AN INTERVIEW WITH JAMES RICKARDS
Octavian Report: Could you take us through what you see happening to the monetary system?
James Rickards: The dollar, the yen, the euro — all are forms of money. I would say gold is a form of money. Bitcoin is a form of money. In times past, feathers and clam shells have been money. One of the criticisms of many modern forms of money, of central bank money and Bitcoin in particular, is that they are not backed by anything.
I make the point — and I’m not the first one to say this, I actually learned this from Paul Volcker — that it is backed by one thing, which is confidence. Meaning if we have confidence that something is money, then it’s money. If you and I think something’s money, and you’re willing to take it from me in exchange for goods and services, and furthermore you believe that you can give it to someone else in exchange for goods and services and make investments, then it’s money. It functions as money. But the problem with confidence is that it’s fine as long as it lasts, but it’s very fragile and it’s very easily lost. Once it’s lost, it’s impossible to get back, or at least extremely difficult to get back.
When I talk about the collapse of the international monetary system, people think I must be an apocalyptic doom-and-gloomer. End of the world, we’re all going to be living in caves, eating canned goods. I say no, not at all. I don’t think it’s the end of the world, I just think it’s the end of a system that has in fact collapsed three times in the past 100 years. There’s nothing unusual about breakdowns in the international monetary system. When it happens, the major trading financial powers get together, sit around a table, and rewrite what they call the rules of the game. “Rules of the game” is actually a phrase, a term of art in international finance, for the operating system (just to use modern jargon) of the international monetary system.
All I’m doing is looking at the system dynamics. It’s very easy to see the collapse coming based on that, and then ask the question: when the collapse comes, what will the new system look like? That is, what will it look like after the next Bretton Woods, or the next Smithsonian agreement, or for that matter Genoa in 1922? The next time the powers sit around the table, what deal will they come up with? Then I work backwards from that to today, and ask: what can I or should I do with my portfolio now to prepare for this new deal?
That’s the scenario. Now, I have the view that basically all the central-bank models, all the risk-management models used on Wall Street and in capital markets around the world are obsolete. There are much better tools available today. The three that I use most frequently — not the only three — are complexity theory, behavioral psychology, and causal inference. Causal inference also goes by the name inverse probability, and it’s also known as Bayes’ theorem. Three branches of science: one’s physics, one’s applied mathematics, and one’s social-psychological. That’s my tool kit, along with some other things.
Using those tools, it’s very easy to see the collapse coming for two reasons. One, in complex systems — and I would make the case that capital markets are complex systems nonpareil — the worst thing that you can have happen is an exponential function of scale. Meaning that as you scale up the system, you don’t increase the risk in a linear way, you increase it in an exponential way. To take a simple example, let’s say that J.P. Morgan tripled the gross notional value of its derivatives. You go to Jamie Dimon and say, “Okay, Mr. Dimon, you tripled your balance sheet. How much did the risk go up?” He would say: “Yeah, we tripled the balance sheet, but it’s long, short, long, short, long, short. The longs offset the shorts. You net it down, the actual risk is quite small relative to the gross notional value. That’s not the way to think about it. We tripled the balance sheet, but the risk went up a little bit.”
If you ask the everyday citizen, they would probably use intuition and say, “Well, if you tripled the balance sheet, sounds like you tripled the risk.” The correct answer is that Jamie Dimon’s wrong, and the everyday citizen using intuition is wrong. The correct answer is if you triple the scale of the system, you increase the risk by a factor of 10 or 100, some X-factor based on the slope of the curve, which is a power curve. It’s basically the degree, the distribution of severity and frequency of risk.
You go back to 2008: what did we hear about? Too big to fail, too big to fail, too big to fail. Today, the five largest banks in the United States are bigger than they were in 2008. They have a larger percentage of all the banking assets, and their derivative books are much bigger. Everything that was too big to fail in 2008 is much bigger today. Given the exponential function I just described, the risk is exponentially greater than 2008. Whatever you saw in 2008, get ready. A much bigger collapse is coming. Probably sooner than later.
I was general counsel of Long-Term Capital Management. I negotiated their bailout, so I had a front row seat for that. I was on the phone with the heads of the major banks. Jon Corzine at Goldman Sachs, Sandy Warner at J.P. Morgan, David Komansky at Merrill Lynch, Herb Allison and others, and Bill McDonough and Gary Gensler from the Treasury in Washington. I basically negotiated that bailout and saw exactly how close the global system came to complete collapse. We were hours away from shutting every stock and bond exchange in the world. Literally hours away, and the bailout got done. Four billion dollars changed hands. The balance sheet was supported. A press release was issued and the crisis passed. But it was extremely close, and not a foregone conclusion at all that we could get that done.
