Bretton Woods, Nixon Shock, OPEC, Yom Kippur War, Oil Embargo, Stagflation, Paul Volcker, Ronald Reagan and Morning in America

Posted by PITHOCRATES - October 1st, 2013

History 101

(Originally published September 18th, 2012)

Under the Bretton Woods System the Americans promised to Exchange their Gold for Dollars at $35 per Ounce

Wars are expensive.  All kinds.  The military kind.  As well as the social kind.  And the Sixties gave us a couple of doozies.  The Vietnam War.  And the War on Poverty.  Spending in Vietnam started in the Fifties.  But spending, as well as troop deployment, surged in the Sixties.  First under JFK.  Then under LBJ.  They added this military spending onto the Cold War spending.  Then LBJ declared a war on poverty.  And all of this spending was on top of NASA trying to put a man on the moon.  Which was yet another part of the Cold War.  To beat the Soviets to the moon after they beat us in orbit.

This was a lot of spending.  And it carried over into the Seventies.  Giving President Nixon a big problem.  As he also had a balance of payments deficit.  And a trade deficit.  Long story short Nixon was running out of money.  So they started printing it.  Which caused another problem as the US was still part of the Bretton Woods system.  A quasi gold standard.  Where the US pegged the dollar to gold at $35 per ounce.  Which meant when they started printing dollars the money supply grew greater than their gold supply.  And depreciated the dollar.  Which was a problem because under Bretton Woods the Americans promised to exchange their gold for dollars at $35 per ounce.

When other nations saw the dollar depreciate so that it would take more and more of them to buy an ounce of gold they simply preferred having the gold instead.  Something the Americans couldn’t depreciate.  Nations exchanged their dollars for gold.  And began to leave the Bretton Woods system.    Nixon had a choice to stop this gold outflow.  He could strengthen the dollar by reducing the money supply (i.e., stop printing dollars) and cut spending.  Or he could ‘close the gold window’ and decouple the dollar from gold.  Which is what he did on August 15, 1971.  And shocked the international financial markets.  Hence the name the Nixon Shock.

When the US supported Israel in the Yom Kippur War the Arab Oil Producers responded with an Oil Embargo

Without the restraint of gold preventing the printing of money the Keynesians were in hog heaven.  As they hated the gold standard.  The suspension of the convertibility of gold ushered in the heyday of Keynesian economics.  Even Nixon said, “I am now a Keynesian in economics.”  The US had crossed the Rubicon.  Inflationary Keynesian policies were now in charge of the economy.  And they expanded the money supply.  Without restraint.  For there was nothing to fear.  No consequences.  Just robust economic activity.  Of course OPEC didn’t see it that way.

Part of the Bretton Woods system was that other nations used the dollar as a reserve currency.  Because it was as good as gold.  As our trading partners could exchange $35 for an ounce of gold.  Which is why we priced international assets in dollars.  Like oil.  Which is why OPEC had a problem with the Nixon Shock.  The dollars they got for their oil were rapidly becoming worth less than they once were.  Which greatly reduced what they could buy with those dollars.  The oil exporters were losing money with the American devaluation of the dollar.  So they raised the price of oil.  A lot.  Basically pricing it at the current value of gold in US dollars.  Meaning the more they depreciated the dollar the higher the price of oil went.  As well as gas prices.

With the initial expansion of the money supply there was short-term economic gain.  The boom.  But shortly behind this inflationary gain came higher prices.  And a collapse in economic activity.  The bust.  This was the dark side of Keynesian economics.  Higher prices that pushed economies into recessions.  And to make matters worse Americans were putting more of their depreciated dollars into the gas tank.  And the Keynesians said, “No problem.  We can fix this with some inflation.”  Which they tried to by expanding the money supply further.  Meanwhile, Egypt and Syria attacked Israel on October 6, 1973, kicking off the Yom Kippur War.  And when the US supported their ally Israel the Arab oil producers responded with an oil embargo.  Reducing the amount of oil entering America, further raising prices.  And causing gas lines as gas stations ran out of gas.  (In part due to Nixon’s price controls that did not reset demand via higher prices to the reduced supply.  And a ceiling on domestic oil prices discouraged any domestic production.)  The Yom Kippur War ended about 20 days later.  Without a major change in borders.  With an Israeli agreement to pull their forces back to the east side of the Suez Canal the Arab oil producers (all but Libya) ended their oil embargo in March of 1974.

