The Monetary Sin of the West

The 1920s-1930s and 1960s-1970s are two periods with remarked monetary disorder, similar to today. After reading Rothbard’s America’s Great Depression, I read French economist Jacques Rueff’s “the monetary sin of the west” to gain a few insights on the 60’s. The world was meant to be on a gold standard during both the 20s and 60s. But its poorer cousin, the gold exchange standard, was implemented, leading to monetary imbalances, geopolitical tension and eventually currency devaluations vs. gold to avert the pressure. There is a growing possibility of an analogous monetary restructuring in the 2020s as authorities double down on their monetary sins in an attempt to get the global economy out of a crisis, of their own making. To be honest, the book was pretty average, but it got my mind churning through a number of challenging questions, so it served its purpose.

Detailing the gold exchange standard briefly, in the 1920s-1930s both British Sterling and the US dollar were convertible into gold and in the 1960s-1970s only the USD was convertible. The rest of the world’s currency markets used USDs as reserve rather than gold. During a full gold reserve standard, gold would automatically restrain global monetary. For example, if the USD ran a current account deficit, importing more capital than exporting, then gold would flow externally to re-balance. Gold supply is naturally constrained and thus if the US authorities wanted to discourage sustained gold outflows, they’d have to tighten monetary policy. Tighter monetary policy encourages US Treasury holdings, supports the USD, lowers imports relative to exports and corrects the monetary imbalance. Automatic and seamless.

While this balancing mechanism was theoretically in place during the gold exchange standard, the US discouraged gold redemptions in favour of US dollar reserves. Similarly, the UK encouraged the build-up of GBP reserves when it was a cornerstone of the 1920s monetary system. USDs can be created at will which allowed US imbalances to persist for extended periods. Imbalances create systemic fragility and mask underlying economic problems, which is precisely the challenge of the current system. The French government under Charles de Gaulle, advised by Mr. Rueff, saw the systemic cracks in the 1960s, demanded gold rather than USDs. This placed US gold stockpiles under pressure, which led Nixon to repeal gold convertibility in Oct 1971 to prevent further redemptions. 

Nixon’s USD devaluation vs. gold in 1972 was the first of its kind since Roosevelt’s devaluation in 1931. That got me thinking… Will global monetary authorities need to implement a shocking devaluation in order to push the global economy through the current period of severe monetary imbalance?

Don’t get me wrong, central banks are already devaluing their currencies through zero interest rates and Quantitative Easing (QE) across the developed world. This is significant monetary debasement with pernicious impacts. But it is murky devaluation vs. financial assets whereas a devaluation vs. gold provides a few clear signals. Gold is a sound monetary asset that cannot be created out of thin area so a renewed commitment to convertibility vs. gold restores confidence in currency. It provides a clear and transparent signal to every participant in the economy that the actions taken by the central bank made the currency is worth less. There’s a semblance of honesty in this monetary decision, owning up to the inflation of the past. The devaluation rewards savers and creates confidence in the currency, albeit at a weaker level. By contrast, QE muddies the waters through distorting a broad range of financial markets, encouraging speculation, discouraging savings, misallocating capital, and it incentives governments to spend, which is regressive and bad for long-term economic growth.

QE has also been tried before, in 2008/2009, to little avail. Sure, the 2020 version is enormous but is this devaluation remarkable enough relative to the 1972 and 1931 devaluations when gold gained approximately 100% vs. the USD? I’m unconvinced. I think the 2020 solution remains patchwork and that bigger structural changes are afoot over the coming years.

It’s challenging to forecast but allowing some star gazing for a moment, the building social pressure suggests that a more extreme structural shift towards direct monetary financing of governments is a growing possibility – what some call Modern Monetary Theory (MMT, Magic Money Tree in jest). MMT is a terrible idea because it introduces further inflation and the political contestation over the spending packages will get heated. But it’s a structural change towards direct monetary financing, rather than indirect through the banking sector. The MMT case gets stronger as the current monetary measures fail to result in higher growth and inflation expectations. It’ll be very difficult to keep CPI inflation expectations under wraps during MMT.

What societies really need are currencies that are linked to something tangible. I don’t really care what backs a currency, but the market has always tended to choose gold due to its monetary characteristics (difficult to create, limited in supply, divisible, transportable, durable, etc). These linkages create accountability, discipline to avoid inflating and honesty when owning up to inflating. Bitcoin, often called digital gold because it replicates golds monetary characteristics digitally, must also be thrown into the mix with gold. It’ll be wonderful when a central bank takes the leap to buy bitcoin as part of its FX reserves. Perhaps a small tech-savvy national like Estonia will take the plunge in the next 10/15 years? I’d consider immigrating to the first mover.

Returning to the book, it’s funny how central bankers in both the 1920s-1930s and 1960s-1970s showed external support for gold’s monetary role but seemingly misunderstood the re-balancing mechanism, constantly trying to circumvent rather than own up to the discipline it imposes. Post WW1 Britain returned to the gold standard to generate the perception of British financial exceptionalism but fixed the GBP at the same price vs. gold as pre-war, despite a doubling in the British money supply during the war. Clearly if you double money supply, gold priced in your currency needs to be higher in compensation. I.E. currency devaluation is required. Despite this logic, there was strong aversion to revaluing the price of gold higher.

In the 1960s-1970s authorities detested the power that a higher gold price gave to miners in South Africa and Russia. Their governments were pariahs of the international community, which was an added reason to ignore the merits of the gold standard. Critics also praised the perceived knowledge of global central bankers and questioned the desire of hard money advocates to place global monetary decisions in the hands of a commodity. Critics misunderstand that the simple rules are the best in economics. Moreover, a gold standard doesn’t really give much power to gold miners. New gold mined each year is a tiny fraction (between 1 & 1.5%) of outstanding global stockpiles.  Oil’s large annual flow to low outstanding stock gives oil producers a much greater chance of global collusion, and even OPEC is failing highlighting the limitations of collusion in raw commodities.

Studying the 1930s and 1970s displays the progressive shifts away from independent central banking accountability towards institutionalization of the US dollar as the world’s global reserve asset. Rather than gold or gold substitutes, USDs sit on the balance sheets of every large institution around the globe. This gives the US Fed and the US Treasury the ability to expand their balance sheets by $6tn each in 2020, with very little recourse. If an emerging market blew out its fiscal and monetary balance sheets, financial markets would discipline bond and currency markets severely. Rightfully so!

I’m convicted that progressive monetary corruption by the US Fed and the rest of the global central banking cabal who follow in the Feds inflationary footsteps is the biggest challenge facing society in the 21st century. The impacts of monetary dislocation filter through into every corner of our existence. Satoshi Nakamoto’s disgust with the 2009 monetary corruption is the reason why bitcoin was created. It has subsequently grown into a digital decentralized monetary system that cannot be manipulated by central authorities. It’s going some way to repairing or at least counteracting the damage posed to society by central authorities who are completely unhinged from any sense of independent monetary accountability.

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