Having witnessed that, and knowing the team at LTCM — we had sixteen Ph.D.s from MIT, Harvard, Chicago, Stanford, and Yale, and two Nobel Prize winners — I said, well, if the smartest people in the world in this field with 160-plus IQ’s can get it that badly wrong, they must be missing something. There must be something wrong with the theory, because they’re not stupid. Nobody likes to lose their own money, so there must be something wrong with the theory.
I spent the next 10 years working on this, about five years figuring out what was wrong, where the flaws were, and another five years figuring out what actually works to remedy them. I refined my models enough that in 2005 and 2006 I was warning people that a collapse was coming again. That it would be worse.
Now, I didn’t say, Bear Stearns’ hedge fund is going to fail at the end of July 2007. I didn’t say that Lehman Brothers was going to collapse in mid-September 2008. It wasn’t necessary. It was sufficient to say that the collapse was coming because none of the lessons of 1998 had been learned. I’m in the same state today: the lessons of 2008 have not been learned. I’m watching the dynamics, I’m watching it play out, and you can see the next collapse coming. Here’s the tempo. In 1998, Wall Street bailed out a hedge fund to save the world. In 2008, central banks bailed out Wall Street to save the world. Move forward 10 years — let’s say 2018, to pick a number — and who’s going to bail out the central banks? Each bailout gets bigger than the one before. Each collapse is bigger than the one before, which is exactly what complexity theory would forecast based on the scaling metrics and the dynamics I described.
So who bails out the central banks? There’s only one clean balance sheet left in the world. There’s only one source of liquidity. After all, the Fed took their balance sheet from $800 billion approximately in 2008 to a little over $4 trillion dollars today. The problem is they haven’t normalized. Now that the crisis is long over, they haven’t gone back to the $800-billion-dollar level, which would be a more normal balance sheet. They stayed at $4 trillion; they’re stuck there. They’re not doing more QE, but they are rolling over what they have and they can’t reduce the size of the balance sheet.
What are they going to do in the next crisis? Go to $8 trillion? To $12 trillion? What is the outer boundary of how much money they can actually print? Legally, there is no boundary. They could actually print $12 trillion if they wanted to. At some point, however, you cross this intangible, invisible confidence boundary that I described earlier — and that goes back to the original problem of confidence in any form of money. And all the other central banks are in the same situation. The People’s Bank of China, the Bank of England, the Bank of Japan, the European Central Bank. It’s not unique to the U.S. If the central banks don’t have the wherewithal to liquefy the world in the next panic, and if the next panic is coming and you can see it a mile away, where will the liquidity come from? There’s only one source of liquidity left in the world, which is the IMF. They can print world money, which are the special drawing rights or SDRs.
When you get to the endgame, they’re going to have to print trillions of SDRs (each SDR is worth about $1.50) to re-liquefy the world in a global financial panic. Will that work? In theory it could work, but I expect if it works, it will only be because nobody understands it, like something’s happening and, as Bob Dylan sang in “Ballad of a Thin Man,” “Something’s happening here and you don’t know what it is.” At best, it will be highly inflationary.
Now, maybe it won’t work. Maybe people will say, “I’ve lost confidence in Federal Reserve money and European Central Bank money and Bank of Japan money. Why should I have any more confidence in IMF money? It’s just another form of currency, and I’ve lost confidence in all of them and I’m going to go get some gold.” If that actually happens, the world may have to go to a gold standard. Now, I guarantee there’s not a central bank in the world that wants a gold standard. They may have to go to one, not because they want to, but because they have no choice, because it’s the only way to restore confidence. That raises an interesting question: if you go to a gold standard, what’s the price of gold? I talk about this in The New Case for Gold, about the blunder of 1925 with Churchill taking the U.K. back to a gold standard at a price that Keynes warned him was deflationary. Keynes didn’t favor a gold standard at the time. He did in 1944 and he did in 1914. He didn’t in 1925, but he did tell Churchill if you’re going to do this, you need a much higher price to avoid deflation. Churchill ignored him and threw the U.K. into a depression.
So question is: what is the implied non-deflationary price of gold today? I’ll use M1 of China, U.S., and the ECB, just as a frame. The answer’s $10,000 now if you have 40 percent backing — and over $50,000 if you have 100 percent backing of M2, which is a broader money supply. I don’t think you have to use M2. I don’t think you need 100 percent. It’s a judgement that’s debatable. But even on the modest assumptions of M1 using 40 percent backing, gold would have to be $10,000 an ounce to support the money supply. You may or may not have a gold standard, but if you do gold will be $10,000 an ounce.