It was Morning in America thanks to the Abandonment of Keynesian Inflationary Policies

So oil flowed into the US again.  But the economy was still suffering from high unemployment.  Which the Keynesians fixed with some more inflation.  With another burst of monetary expansion starting around 1975.  To their surprise, though, unemployment did not fall.  It just raised prices.  Including oil prices.  Which increased gas prices.  The US was suffering from high unemployment and high inflation.  Which wasn’t supposed to happen in Keynesian economics.  Even their Phillips Curve had no place on its graph for this phenomenon.  The Keynesians were dumfounded.  And the American people suffered through the malaise of stagflation.  And if things weren’t bad enough the Iranians revolted and the Shah of Iran (and US ally) stepped down and left the country.  Disrupting their oil industry.  And then President Carter put a halt to Iranian oil imports.  Bringing on the 1979 oil crisis.

This crisis was similar to the previous one.  But not quite as bad.  As it was only Iranian oil being boycotted.  But there was some panic buying.  And some gas lines again.  But Carter did something else.  He began to deregulate oil prices over a period of time.  It wouldn’t help matters in 1979 but it did allow the price of crude oil to rise in the US.  Drawing the oil rigs back to the US.  Especially in Alaska.  Also, the Big Three began to make smaller, more fuel efficient cars.  These two events would combine with another event to bring down the price of oil.  And the gasoline we made from that oil.

Actually, there was something else President Carter did that would also affect the price of oil.  He appointed Paul Volcker Chairman of the Federal Reserve in August of 1979.  He was the anti-Keynesian.  He raised interest rates to contract the money supply and threw the country into a steep recession.  Which brought prices down.  Wringing out the damage of a decade’s worth of inflation.  When Ronald Reagan won the 1980 presidency he kept Volcker as Chairman.  And suffered through a horrible 2-year recession.  But when they emerged it was Morning in America.  They had brought inflation under control.  Unemployment fell.  The economy rebounded thanks to Reagan’s tax cuts.  And the price of oil plummeted.  Thanks to the abandonment of Keynesian inflationary policies.  And the abandonment of oil regulation.  As well as the reduction in demand (due to those smaller and more fuel efficient cars).  Which created a surge in oil exploration and production that resulted in an oil glut in the Eighties.  Bringing the price oil down to almost what it was before the two oil shocks.

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2012 Endorsements: Alexander Hamilton

Posted by PITHOCRATES - October 18th, 2012

2012 Election

When Hamilton looked out Across the Vast North American Continent he saw Great Economic Opportunity

Alexander Hamilton was born in the British West Indies.  At the age of eleven he had to get a job.  As his father abandoned his family after losing all the family money.  Young Alexander worked at Cruger and Beckman’s.  a New York trading house.  A window onto the world.  And international trade.  Where young Alexander learned about the world.  And business.  He had a gift for numbers.  He was bright.  And driven.  Born in the British West Indies he was also something else.  A Founding Father without any state lineage.  With no provincial views.  During the prelude to American independence when other patriots talked about the states going their own way he was already thinking of an American union.  And only of an American union.

The British response to the Boston Tea Party was the Intolerable Acts.  Or the Coercive Acts in Britain.  Where the British put the hurt on Boston.  And Massachusetts.  To separate it and isolate it from the rest of the colonies.  Reverend Samuel Seabury took to the papers and argued against uniting the other colonies to support Massachusetts.  That the people should support their king.  And Parliament.  And not the spoiled, trouble-making people of Boston.  Hamilton took to the papers and argued in support of union.  And Boston.  Warning the people that this was just the beginning for Britain.  More taxes would certainly follow.  Hamilton warned the people to put away their sectional differences.  As this attack on one was an attack on all.  And that if they gave up on Boston it would only be a matter of time before other colonies met the same fate.

That was all well and fine during the warm months of summer.  But the American colonies were part of the British Empire.  Which was a mercantilist empire.  Whose colonies shipped raw materials to the mother country.  And the proceeds from those sales were used to buy manufactured goods made from those raw materials in the mother country.  Making the colonists dependent on Britain for their clothing.  The lack of which would make a very cold and miserable winter.  Which led a lot of people to agree with Reverend Samuel Seabury.  But not Hamilton.  For he looked out across the American colonies and saw something else.  Economic independence.  The South had cotton.  The North could raise sheep for wool.  And they could build factories in the cities to make cloth and clothing.  Staffed by skilled immigrants from European factories.  This is what Hamilton saw when he looked out across the vast North American continent.  Great economic opportunity.  Made possible by an American union.

