price of gold at the artificially low $35/ounce of 1934. The other nine, plus Switzerland, agreed to pay the second half of such “emergency” interventions, on the argument the situation would be temporary.
But the “emergency” had become chronic by 1967. Washington refused to bring its war spending deficits under control, and Sterling continued to weaken along with the collapsing British economy. De Gaulle withdrew from the Gold Pool, not wanting to lose additional French central bank gold reserves to the bottomless pit of interventions. The American and British financial press, led by the London Economist, began a heightened attack against French policy.
But de Gaulle made one tactical blunder in the process. On January 31, 1967, a new law came into effect in France which allowed unlimited convertibility for the French Franc. At the time, with French industrial growth among the strongest in Europe, and the Franc, backed by strong gold reserves, one of the strongest currencies, convertibility was seen as a confirmation of France’s successful economic policy since de Gaulle took office in 1958. It was soon to become the Achilles heel which finished de Gaulle’s France at the hands of Anglo-American financial interests.
French Prime Minister Georges Pompidou, in a public speech in February 1967, reaffirmed French adherence to a gold-backed monetary system as the only way to avoid international manipulations, adding that the “international monetary system is functioning poorly because it gives advantages to countries with a reserve currency (i.e., the United States): these countries can afford inflation without paying for it.” In effect, the Johnson administration and the Federal Reserve simply printed dollars and sent them abroad in place of its gold.
The lines were more sharply drawn over the course of 1967. France’s central bank, determined to exchange its dollar and Sterling reserves for gold, left the voluntary 1961 “gold pool” arrangement. Other central banks followed. The situation assumed near panic dimensions; some 80 tons of gold were sold on the London market toward the end of the year in an unheard-of period of five days, in a failed effort to stop the speculative attack. Fear grew that the entire Bretton Woods edifice was about to crack at the weakest link, the Pound Sterling.
By the second half of 1967, financial speculators were selling Pounds and buying dollars or other currencies which they then used to buy commercial gold in all possible markets from Frankfurt to Pretoria, sparking a steep rise in the market price of gold, in contrast to the$35/ounce official U.S. dollar price. The Sterling crisis indirectly focused attention on the growing vulnerability at the core of the international monetary system, the U.S. dollar itself.
By November 18, 1967, the British Labour government of Harold Wilson bowed to the inevitable, despite strong pressure from Washington, and announced a 14% devaluation of Sterling from $2.80 down to $2.40 per Pound, the first devaluation since 1949. The Sterling crisis abated, but the dollar crisis was only beginning.
Once Sterling was devalued, speculative pressures turned directly to the U.S. dollar at the end of 1967. International holders of dollars went to the New York Federal Reserve Gold Discount Window and demanded their rightful gold in exchange. The market price of gold began an even steeper rise as a result, despite efforts of the U.S. Federal Reserve to dump its gold reserves onto the market to stop the rise. Washington, under the sway of the powerful dollar-based New York banks, adamantly refused to budge from the $35/ounce official valuation of gold. But the withdrawal of France, one of the largest holders of gold, from the Group of Ten Gold Pool, had intensified Washington’s problem. By the end of the year, Washington’s official gold stock declined another $1 billion, to only $12 billion.
De Gaulle is toppled
The crisis gathered momentum into 1968, and between March 8 and March 15 of that year the Gold Pool in London had to provide nearly 1,000 tons to hold the gold price. The weighing-room floor, loaded with gold at the Bank of England, almost collapsed under the weight. U.S. Air Force planes had been commandeered to rush gold in from the U.S. reserve at Fort Knox. On March 15, the U.S. requested a two-week closing of the London gold market.
By April, 1968, a special meeting of the Group of Ten was convened, in Stockholm, at Washington’s request. U.S. officials planned to unveil yet another scheme, the creation of a new “paper gold” substitute through the IMF, so-called Special Drawing Rights (SDRs), in an effort to postpone the day of reckoning still further.
At the Stockholm gathering, designed to set the stage for official I MF adoption of the Washington SDR scheme at the upcoming IMF meeting the following month, France defiantly blocked unanimous agreement, with France’s Minister Michel Debre reasserting traditional French policy on a return to the original rules of Bretton Woods. De Gaulle’s adviser Rueff had repeatedly proposed a “shock” devaluation of the U.S. dollar of 100% against gold, which would have been elegantly simple, would have doubled official U.S. gold reserves in dollar terms and would have been sufficient to allow the U.S. to convert the approximate $10 billion of foreign held dollars, while still maintaining the value of its gold reserves as before. This would have been far more rational and painless, in human terms, than what ensued from Washington’s side. But tragically, it was not to result.
Within days of the French refusal to back Washington’s SDR dollar bailout scheme, France itself was the target of the most serious political destabilization of the postwar period. Beginning with leftist students at the University of Strasbourg, soon all of France was brought to a chaotic halt as students rioted and struck across France. Coordinated with the political unrest (which, interestingly the French Communist Party attempted to calm down), U.S. and British investment houses started a panic run on the French Franc which gained momentum as it was touted loudly in Anglo-American financial media.
The May 1968 student riots in France were the result of the vested London and New York financial interests in the one G-10 nation which continued to defy their mandate. Taking advantage of the new French law allowing full currency convertibility, these financial houses began to cash in Francs for gold, draining French gold reserves by almost 30% by the end of 1968, and bringing a full- blown crisis in the Franc.
Sadly, the counterattack of the Anglo-Americans succeeded. Within a year, de Gaulle was out of office and France’s voice severely weakened. One of his last meetings while still President in 1969, was with British Ambassador to France, Christopher Soames. Once again, the General told Soames, in a broad review of French postwar policy, that Europe must be independent and that her independent stance had been profoundly compromised by the “pro-American” sentiments of many European countries, most especially Britain.