Now, if you don’t, if the SDR thing actually works, gold will get to $10,000 an ounce the other way, which is inflation. Gold is going to shoot much higher. In the SDR scenario it will shoot much higher because of inflation, and in the gold-standard scenario it will shoot much higher because it has to, to avoid deflation. It’s not really the price of gold going up, it’s the devaluation of the paper currency. It’s the same thing. The dollar price of gold is just the inverse of the value of the dollar.
OR: Why do you say gold has to be part of a new system? What do you say to the people who think it’s an anachronism?
Rickards: The flaw in that — and I think this is one of the biggest problems today, and certainly an issue with everyone from Milton Friedman to Janet Yellen — is that they take confidence for granted. If you assume that confidence in paper money is infinitely elastic, then there’s no reason why the money supply cannot be infinitely elastic.
There are a lot of gold bashers out there who will be very quick to tell you that gold’s a barbarous relic, blah blah blah. But there are some more thoughtful people out there, among whom I would include Stephanie Kelton, Warren Mosler, Richard Duncan, and others. They’re all different, but they’re smart people. I’ve met a lot of them. Paul McCulley, formerly of PIMCO and a close associate of Bill Gross. They call themselves modern monetary theorists.
I think Adair Turner is coming out this way in his new book, Between Debt and the Devil, and even Larry Summers in some ways. What they’re saying is that there’s nothing you cannot print yourself out of. You get too much deflation? Print more money. Deflation won’t go away? Print more. People won’t spend? The government can spend. Maybe you cannot force people to spend it, but the government loves to spend money, they know how to do that really well. If it increases the deficit, so what? Just issue more debt to cover the deficit, and if people don’t want your debt, the central bank can buy it. Don’t worry about paying it back because the central bank can convert the treasury bonds into perpetual bonds. The whole thing just goes away. You don’t have to worry about the national debt — the Fed can just buy the whole $19 trillion of it, sock it away on their balance sheet, make it a perpetual note, and go play golf. What’s the problem?
This is sometimes called “helicopter money.” It’s called “people’s QE” by Jeremy Corbyn, it’s called “fiscal dominance” by Rick Mishkin. It has different names, but it always says the same thing: there’s no outer boundary on how much money you can print, so what’s the problem?
My thesis — and here I’ll flip over to the behavioral-psychology side a little bit — is that it’s not a problem until it is. In other words, confidence can be sustained until it can’t. You can lose this very quickly, so I don’t believe that confidence is infinitely elastic. There’s nothing in human nature or history that says that. If you’re relying on confidence to say that money can be infinitely elastic, then you’re wrong. The concern is that the elites will go down this road — having been wrong about the wealth effect, about QE1, QE2, and QE3, about Operation Twist — and then they’ll somehow wake up and see they’re wrong again. But they’ll find out the hard way because confidence in the entire system will collapse. At which point, your only two remedies are SDRs and gold.
OR: What’s your take on central banks and gold?
Rickards: With regard to central banks and gold, I always say watch what they do, not what they say. If the U.S. has a budget problem, and we’re sitting on about $380 billion in gold, why don’t you just sell the gold and get some money? That’s what Canada did. That’s what the U.K. did. Why are we hanging onto it?
The question answers itself. Obviously, it has some value. Obviously, it has some role in the monetary system. In my book, I write about a discovery I made — one of those discoveries that’s hiding in plain sight. I had been working on a thesis that the Fed is, at least on occasion, insolvent. My basis for that was to look at the Fed’s balance sheet. They’re leveraged today about 113 to one. That’s unheard of. I’ve been in the hedge-fund business, I’ve been in the investment-banking business, I’ve been in the banking business for decades. Banks leverage maybe 12 to one, broker-dealers and investment banks leverage maybe 15 to one, a hedge fund will lever two or three to one (although that’s getting a little risky). Even Long-Term Capital Management was never leveraged more than 20 to one, and we were very aggressive about leverage. 113 to one is way, way off the charts.
Now, just to be clear, the Fed does not mark its value sheet to market. My thought experiment is: what if they did? There’s a lot of data out there about the composition of the bond holdings of the Fed, particularly those held at the New York Fed. It’s not difficult to get that information, to do some bond math, and mark it to market. Doing that, I discovered that they were in fact insolvent at various times along the way. I had this conversation with several Fed officials. One member of the board of governors, another individual who was not a member of the board, but a very, very close advisor to Bernanke and Yellen, a true insider, a Ph.D. economist, a friend of mine. I was able to have this conversation with him. Interestingly, the member of the board of governors more or less conceded my point, but her rejoinder was, “Well, maybe we’re insolvent, but it doesn’t matter.” In other words, central banks don’t need capital. That’s a point of view.
The other conversation was with the insider: he was adamant that they’ve never been insolvent, ever. Regardless of bond-market moves. He wouldn’t tell me why, so I got to thinking about it. I went back to the balance sheet to see what I was missing. And lo and behold, there was this gold item valued at $42 an ounce. I said, “Well I should mark that to market. If I’m going to mark the bonds to market, I need to mark the gold to market.”
