The End of an Era (Part I)

To many of those seeking to preserve the economic and political structures of the last seventy years, the two seismic events of 2016 – the decision of the British people to leave the EU and the election of Donald Trump to the presidency of the United States – are held, as a matter of faith, to be aberrations: unaccountable departures from the norm which will be overturned or reversed in due course, thereby allowing the world to return to its natural and proper state. Even though the Mueller report failed to find President Trump guilty of any wrong-doing, the US establishment and media are thus still determined to find some way to impeach him, while the British government continues to delay Brexit in the hope that its supporters will eventually become exhausted and lose the will to fight, thereby allowing Article 50 to be revoked. 

Whether or not either of these ‘reversal’ events occurs, however, I believe that in the longer term the changes which the UK referendum and the 2016 US presidential election presaged will not only continue inexorably but will do so at an accelerating pace. For far from being the inexplicable anomalies which others believe them to be, I believe that they constitute the first clear indications that the post war era – fashioned at the Bretton Woods Conference in New Hampshire in the autumn of 1944 – is on the point of collapse and is so due to two fundamental errors actually built into the Bretton Woods Agreements themselves. 

The most glaring of these was a contradiction in the political consensus upon which such international institutions as the UN and, later, the EU were built: a contradiction which is at the heart of the Brexit debate and to which I shall be returning in Part III of this three part exposition. In Parts I and II, however, I want to start by looking at what was possibly an even more catastrophic error: one which was built into the very foundations of the post-war monetary and financial system, which not only included the creation of the World Bank and the IMF, but also saw the re-establishment of a gold standard in which the price of gold was (permanently) set at $35 an ounce, with all other currencies being pegged to the dollar at fixed, though not immutable exchange rates. 

The purpose of this was to impose fiscal discipline on governments around the world by preventing them from simply printing money to finance deficits, as had happened in Germany after the first world war, leading to a period of hyperinflation which, in turn, led to the great economic depression which allowed National Socialism to come to the fore. What it also did, however, was effectively make the dollar a reserve currency which other countries could hold in lieu of gold due to the commitment made by the USA that it would convert dollars to gold on demand, thereby making the dollar ‘as good as gold’.

All very well, you might think. The trouble was that the US consequently had a responsibility to keep the price of gold fixed at $35 an ounce, if necessary by adjusting the domestic supply of dollars in order to maintain confidence in future gold convertibility. This meant that the US, more than any other country, had to maintain fiscal discipline, thereby greatly limiting the flexibility with which American presidents could manage the US economy to their own political advantage: a flexibility which only the most optimistic idealist could have imagined American presidents would forego.

In fact, it is a wonder that this new monetary order lasted as long as it did: a miracle which was almost entirely due to the probity of President Eisenhower, probably the most fiscally disciplined president the US has even known. Not only did he end the wasteful Korean War within six months of taking office but, even at the height of the Cold War, he then set about cutting military expenditure – the only post-war president ever to do so – such that by the end of his first year in office he had actually balanced the federal budget, which remained in balance for the next seven years of his presidency.

The result was what was probably the golden age of the American economy. With very little growth in base money, there was almost no inflation, while underlying economic growth remained virtually constant at between 3% and 4% per annum, meaning that, even taking into account the rise in population, the average standard of living for American citizens during Eisenhower’s presidency rose by around 35%. 

Nor were these good times restricted to the USA. All across the developed world, economies were booming. In the UK, for instance, the then Prime Minister, Harold Macmillan, famously told the British people at that time that they’d ‘never had it so good’. And he was right. All of which suggests that the system, itself, worked and would have gone on working had all US presidents been as honest and responsible as Ike. The sad truth is, however, that the participants at Bretton Woods were simply naïve to think that they would be.

Indeed, the problems started almost as soon as Eisenhower left the White House, when a new war in Southeast Asia, combined with the cost of a space race and additional welfare spending in response to the Civil Rights movement forced the administrations of both John F. Kennedy and Lynden B. Johnson to increase borrowing: something which they could only do by also increasing the base money supply, which they therefore did. The result was that even by as early as 1966, the earliest year for which I have managed to find figures, there were almost twice as many dollars in circulation as the US held in gold reserves. According to an IMF publication from 2014, in that year there were a total $24 billion in existence issued by the Federal Reserve, $14 billion of which were held by foreign central banks as dollar reserves, while the US bullion repository at Fort Knox held only $13.2 billion worth of gold priced at $35 an ounce.