One other country openly daring to defy the powerful financial interests of London and New York at this time was the largest gold-producer in the west, the Republic of South Africa. During the early part of 1968, South Africa refused to sell its newly-mined gold for Pounds or dollars at the official price of $35/ounce. France and South Africa had been holding talks to form a new gold basis for reforming the Bretton Woods monetary order. This provoked a U.S.-led central bank boycott of South Africa, a move again repeated by the same interests almost exactly 20 years later, in the mid-1980’s.
Despite the apparent decline of the French “threat,” Washington and London’s success was to prove a Pyrrhic victory.”
The US Federal Reserve requested the London Gold Market be closed for two weeks on March 15, 1968. While the London Gold Market was closed, the Gold Pool was dismantled. Upon the London Gold Market’s reopening, gold rose to $39 per ounce. On the same day, western central banks, led by the US Treasury Secretary Robert Fowler, in what is known as the Washington Accord, announced the world’s monetary reserves to be “sufficient” and no additional purchases or sales of gold by any central bank in any market was needed. Letters were sent to some 95 central banks asking them not to buy gold. Fowler hoped that by boycotting South Africa, monetary demand for gold would drop, thus forcing South Africa, producer of 77% of the non-Communist world’s output of gold at the time, to dump its gold on markets in London and Switzerland and thus drive the price down to the official $35-per-ounce level.
The boycott had no effect at first. As the price of gold by July 1968 was over $40 per ounce and by mid-1969 was approaching $44. South Africa was able to pay for its imports in several ways: In the three years prior to 1968, South Africa had run capital account surpluses; also, after the bear market bottom in 1966, South Africa saw huge foreign currency inflows from bullish investors. South Africa was even able to sell some of its gold to western central banks despite the US led boycott. The Bank of Portugal broke the central bank boycott and bought $145 million worth of gold in 1968 and another $120 million by mid 1969. South Africa also sold gold to three Swiss banks, Credit Suisse, Union Bank and Swiss Bank Corp.(apparently these three wanted Zurich to challenge London’s status as the leading gold market in the world)
South Africa even offered to sell gold to the IMF–which IMF rules stated the fund must buy all gold offered to it, by its members. South Africa offered the IMF 1 million ounces of gold in May 1968, but the IMF deferred decision on the legality of gold purchases, with the US having 25% of the board votes.
However, by mid 1969, South Africa was in desperate need of exporting its gold to pay for its imports. The Bull market in stocks that had started in 1966 had ended and investors were increasingly shunning South Africa, who in the 2Q of 1969 had its first capital account deficit since 1965. As a result, South Africa began dumping gold on the market in London. South Africa’s reserves fell from $1.4 billion in May 1969 to $1.1 billion the following August. An estimated 20 tonnes of South African gold was hitting the market. This dumping of gold on the markets was a disaster for gold prices. Gold prices would fall from $43.50 to $35 by the end of that October and all the way down to $34.80 on January 16, 1970.
This decline was short lived however. By the end of 1970 gold was back to $37.50 per ounce, as the economic situation in the US deteriorated. For the first time in the 20th century, the US had a trade deficit in 1970. This flood of new dollars to foreign countries would soon find their way back home in the form of gold demands; demand for gold the US could not cover. By 1971, total US gold reserves had fallen to just $10 billion, while foreign central banks held some $80 billion — eight times the total of US gold reserves.
With the Vietnam War still raging and now not only a balance of payments deficit, but now also a trade deficit and a major economic recession looming, the Federal Reserve, in the face of rising inflation and commodity prices in 1971, increased the money supply by 10%. Fearing massive inflation and no longer willing to prop up the dollar, inflation-leery West Germany — Wiemar Germany hyperinflated in the early 1920s — pulled its Deutsche Mark from the Bretton woods agreement. This move actually strengthened the German economy and also the Deutsche Marked as it appreciated some 7.5% vs. the dollar by August 1971.
The German withdrawal from the Bretton Woods agreement sparked panic and a currency crisis. By the end of June 1971, $22 billion in assets had left the US. Later, in July 1971, Switzerland redeemed $50 million for gold and one month later in August, pulled its Swiss Franc from the Bretton Woods agreement. At the same time, France redeemed $191 million for gold by sending a French battleship to New York to take delivery of the gold from the Federal Reserve and to bring back to France. Then, in a shocking move on August 11, 1971, the British ambassador requested to redeem an astonishing $3 billion for gold -roughly one third of the total gold reserves of the US, at the time. The same day, Congress released a report recommending a devaluation of the dollar in an effort to protect the dollar from “foreign price-gougers.”
It was too little, too late. The dollar was in a full blown crisis and was on the brink of collapse and hyperinflation as faith had been lost. So, on August 15, 1971 President Richard Nixon, in an event that would come to known as the Nixon shock, unilaterally closed the US gold window and imposed a 90 day price and wage freeze along with a 10% surcharge tax on imports. For the first time ever, America was on a full fiat paper system.
This concludes part one. The Bretton Woods agreement put us on this path and infected us wth an illness, an illness in which today has grown to monstrous proportions and has us gasping for our last breaths. What is this illness and how did it contribute to America’s first bankruptcy in 1971? How will it lead to the second and final currency crisis and bankruptcy of the US?
I am currently working on part two and hope to have it finished and published in the coming weeks. Part two will take us through the post Bretton Woods era, from the high inflation of the 70s and early 80s, to the Gordon Gekko era of greed in the mid-late 80s till today. The asset mania that engulfed the nation in the 90s and continues till this day and the dot com bubble in the late 90s. And all the other events, manias, wars etc. over the last 10 years.