Now, as I was doing this I noticed a couple things. The Fed’s gold holdings are approximately 8,000 tons exactly. Close to exactly the amount held by the U.S. Treasury. In intelligence work, the first rule is there are no coincidences, and this non-coincidence explains why the Treasury stopped selling gold in 1980. Bven as late as the late 70’s, the Treasury was still dumping gold to suppress the price. That’s not speculation; there’s declassified correspondence among President Ford, Henry Kissinger, Arthur Burns, and the Chancellor of Germany that lays this out. The Treasury was actually dumping thousands of tons of gold in the late 1970s, but then in 1980 it just stopped on a dime. The U.S. has sold almost no gold since. Instead, we got everyone else to dump their gold. We got the U.K. to dump six hundred tons in the beginning of 1999. We got Switzerland to dump over a thousand tons in the early 2000s. We got the IMF to dump four hundred tons in 2010. The U.S. has been prevailing upon all these other people to sell their gold, but we won’t sell any ourselves. Why? They can’t. The Treasury has to hold the gold they’ve got in order to honor, on legal and constitutional grounds, the certificate held by the Fed. This was received in exchange for the gold (with an explicit guarantee that the gold was there to backstop the Fed’s balance sheet).
So I was wrong the first time. The Fed has never been insolvent; my insider friend was correct. The reason I was wrong was not because of the bond portfolio, which would have made them insolvent, but because of the gold, which adds about $350 billion to the balance sheet. When you add that to capital on a mark-to-market basis, the leverage ratio drops from 113 to one to about 13 to one, which is pretty healthy for a normal bank. On top of everything else we’re discussing, you find that the Federal Reserve has a hidden asset, which is the value of gold, and that it’s well capitalized — if you count the gold. What does it mean when central bankers and public officials disparage gold, tell you it’s an anachronism, tell you it’s a tradition, tell you it’s a barbarous relic, tell you that you’re a fool to own it — and yet they themselves are propped up and made solvent by gold?
OR: More and more physical gold is leaving the tradable system as China and Russia stockpile it, yet huge derivatives are still being written on it. Can you talk about that disconnect?
Rickards: Well, there is a world of paper gold and there’s a world of physical gold. Now, paper gold to me is not paper gold. It’s paper, but it references the price of gold. There’s not going to be any actual large difference between the paper price and the physical price quoted whether it’s in London or Beijing, because of the arbitrages.
I just recently returned from Switzerland where I met with the head of the country’s biggest gold refinery, who told me that he’s seeing severe shortages in supply. This guy, he knows who all the big sellers are, he knows who all the big buyers are because he’s the biggest gold refiner and he takes it in and ships it out. He knows who all the players are and this is, again, in the physical world. He said that with regard to his selling side, he has more demand than he can handle. He’s sending the Chinese 10 tons a week; they want 20 tons. He won’t provide it because he doesn’t have that much gold and he has other customers to take care of.
The physical shortages are already showing up and they’re getting worse. I’ve heard similar things from wholesale dealers — people who deal directly with London Bullion Market Association members and Comex-approved warehouses. These are the large holders of gold in the world, and they are saying that it is taking longer and longer to fill deliveries. The supply situation is stretched and probably about to break.
Meanwhile, the paper gold market continues to expand with 100-to-one leverage. Warehouses continue to get drawn down, contracts continue to be written. You have a very, very large inverted pyramid, with a broad base of paper gold on top and a tiny sliver of physical gold supporting the whole thing. It’s becoming wobbly, and it’s about to tip over.
Any break in that market — coming back to the issue of confidence — would lead directly to what I would call the mother of all short squeezes and a buying panic. What would I mean by a break? Well, most likely a failure to deliver. Suppose some dealer, some large bank, some exchange, some intermediary somewhere has sold a lot of paper gold and has been called upon by the buyers to deliver. They say, “I don’t want to roll over my contract, I don’t want cash settlement, I want the gold, please. Give me the gold.”
They’re not going to be able to get it. That failure will become public, because it always does, and will create a crisis of confidence. Everyone will run down to their dealers, their exchanges, and their brokers all at once and say, “Give me my gold!” They’ll then discover that there’s only about one percent of what’s needed to fulfill that demand, and there’s nowhere near enough gold in the world at anything close to today’s prices (even if you could find it, which you probably will not be able to) to satisfy those contracts.