What this also tells us is just how big the US trade deficit had become by this point. For apart from foreign aid and loans issued under the Marshal Plan, what this $14 billion held by foreign central banks represented, of course, was a massive imbalance of trade with those other countries, especially West Germany and Japan, whose economies and exports to the US were by then flourishing. In fact, so acute had the trade imbalance between the US and West Germany become that eventually the US demanded that West Germany increase the value of the Deutsche Mark in order to make its exports more expensive, something which the West German government naturally declined to do, thereby effectively leaving the Bretton Woods convention. 

Everywhere one looked, in fact, the system was now creaking, with the price of gold inexorably rising on all the metals exchanges on which it was traded, while the dollar, itself, was repeatedly brought under pressure by countries trying to unload their dollar reserves in the very genuine fear and belief that they would eventually become devalued. Despite numerous international attempts to shore up the system, principally by creating a two-tier market for gold – with one tier for commercial traders and another for central banks – and the use of currency swaps rather dollar conversion in international settlements, it was fairly clear, therefore, that it was only a matter of time before the system collapsed: an inevitability which duly came to pass in the summer of 1971, when, to the consternation of all those who knew what it meant and the utter obliviousness of all those who didn’t, President Nixon announced to the world that, as a temporary measure – which inevitably became permanent – the United States of America would no longer be exchanging dollars for gold.

In the years since, much has been written about this cataclysmic event, with much of blame, quite unfairly I think, being attributed to Nixon, himself. In his seminal work, ‘The Great Deformation: The Corruption of American Capitalism’, David Stockman, for instance, argues that with the Vietnam war still dragging on and Nixon needing to boost his popularity ahead of the 1972 presidential election – principally by dolling out various form of largesse to various sectors of the public – his motives for acting how and, more especially when he did were purely political and selfish. This is to ignore that fact, however, that by the summer of 1971, the situation had simply become untenable. The United States simply didn’t have enough gold to cover its international commitments and refusing to face up to this reality was only adding to the pressure. More to the point, Nixon didn’t start the deficit spending and excess money-printing. John F. Kennedy and Lyndon B. Johnson were just as much to blame, if not more so. More than anyone else, however, the true culprits were the participants at Bretton Woods, who not only didn’t see the inevitability of this outcome but failed to grasp the magnitude of its truly catastrophic consequences. For if other countries around the world had little reason to continue holding dollars before the closing of the gold window, they had even less reason to hold them afterwards. Which meant that unless the US could find some other reason for countries to hold dollars, not only was a crash in the value of the dollar more or less inevitable but a gradual repatriation of dollars to the US was also very likely, thereby fueling an already high rate of inflation, something which Nixon just couldn’t allow.

His now famous solution, therefore, was to send Henry Kissinger to Saudi Arabia, the largest oil producer in the world, to convince the Saudis to continue selling their oil for dollars, promising in return that the USA would provide diplomatic and military protection for Saudi Arabia for as long as this arrangement was maintained. Thus the petro-dollar was born, along with an alliance which has continued to see America defend Saudi Arabia ever since, no matter how shockingly and brutally it behaves. Even more significantly, however, it also established what has probably become the most central plank in American foreign policy, which is to defend the reserve currency status of the dollar at all costs. For if the consequences of losing that status in 1972 would have been disastrous – at a time when there were only a few billion dollars held in foreign banks – they became even more unthinkable as the years passed and those billions turned into trillions.

Of course, it is very difficult to say how much this consideration has influenced individual American interventions around the world over the last forty-five years, especially as none of these interventions have ever been advertised as being for this purpose. When the preservation of the dollar’s status as a reserve currency is a consequence of one of these interventions, however, it is equally difficult to regard it as being merely coincidental. Do we really believe it to have been a mere coincidence, for instance, that in October 2000, before the invasion of Iraq in 2003, Saddam Hussein had begun selling Iraqi oil in Euros, thereby directly challenging the position of the dollar, or that prior to his overthrow and brutal murder in 2011, Colonel Gadhafi had been actively discussing the creation of an alternative reserve currency with fellow African leaders and had already amassed an estimated 150 tons of gold to this end. After all, both Muammar Gadhafi and Saddam Hussein had been tolerated and even accommodated by the USA for decades up until they each started going down this route. Moreover, just as we now know that Saddam Hussein did not have weapons of mass destruction, so there is no real evidence that Colonel Gadhafi was actually committing genocide against the people of Sirte as was then widely reported in justification of military action. The only wrong-doing of which we know for certain that the two men were guilty, therefore, is that they had both, in their different ways, threatened the reserve status of the dollar.

