As the story goes…
On the afternoon of Friday, August 13, 1971, Federal Reserve banking officials along with twelve other high-ranking White House and Treasury advisors met secretly with President Richard Nixon at Camp David. There was great debate about what Nixon should do, but ultimately Nixon, relying heavily on the advice of the self-confident Connally, decided to break up Bretton Woods by announcing the following on August 15:
Nixon directed Treasury Secretary Connally to suspend, with certain exceptions, the convertibility of the dollar into gold or other reserve assets, ordering the gold window to be closed such that foreign governments could no longer exchange their dollars for gold.
The significance of this policy action would slowly be felt over the next 50 years and puts us where we are today. The end of the US$ peg put the global monetary system on a floating exchange rate basis and currency trading exploded. However, in the 1970s and mid- 80s the US monetary authorities and markets were still operating under the previous regime where government borrowing and spending was restrained by gold redemptions, even though the redemptions had been closed. In 1981-82, Fed chairman Volcker contracted credit with sharply higher interest rates, plunging the US into a steep recession but wringing CPI inflation out of the system.
Credit became quite cheap, fueling a rapid technology-driven expansion in the mid-1980s that strengthened the US$. Then Volcker was replaced by Greenspan and soon after Black Monday hit the global markets that had been flying high on cheap credit. It was then that the Fed realized it had an open checkbook to throw at the markets and prevent them from crashing. This has been the policy ever since because the only consequence of excessive credit has been financial asset bubbles, primarily securities markets and real estate.
But fomenting asset bubbles has created severe disparities between those who own assets and those who don’t. During this period, the economic liberalization of the two most populous societies on the planet – China and India – has driven the world price of labor down across the board, depreciating the value of that labor, constraining cost-push inflation of consumer prices.
These three trends – cheap credit, technology, and globalization – have promoted casino capitalism encompassing asset speculation and the massive substitution of cheap capital for more expensive labor, reducing labor participation rates across developed countries, and greatly aggravating wealth and income inequality.
This puts us where we are today and unfortunately the cheap credit and technology trends are accelerating. Most people today think Donald Trump has something to do with our plight, but that’s absurd on the face of it. This has been a 50-year trend in policy choices by a slowly degenerating political class under the Federal Reserve in coordination with other developed countries’ central banks. It’s all great fun until the bubble bursts.
So, how much is your house worth? Don’t kid yourself. At some point, all asset prices will reflect real value or phony currency value. There will be a massive battle between those who possess the assets and those who hold the debts used to buy them.
As propounded by Herbert Stein’s Law, “If something cannot go on forever, it will stop.”