What would happen next? The answer is that, since you cannot deliver the gold, you’re going to have to terminate the contract, and it will come as a surprise to a lot of paper gold buyers that such terminations are totally legal. If you actually read the contracts gold buyers sign you’ll find what are called force majeure clauses or material adverse change clauses, meaning gold exchanges have the power to suspend delivery. There’s also what’s called trading for liquidation only, which means you can roll over your contract or close it out, but you cannot take delivery. They have emergency powers to do, really, whatever they want to maintain orderly markets. So what they’ll do is they’ll terminate all these contracts using these contractual and governance provisions. They won’t steal your money, they’ll send you a cash settlement for yesterday’s price. But meanwhile the price of gold today will be going up $200, $300, $400, $500 an ounce. Day after day you’ll be sitting there, watching the exact hyperbolic price movements that were the reason you bought the gold in the first place — and you will not be participating in them.
You will be closed out at exactly the time when you most want the contract. That always happens. That’s the conditional correlation effect. The time you most want it is the time you won’t have it, because it doesn’t work for the other guy. They close you out, send you a check for yesterday’s price, and you’ll miss the move. And by the way, even if you want to jump back in, you won’t be able to buy any. Dealers will be sold out, mints will be backlogged, refiners will be backlogged. They won’t even take your calls. That’s what my friend in Switzerland told me. He said if I didn’t know you and you weren’t already a customer, I wouldn’t take your call. I’m not taking any new business because I cannot supply it.
OR: Can you talk about the so-called war on cash and the potential confiscation of gold?
Rickards: The war on cash is over. The government won. We hear about the cashless society and I think Sweden may be the first to get there. Others are considering it. Larry Summers writes an op-ed on abolishing the 100-dollar bill, and there’s a movement in Europe to get rid of the 500-euro note, so there are a lot of significant legal and political trends against cash. It’s really irrelevant, because we don’t use cash anywhere. You might have a few bucks in your wallet, but people get their paychecks from direct deposit, they get their retirement checks from direct deposit, they pay their bills online, they use their credit cards, they use their debit cards, and there hasn’t been a paper Treasury security issue, I think, since the late 1970’s. The dollar is already a digital currency, and so are all the other major currencies.
To the extent we have any paper money at all, it’s a token. To the point where you buy a two-dollar candy bar, you don’t even reach in your pocket and get out a five, you just swipe your debit card. We already live in a world of digital currencies, with respect to the dollar, the major currencies.
People say, “Yeah, but it’s still legal. I can go down to the bank and get $10,000 or $20,000 and stick it in a safe to avoid negative interest rates or have it for an emergency.” They’re wrong. It’s not that easy. If you go actually do it, actually go down to the bank and ask them for $15,000 or $20,000, you will be treated like a drug dealer or a tax evader. Some banks will tell you to come back in a couple days, that they have to order the cash. There’ll be reams of paperwork to fill out. They’ll file a report with the Treasury.
People are kidding themselves about the ease with which they can get cash. They are locked into a digital system. The war on cash is over and the government won. That’s just the prelude to negative interest rates. It’s like slaughtering pigs: you don’t chase the pigs around a field. You get them into a pen and then you slaughter them. What’s happening with savers is that everyone’s being rounded up into one of four or five digital pens, i.e. Citi and J.P. Morgan and Wells Fargo, and they’re going to be led to the slaughterhouse of negative interest rates.
OR: Do you think we are seeing a currency war going on internationally at the moment?
Rickards: About currency wars, let me say I’m always amused when I see a journalist or someone write a story saying “Oh gee, there’s a currency war. Look at this. China’s weakening against the yen.” I make the point that the most recent currency war started in 2010. I talk about it in my book on the subject which came out in 2011. It’s the same currency war. Wars consist of many battles, wars are not continuous fighting all the time. There are big battles and little battles; there are quiet periods and then a new battle erupts. You have an occasional D-Day or Battle of the Bulge, but some episodes are more intense than others.
Currency wars are the same. There are quiet periods, but it’s the same war. What I call Currency War One lasted from 1921 to 1936. What I call Currency War Two lasted from 1967 to 1987. I make the point that the world is not always in a currency war, but when we are they can go on for a very long time because they have no logical conclusion. It’s just back and forth, with a race to the bottom via competitive devaluations. The only conclusion to a currency war is either systemic reform or systemic collapse. Either the system breaks down completely or people get together, as they did at the Plaza Hotel in 1985, to give the system some coherence.
I don’t see the leadership, I don’t see the giants today. I don’t see people like James Baker, Bob Rubin, George Schultz, or John Maynard Keynes. I don’t see people like that on the landscape. I see a lot of people not of that stature in positions of power. I don’t see any awareness that this collapse is coming. So given the two possible outcomes — systemic reform or systemic collapse — I think systemic collapse is the more likely. But we are in a currency war and have been since 2010. We will be perhaps until 2025. Unless the system collapses earlier, which is what I expect.
James Rickards is an investor and the bestselling author of The New Case for Gold, Currency Wars, and The Death of Money.