Which is something of an irony. For even if this posited motive for the removal of the two men is only partially true, that preserving the reserve status of the dollar was only one of the reasons for getting rid of them – the last straw perhaps – it is nevertheless the case that, for extended periods in their long careers, both of these men had actually contributed to the system that was ultimately to bring about their downfall. 

I say this because the cost of maintaining sufficient military power to execute this kind of regime change whenever it is deemed necessary is astronomically high. At present, for instance, the combined budgets of the US military and security and intelligence services amount to around $1 trillion per annum ($750 billion for the military, $250 billion for the security and intelligence services). To put this in perspective, current Russian military expenditure, for instance, stands at just $69 billion. Nor is it a coincidence that in the current financial year the US federal government will also be running budget deficit of around £1 trillion. For in order to fund this enormous military and intelligence machine, the US government invariably has to borrow at least some of the money it needs. And in 2019, the fact is that it is effectively borrowing all of it. And who will be lending it to them? Well, high on the list of lenders are quite naturally those countries which sell commodities denominated in dollars, especially oil. After all, what else are they going to do with all the dollars they receive for these commodities? They are not just going to put them in vault where they can’t earn any interest. So they buy dollar denominated assets, including US Treasury bonds, thus providing the funds with which to pay for the military which then crushes anyone who tries to break out of this self-perpetuating vicious circle. 

Nor was this the only monster which the petro-dollar unleashed upon the world. For back in 1972, military protection was only one of the conditions the Saudis laid down for continuing to sell their oil in dollars. Of far more immediate consequence was their demand for an increase in the price of the oil, itself, which went from $3 a barrel in 1972 to $12 a barrel by the end of 1973, an increase of 300% which sent a tide of inflation rippling around an oil-dependent world. 

That OPEC justified this price hike on the grounds that the West was supporting Israel and therefore needed to be taught a lesson made it seem, of course, that the US/Saudi accord had nothing to do with their demands for a price increase, especially as the US was among the group of countries, including the UK, that were also singled out for an embargo. Anyone who actually believes that the US/Saudi pact and the oil price hike were not connected, however, or that the US did not sanction the latter, is more than a little naïve, especially as the price rise, itself, was in America’s interest. For not only did it further increase the need of other countries to hold dollars – and more of them – thereby strengthening America’s position on the world stage, it also gave the direct recipients of this windfall – Saudi Arabia, the Gulf States, Libya, Iraq and even Iran, then ruled the CIA-installed Shah – even more dollars with which to buy US manufactured goods – including armaments – and US treasury bonds, thereby providing the US with the funds it needed to maintain the military and intelligence establishment required to police this new world order. 

The people who actually footed the bill for all this, in fact, were rather the citizens of the non-oil-producing countries of Europe, especially the UK, which had yet to discover – or, at least, start to exploit – its own oil reserves in the North Sea, and which, after a decade of financial mismanagement, was saddled with what was probably the weakest economy in the developed world. Already in 1967, the Wilson government had had to devalue the pound against the dollar from $2.80 to $2.40 almost entirely as a result of having indulged in the kind of fiscal and monetary policies which the Bretton Woods system was designed to prevent. Spending far more money on its welfare system and nationalised industries than it was able to raise in taxes, it inevitably ended up printing far more money than the growth in the underlying economy would have justified. The result was soaring inflation which meant that, at $2.80 to the pound, its exports had simply become uncompetitive, with the further consequence that it was also running a trade deficit with the rest of the world, which in turn meant that it was haemorrhaging dollar reserves, thus rendering further money printing even more problematic. 

When West Germany and others left the Bretton Woods system and allowed their currencies to float freely on foreign exchanges, this then made the position even worse by opening the door to arbitrage: a method of making money which exploits any differential in the price of a particular commodity – in this case, the UK pound – on different markets. Just as in the early 1990s, when the pound was artificially pegged to a basket of European currencies under the European Exchange Rate Mechanism or ERM and consequently came under predatory pressure from George Soros, so too, in the early 1970s, the Bank of England thus found itself repeatedly forced to support the official exchange rate by expending even more of the country’s gold and dollar reserves on buying pounds, until eventually, in June 1972, the then Chancellor of Exchequer, Anthony Barber, finally conceded defeat and allowed the pound to float freely, at which point, being grossly overvalued, it duly sunk like a stone.

The result was a further increase in the price of imports, including oil, and hence a further increase in inflation. When the hike in the price of oil also took effect later in the year, inflation then simply spun out of control, reaching a peak of 28% in 1974.

