On August 15, 1971, Richard Nixon announced to the nation an end to the Bretton Woods agreement that was instituted around the end of World War 2. This put an end to the last remnant of the gold standard for the U.S. dollar.
Gold, in most forms, had been illegal to be held by Americans since the authoritarian Franklin Roosevelt dictated so right upon taking office in 1933. But despite this, and despite the creation of the Federal Reserve in 1913, gold could still be redeemed by foreign governments for their U.S. dollars.
Charles de Gaulle of France took advantage of this in the 1960s. With the government’s “guns and butter” under Lyndon Johnson, the dollar was being inflated. This is what happens when you are supporting a welfare state or a warfare state, and especially so when you are supporting both.
It presented a problem for the U.S. government that France was redeeming gold for dollars because the U.S. government would eventually run out of gold. This is what happens when you print money. You can’t maintain a gold standard unless you continually reduce the amount of gold that can be redeemed per dollar, but that wouldn’t be much of a gold standard.
Many people blame Nixon for completely abandoning the gold standard, which is fine. Nixon really was a big government guy. When he announced the end of gold redeemability, he also announced wage and price controls. He was not a free market guy.
Still, I don’t think things would have turned out much different if someone else had been president during this time. Something had to change. The government was going to run out of gold. If it didn’t break the promise of exchanging gold for dollars, then it would have had to get the Fed to stop printing money, or perhaps even deflating the money supply. This was not going to happen.
Monetary deflation only happened later in 1979 when there was double-digit price inflation and double-digit interest rates. It is almost inconceivable in today’s world when the 10-year yield sits at about 2.5% and you can get a fixed mortgage rate around 4%.
Paul Volcker became chairman of the Federal Reserve in August 1979. He almost immediately slammed on the monetary brakes. He allowed interest rates to rise in accordance to market levels. It led to back-to-back recessions in the early 1980s. Some would say it was just one big recession. It helped defeat Jimmy Carter, but Carter may have lost to Reagan anyway.
We are accustomed to the establishment cheering on money printing (or its electronic equivalent). But in 1979, I think Volcker’s deflation was quietly supported by the establishment. It helped to save the dollar. If the Fed had just kept its monetary inflation going, the dollar may have slipped into something close to hyperinflation.
Consumer Prices
If you go to the BLS website and calculate consumer price inflation, it tells us that prices have risen extraordinarily since 1971. If you plug in a value of $100 in August 1971, that is equivalent to $626.34 today (April 2019). For a period of less than 50 years, that is a lot of depreciation, especially considering that the U.S. dollar is the world’s reserve currency. We aren’t Argentina or Venezuela.
Everything seems relatively calm right now in the financial markets. Stocks have been a little volatile, but mostly up for the last decade. The reported unemployment is low. The federal deficits are incredibly high, especially for a period that is supposed to represent prosperity. Yet, consumer price inflation, at least as reported by the government, is relatively low.
Warren Buffett does not think this is sustainable. I don’t agree with Buffett on a lot of economic points, but on this one I do. His 95-year old business partner, Charlie Munger, is warning about using money printing to solve all of our problems. He is pointing out that we can’t just print money like crazy without consequences.
I do not believe we are going to hit a point of hyperinflation, as some alarmists do. I don’t think it’s impossible, but I don’t think it’s likely. The powers-that-be are not going to shoot themselves in their collective feet. Hyperinflation would risk their own well-being.
With that said, I don’t think consumer price inflation, as measured by the government, is going to stay forever under 3%. The median CPI has already been running at 2.8% annually. I also don’t think the government statistics fully account for the increased cost of living for the average middle class American. The decreasing price of electronics does not offset the massive increase in health insurance costs.
A good portion of the increased costs in healthcare is due to government regulation and interference, but monetary policy does have an impact too. Regardless, no matter the cause, this is a real and substantial increase that most Americans have faced.
When the next recession hits, it is likely that the Fed will go back to a policy of monetary inflation. I don’t know if it will be to the same degree as we saw beginning in the fall of 2008.
It is also questionable on what will happen in the economy. Will we see a Japan-like scenario where consumer prices stay relatively tame and there is just an overall drag on the economy? Or will it be more like 1970s America again where there is high price inflation, high interest rates, and periods of recession? I tend to lean more to the latter, but we can’t be certain.
I think Japan will actually be something of a canary in the coalmine. Japan has most of the same issues as the U.S., except they seem to be magnified. The debt is higher, the spending is higher, and the monetary inflation is higher. It’s just that the Japanese tend to be very obedient to their government. They are so patriotic that some of them continue to buy the government’s debt, even at near zero or negative interest rates.
Most Americans are not going to buy U.S. government debt that pays a zero percent interest rate. They are more likely to buy gold or real estate.
It’s hard to say where this goes next, but Buffett and Munger are correct that the current situation is not sustainable. Something has to give.