President Richard Nixon’s actions in 1971 to end dollar convertibility to gold and implement wage/price controls were intended to address the international dilemma of a looming gold run and the domestic problem of inflation. The new economic policy marked the beginning of the end of the Bretton Woods international monetary system and temporarily halted inflation.
The international monetary system after World War II was dubbed the Bretton Woods system after the meeting of forty-four countries in Bretton Woods, New Hampshire, in 1944. The countries agreed to keep their currencies fixed (but adjustable in exceptional situations) to the dollar, and the dollar was fixed to gold. Since 1958, when the Bretton Woods system became operational, countries settled their international balances in dollars, and US dollars were convertible to gold at a fixed exchange rate of $35 an ounce. The United States had the responsibility of keeping the dollar price of gold fixed and had to adjust the supply of dollars to maintain confidence in future gold convertibility.
Initially, the Bretton Woods system operated as planned. Japan and Europe were still rebuilding their postwar economies and demand for US goods and services—and dollars—was high. Since the United States held about three-quarters of the world’s official gold reserves, the system seemed secure.
In the 1960s, European and Japanese exports became more competitive with US exports. The US share of world output decreased and so did the need for dollars, making converting those dollars to gold more desirable. The deteriorating US balance of payments, combined with military spending and foreign aid, resulted in a large supply of dollars around the world. Meanwhile, the gold supply had increased only marginally. Eventually, there were more foreign-held dollars than the United States had gold. The country was vulnerable to a run on gold and there was a loss of confidence in the US government’s ability to meet its obligations, thereby threatening both the dollar’s position as reserve currency and the overall Bretton Woods system.
Many efforts were made to adjust the US balance of payments and to uphold the Bretton Woods system, both domestically and internationally. These were meant to be “quick fixes” until the balance of payments could readjust, but they proved to be postponing the inevitable.
In March 1961, the US Treasury’s Exchange Stabilization Fund (ESF), with the Federal Reserve Bank of New York acting as its agent, began to intervene in the foreign-exchange market for the first time since World War II. The ESF buys and sells foreign exchange currency to stabilize conditions in the exchange rate market. While the interventions were successful for a time, the Treasury’s lack of resources limited its ability to mount broad dollar defense.
From 1962 until the closing of the US gold window in August 1971, the Federal Reserve relied on “currency swaps” as its key mechanism for temporarily defending the US gold stock. The Federal Reserve structured the reciprocal currency arrangements, or swap lines, by providing foreign central banks cover for unwanted dollar reserves, limiting the conversion of dollars to gold.
In March 1962, the Federal Reserve established its first swap line with the Bank of France and by the end of that year lines had been set up with nine central banks (Austria, Belgium, England, France, Germany, Italy, the Netherlands, Switzerland, and Canada). Altogether, the lines provided up to $900 million equivalent in foreign exchange. What started as a small, short-term credit facility grew to be a large, intermediate-term facility until the US gold window closed in August 1971. The growth and need for the swap lines signaled that they were not just a temporary fix, but a sign of a fundamental problem in the monetary system.
International efforts were also made to stem a run on gold. A run in the London gold market sent the price to $40 an ounce on October 20, 1960, exacerbating the threat to the system. In response, the London Gold Pool was formed on November 1, 1961. The pool consisted of a group of eight central banks (Great Britain, West Germany, Switzerland, the Netherlands, Belgium, Italy, France, and the United States). In order to keep the price of gold at $35 an ounce, the group agreed to pool gold reserves to intervene in the London gold market in order to maintain the Bretton Woods system. The pool was successful for six years until another gold crisis ensued. The British pound sterling devalued and another run on gold occurred, and France withdrew from the pool. The pool collapsed in March 1968.
At that time the seven remaining members of the London Gold Pool (Great Britain, West Germany, Switzerland, the Netherlands, Belgium, Italy, and the United States) agreed to formulate a two-tiered system. The central banks agreed to use their gold only in settling international debts and to not sell monetary gold on the private market. The two-tier system was in place until the US gold window closed in 1971.
These efforts of the global financial community proved to be temporary fixes to a broader structural problem with the Bretton Woods system. The structural problem, which has been called the “Triffin dilemma,” occurs when a country issues a global reserve currency (in this case, the United States) because of its global importance as a medium of exchange. The stability of that currency, however, comes into question when the country is persistently running current account deficits to fulfill that supply. As the current account deficits accumulate, the reserve currency becomes less desirable and its position as a reserve currency is threatened.
While the United States was in the midst of the Triffin dilemma, it was also facing a growing problem of inflation at home. The period that became known as the Great Inflation had started and policymakers had put anti-inflation policies in place, but they were short lived and ineffective. At first, both the Nixon administration and the Federal Reserve believed in a gradual approach, slowly lowering inflation with a minimum increase in unemployment. They would tolerate an unemployment rate of up to 4.5 percent, but by the end of the 1969-70 recession the unemployment rate had climbed to 6 percent, and inflation, as measured by the consumer price index, was 5.4 percent.