Speaking personally, it is period in our history I remember very well. I was a student at the time, working three or four nights a week on one of the bars at my university in order to augment a small student grant which was set at the beginning of each year but which rapidly lost value as the year progressed, with the result that by the latter half of final term of each I had almost nothing left to live on.

The situation in the country at large, however, was even more dire. Requiring significant pay rises to keep pace with inflation, workers all over the country were going on strike, thereby fuelling inflation even further. One particular strike, in our nationalised coal industry, which denied coal to coal-fired power stations, also meant that there were frequent power cuts. Many domestic customers only had electricity for a few hours each day while most of industry was reduced to working just three days a week. It was as if the whole fabric of our society were falling apart. And it was then, in the midst of all this turmoil, that we joined the European Economic Community, or Common Market as we then called it, our entry into this economic utopia having been sold to us on the basis that it would solve all our economic woes. Which, of course, it didn’t. 

Indeed, in many ways it actually made them worse, the fate of the British car industry being a case in point. 

In 1968, under the auspices of the previous Labour government, most of the country’s many small automotive manufacturers, such as Austin, Morris, MG and Rover, had been merged into a giant conglomerate called British Leyland. The idea had been to reduce costs and hence become more competitive by reducing the overall number of models produced, standardising tooling and unifying distribution. The effect, however, had already been fairly disastrous. Not only was the new mega-corporation cumbersome and overly bureaucratic, but the elimination of competition between the rival makes led to a steady decline in both design and build quality. By the time the country therefore entered the EEC and removed tariffs from French, Italian and above all German imports, the British automotive industry just couldn’t compete. Compared to the modern, well-built Citroens, Alfa Romeos and BMWs of our European neighbours, nobody wanted to buy the poorly designed and fault-riddled models of our own manufacture. Around the old Longbridge plant, to the southwest of Birmingham, where Austins used to be made, they actually rented fields in which to store all the unsold cars: acres and acres of them, all lined up and simply rusting away. 

The inevitable result was that the company also therefore started to lose money, so much so that in 1975 a returning Labour government decided to nationalise it in order to try to save it, at which point the trade unions, particularly at Longbridge, went on strike for higher pay, knowing that the new owners had no choice but to comply. And so it was that British Leyland continued its downward spiral, along with the entire British economy, with the further result that, in 1976, the then Chancellor of the Exchequer, Denis Healey actually had to apply for a loan from the IMF, possibly one of the greatest humiliations the UK has ever suffered. 

What it did, however, was finally convince the British people to try something different. And in May 1979 they duly elected a new Conservative government under Margaret Thatcher. 

As in the case the Reagan administration in the US, such was the revolutionary effect of the Thatcher government on the economy that many people have seen it as some kind of radical new departure in economic thinking. In America, they even have a name for it: they call it Reaganomics. In reality, however, it was merely a return  to the monetary and fiscal discipline of the 1950s. 

To eliminate inflation, both Reagan and Thatcher first put up interest rates, thereby reducing the rate of increase in the secondary supply of money brought about by credit issuance. To avoid depressing the economy they then cut direct taxation for both individuals and businesses and balanced this by reducing public expenditure. Margaret Thatcher also privatised or simply closed down loss-making nationalised industries like British Leyland, many of which, such as British Telecom or BT, then went on to be highly successful. In fact, the whole undertaking was a massive success. Although in the process Margaret Thatcher probably made herself the most hated British Prime Minister of all time, with those on the left quite naturally condemning her for cutting taxes for the rich while reducing benefits for the poor, she nevertheless turned the economy around such that by the mid-1980s Britain was not just stable again but booming. 

And at that point it might have been hoped that the negative effects of Bretton Woods would have finally worked their way through the system. After all, both Britain and America had learnt their lessons, discovering that all that was required for economies to function properly was for governments to act responsibly: something which the gold standard was designed to ensure but which could just as easily be accomplished without the tie to gold, simply by politicians behaving in the best interests of the countries rather than in the best interests of their parties or themselves.

Unfortunately, not only are such lessons easily forgotten, especially when they are barely understood in the first place, but at this point another of the pillars of the Bretton Woods Agreements, their internationalism, started to come into play in a way that had further economic, financial and monetary consequences: consequences which not only led to the financial crash of 2008, but which are still in play today and which will almost certainly cause the whole financial and monetary system to eventually collapse, as I shall endeavour to explain in ‘The End of an Era (Part II).