Hamilton spent the Winter Seasons at Valley Forge and Morristown Reading and Studying Economics and Public Finance

When the Revolutionary War came Hamilton joined the Continental Army.  Fought bravely.  Then ended up as General Washington’s aide-de-camp.  Serving in Washington’s inner circle he knew what the commanding general knew.  And he knew the sorry state of the army.  Half-naked, hungry and unpaid.  While some civilians were living the life of Riley.  Making a fortune off of hording commodities and selling them at high prices.  Which they could do with impunity as the Continental Congress was powerless to stop them.  As it was at the mercy of the states.  The national congress was broke and had little legal authority.  Which let the speculators run roughshod over it.  Leaving the people sacrificing the most for independence half-naked, hungry and unpaid.  Diminishing the fighting ability of the army.  Which greatly increased the risk of defeat.

Hamilton learned an important lesson.  The stronger the national government was, and the richer it was, the easier it was to wage war.  And the easier it was NOT to be defeated in war.  The problem here was that the national government was too weak.  While the state governments were too strong.  Which was fine for the people living normal lives in their states.  But not the soldiers in the field fighting for the nation.  Making things worse was inflation.  The Continental Congress was printing money.  As were the states.  And the more they printed the more they depreciated it.  Which led to even higher prices.  More profits for the speculators.  And even more hardship for the army.  Which had to at times take things from the local people in exchange for IOUs.  Making these people hate the army.  And the army hate the people.  As they were the ones risking life and limb for what was to them an ungrateful people.

Hamilton spent the winter seasons at Valley Forge and Morristown reading and studying economics and public finance.  And set out to solve the inflation problem.  What he learned was that a lot of people were benefiting by the rampant inflation.  Debtors loved it.  For the greater the inflation was the easier it was to repay loans in those depreciated dollars.  Especially the farmers.  They sold their produce at ever higher prices.  Borrowed money to buy land (and repaid those loans in depreciated dollars).  While escaping much of the ravages of inflation themselves.  Because they were farmers.  And were self-sufficient.  Eating what they grew.  Even making their own clothes.  For some inflation was a way to get rich quick at the detriment of others.  To help dissuade such activity Hamilton suggested high taxes in kind (if a farm grew wheat that they turned into flour they would pay a portion of their flour to the government as a tax) on those benefitting from inflation who where destroying the confidence in the dollar.

If Hamilton were Alive Today he would likely Endorse the Republican Candidates Mitt Romney and Paul Ryan

Hamilton also suggested a plan for a national bank.  To help restore the credit of the United States.  And to provide a source of credit for the national government.  The bank would be owned half by the government and half by rich investors.  By letting the rich investors make money on the bank it would, of course, encourage them to invest in the bank.  And provide capital the government could borrow.  Hamilton believed in bringing the rich people closer to the government.  So the government had access to their money.  Both would win in such a partnership.  And both would have a vested interest in seeing the government succeed.  The Continental Congress used some of Hamilton’s ideas.  But not enough to bring his vision to life.  He would get another chance, though.  When he became America’s first Secretary of the Treasury.

At the end of the Revolutionary War the United State’s finances were in a mess.  State governments and the national government owed money.  As they used that money to prosecute the war Hamilton believed the national government should assume the states’ debts and roll in into the national debt.  And, more importantly, the new national debt would help strengthen the union.  By binding the states to the national government.  These actions also helped to restore the nation’s credit.  Allowing it to borrow money to repay old debts.  As well as finance new spending.  Hamilton also got his bank.  And he produced a report on manufacturers.  A plan to use government funds to help launch American industry.  So they could catch up to Great Britain.  And even surpass the former mother country.

Hamilton pushed for these things because he wanted to use the power of government to make America strong and fiercely independent in the world of nations.  With an economic plan that would make the nation wealthy.  And allowing it to afford a military that equaled or surpassed Great Britain.  He did not want to make America wealthy to implement a massive welfare state.  His idea of partnering government with business was to make an American Empire modeled on the British Empire.  Making it a rich military superpower.  Able to project force.  Maintaining peace through strength.  Much like the British did with their Pax Britannica that he didn’t live to see.  And to protect what it had from anyone trying to take it away from them.  So based on this who would he endorse in the 2012 election?  The party that had business-friendly policies to encourage economic growth.  The party that was more anti-inflation.  The party that would best exploit the nation’s resources.  And the party that favored a strong military.  Which is NOT the Democrat Party.  No, if Alexander Hamilton were alive today he would likely endorse the Republican candidates Mitt Romney and Paul Ryan.