When Arthur Burns became chairman of the Board of Governors in 1970, he was faced with both slow growth and inflation, or stagflation. Burns believed that tightening monetary policy and the increase in unemployment that accompanied it would be ineffective against the inflation then occurring, because it stemmed from forces beyond the control of the Fed, such as labor unions, food and energy shortages, and OPEC’s control of oil prices. Moreover, many economists in the administration and at the Fed, including Burns, shared the view that inflation could not be reduced with an acceptable unemployment rate. According to economist Allan Meltzer, Andrew Brimmer, a Fed Board member from 1966 to 1974, noted at that time that employment was the principal goal and fighting inflation was the second priority. The Federal Open Market Committee implemented an expansionary monetary policy.
Bordo, Michael. “The Bretton Woods International Monetary System: A Historical Overview.” In A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, edited by Michael Bordo and Barry Eichengreen, 3-108. Chicago: University of Chicago Press, 1993.
Bordo, Michael D. and Barry Eichengreen, “Bretton Woods and the Great Inflation,” NBER Working Paper 14532, National Bureau of Economic Research, Cambridge, MA, December 2008.
Bordo, Michael, Owen Humpage, and Anna J. Schwartz, “Bretton Woods, Swap Lines, and the Federal Reserve’s Return to Intervention,” Working Paper 12-32, Federal Reserve Bank of Cleveland, Cleveland, OH, November 2012.
Burns, Arthur, “The Anguish of Central Banking,” The 1979 Per Jacobsson Lecture, Belgrade, Yugoslavia, September 30, 1979.
Eichengreen, Barry. Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. New York: Oxford University Press, 2011.
Eichengreen, Barry, “Global Imbalances and the Lessons of Bretton Woods,” NBER Working Paper 10497, National Bureau of Economic Research, Cambridge, MA, May 2004.
Eichengreen, Barry. “Epilogue: Three Perspectives on the Bretton Woods System.” In A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, edited by Michael Bordo and Barry Eichengreen, 621-58, Chicago: University of Chicago Press, 1993.
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Lowenstein, Roger, “The Nixon Shock,” Bloomberg Businessweek, August 4, 2011.
Meltzer, Allan H., “Origins of the Great Inflation,” Federal Reserve Bank of St. Louis Review 87, no. 2, part 2 (March/April 2005): 145–75.
Meltzer, Allan H., “U.S. Policy in the Bretton Woods Era,” Federal Reserve Bank of St. Louis Review 73, no. 3 (May/June 1991): 53–83.
U.S. Department of State Office of the Historian. “The Bretton Woods Conference 1944.” Accessed on October 22, 2013.
Romer, Christina, “Commentary on Meltzer’s Origins of the Great Inflation,” Federal Reserve Bank of St. Louis Review 87, no. 2, part 2, (March/April 2005): 177-85.
Yergin, Daniel, and Joseph Stanislaw. The Commanding Heights. New York: Simon & Schuster, 1998.
Federal Reserve Chair Jerome Powell is grilled by Representative Katie Porter, a California Democrat, during his semi-annual congressional testimony Tuesday for his attendance at a party thrown by Amazon.com Inc. Chief Executive Officer Jeff Bezos last month.
<iframe width=”560″ height=”315″ src=”https://www.youtube.com/embed/8pS1edpeGqI” frameborder=”0″ allow=”accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture” allowfullscreen></iframe>Jesse Ventura visited Google’s Santa Monica office on April 13, 2011 to discuss his new bestseller: “63 Documents the Government Doesn’t Want You to Read.”
Julia Coronado and Simon Potter say recession insurance bonds could activate payments and bypass political wrangling in a crisis.
The coronavirus pandemic that shut down economies around the globe showed how crucial—and difficult—it is to get money swiftly to people who need it most in a crisis. Former central bank officials Simon Potter, who led the Federal Reserve Bank of New York’s markets group, and Julia Coronado, who spent eight years as an economist for the Fed’s Board of Governors, are among the innovators brainstorming solutions. They propose creating a monetary tool that they call recession insurance bonds, which draw on some of the advances in digital payments. Coronado, president and founder of MacroPolicy Perspectives LLC, and Potter, nonresident senior fellow at the Peterson Institute for International Economics, spoke with Bloomberg Markets to explain their idea.
JULIA CORONADO: Congress would grant the Federal Reserve an additional tool for providing support—say, a percent of GDP [in a lump sum that would be divided equally and distributed] to households in a recession. Recession insurance bonds would be zero-coupon securities, a contingent asset of households that would basically lie in wait. The trigger could be reaching the zero lower bound on interest rates or, as economist Claudia Sahm has proposed, a 0.5 percentage point increase in the unemployment rate. The Fed would then activate the securities and deposit the funds digitally in households’ apps.
And so instead of these gyrations we’ve been going through to get money to households, it would happen instantaneously.
SIMON POTTER: It took Congress too long to get money to people, and it’s too clunky. We need a separate infrastructure. The Fed could buy the bonds quickly without going to the private market. On March 15 they could have said interest rates are now at zero, we’re activating X amount of the bonds, and we’ll be tracking the unemployment rate—if it increases above this level, we’ll buy more.
The bonds will be on the asset side of the Fed’s balance sheet; the digital dollars in people’s accounts will be on the liability side.
BM: Aside from speed, what are the main advantages of this approach?
JC: It’s the most efficient from a macroeconomic standpoint in supporting spending and confidence. The fear of unemployment acts as an accelerant on a recession. There’s a shock—people are losing their jobs or worry about losing their jobs. They get very risk-averse. [By] getting money to consumers you can limit the depth and duration of a recession.
And you could actually generate real inflation. It could be beneficial for not only avoiding negative rates but creating a more healthy interest-rate market, a more healthy yield curve.
BM: What are the origins of the idea?
JC: The Bank of England has proposals for digital currency. And a number of people have talked about the need for monetary financing—the idea that the interest-rate tool is simply less effective in lower growth, slower credit growth economies. Helicopter money [making direct payments to the public] goes back to Milton Friedman, but Ben Bernanke revisited it.
Some people proposed doing that through financing fiscal stimulus. We think going directly to consumers is more efficient than wading through that sticky fiscal process.
BM: This policy could be complementary to Treasury stimulus?
JC: It’s not a replacement for fiscal policy. It makes sense from a fiscal perspective, for example, to authorize unemployment insurance benefits for people who lose their jobs and other assistance for medical-care providers in the current situation.
SP: The central bank is not elected. It cannot make allocation decisions about fiscal transfers. It’s now being pushed to make allocation decisions around credit with the Treasury, because we believe this situation is so unique that the private sector cannot make those decisions itself.
The simplest way to do this would be a lump sum. Not in the way Congress did it. We’d take the bluntness of monetary policy and say anyone who’s eligible should get the same amount of bonds.
Fiscal controls could use the same infrastructure. The imperative to invest in it is high. Nearly all Treasury payments at some point touch the Fed because it’s the Treasury’s bank. The digital payment providers—called interface providers in the Bank of England proposal—would manage these accounts and link them to the Fed and Treasury.
BM: What are the objections from the Fed, and other challenges?
SP: The reaction from some of my former colleagues a while ago to the notion of helicopter money was not the most embracing. Some of those concerns have disappeared.
The two objections were related to the switch of deposits in normal times from the traditional banking system into digital accounts and the extra stress in crisis times as people want to get safe. An account with the central bank is safe because the central bank can always print money to honor that claim. A private bank can’t do that because their asset side has all kinds of credit on it. What we’ve created is a narrow bank-type model [narrow banks only take deposits and invest them in the safest assets] that’s small and fit for purpose, with a cap of $10,000 [per person].
JC: One challenge is making it profitable for digital providers. We want strict limitations on the fees so we’re reaching people that are underbanked, but we also want a public-private partnership with a diversity of competitors jumping into this market.
Privacy is just as important, because one thing that might induce them is access to people’s data. As the Fed, are you blessing that, and what structure do you put around that?
SP: We’ll all have to deal with deep questions of privacy in the digital world. One of the issues Congress had in passing the Cares Act is identifying who’s got mainly tip income, who doesn’t have sick days. If society wanted, you could use large datasets to direct fiscal transfers to those people. But that’s a job for Congress.
BM: Have you seen similar trials elsewhere?
SP: Sweden is a leader in thinking about this in part because they had a large decline in cash use. China is testing versions of digital currency. Fintech firms in the U.S. are interested in this—there’s a stable coin version of our proposal.
There’s easily sufficient innovation within the U.S. to do this. How to do it in a way that’s well regulated and serving the public purpose is something the Fed should focus on over the next few years. It would be a key accomplishment of the Fed and Treasury to get this infrastructure in place.
How The Fed Bubble Will Burst | The Stock Market Bubble Explained Recently I have highlighted how the liquidity provided by the Federal Reserve (Fed) has driven the stock market to new highs and, if the Fed continues to provide liquidity the stock market will continue to rise higher. This has left many people wondering if the stock market is a bubble and, if so, how and when will the stock market bubble burst. In this video I describe the dynamics of the current stock market bubble and some likely scenarios for how the stock market bubble might burst.