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Bretton Woods, Nixon Shock, OPEC, Yom Kippur War, Oil Embargo, Stagflation, Paul Volcker, Ronald Reagan and Morning in America

Posted by PITHOCRATES - September 18th, 2012

History 101

Under the Bretton Woods System the Americans promised to Exchange their Gold for Dollars at $35 per Ounce

Wars are expensive.  All kinds.  The military kind.  As well as the social kind.  And the Sixties gave us a couple of doozies.  The Vietnam War.  And the War on Poverty.  Spending in Vietnam started in the Fifties.  But spending, as well as troop deployment, surged in the Sixties.  First under JFK.  Then under LBJ.  They added this military spending onto the Cold War spending.  Then LBJ declared a war on poverty.  And all of this spending was on top of NASA trying to put a man on the moon.  Which was yet another part of the Cold War.  To beat the Soviets to the moon after they beat us in orbit.

This was a lot of spending.  And it carried over into the Seventies.  Giving President Nixon a big problem.  As he also had a balance of payments deficit.  And a trade deficit.  Long story short Nixon was running out of money.  So they started printing it.  Which caused another problem as the US was still part of the Bretton Woods system.  A quasi gold standard.  Where the US pegged the dollar to gold at $35 per ounce.  Which meant when they started printing dollars the money supply grew greater than their gold supply.  And depreciated the dollar.  Which was a problem because under Bretton Woods the Americans promised to exchange their gold for dollars at $35 per ounce.

When other nations saw the dollar depreciate so that it would take more and more of them to buy an ounce of gold they simply preferred having the gold instead.  Something the Americans couldn’t depreciate.  Nations exchanged their dollars for gold.  And began to leave the Bretton Woods system.    Nixon had a choice to stop this gold outflow.  He could strengthen the dollar by reducing the money supply (i.e., stop printing dollars) and cut spending.  Or he could ‘close the gold window’ and decouple the dollar from gold.  Which is what he did on August 15, 1971.  And shocked the international financial markets.  Hence the name the Nixon Shock.

When the US supported Israel in the Yom Kippur War the Arab Oil Producers responded with an Oil Embargo

Without the restraint of gold preventing the printing of money the Keynesians were in hog heaven.  As they hated the gold standard.  The suspension of the convertibility of gold ushered in the heyday of Keynesian economics.  Even Nixon said, “I am now a Keynesian in economics.”  The US had crossed the Rubicon.  Inflationary Keynesian policies were now in charge of the economy.  And they expanded the money supply.  Without restraint.  For there was nothing to fear.  No consequences.  Just robust economic activity.  Of course OPEC didn’t see it that way.

Part of the Bretton Woods system was that other nations used the dollar as a reserve currency.  Because it was as good as gold.  As our trading partners could exchange $35 for an ounce of gold.  Which is why we priced international assets in dollars.  Like oil.  Which is why OPEC had a problem with the Nixon Shock.  The dollars they got for their oil were rapidly becoming worth less than they once were.  Which greatly reduced what they could buy with those dollars.  The oil exporters were losing money with the American devaluation of the dollar.  So they raised the price of oil.  A lot.  Basically pricing it at the current value of gold in US dollars.  Meaning the more they depreciated the dollar the higher the price of oil went.  As well as gas prices.

With the initial expansion of the money supply there was short-term economic gain.  The boom.  But shortly behind this inflationary gain came higher prices.  And a collapse in economic activity.  The bust.  This was the dark side of Keynesian economics.  Higher prices that pushed economies into recessions.  And to make matters worse Americans were putting more of their depreciated dollars into the gas tank.  And the Keynesians said, “No problem.  We can fix this with some inflation.”  Which they tried to by expanding the money supply further.  Meanwhile, Egypt and Syria attacked Israel on October 6, 1973, kicking off the Yom Kippur War.  And when the US supported their ally Israel the Arab oil producers responded with an oil embargo.  Reducing the amount of oil entering America, further raising prices.  And causing gas lines as gas stations ran out of gas.  (In part due to Nixon’s price controls that did not reset demand via higher prices to the reduced supply.  And a ceiling on domestic oil prices discouraged any domestic production.)  The Yom Kippur War ended about 20 days later.  Without a major change in borders.  With an Israeli agreement to pull their forces back to the east side of the Suez Canal the Arab oil producers (all but Libya) ended their oil embargo in March of 1974.

It was Morning in America thanks to the Abandonment of Keynesian Inflationary Policies

So oil flowed into the US again.  But the economy was still suffering from high unemployment.  Which the Keynesians fixed with some more inflation.  With another burst of monetary expansion starting around 1975.  To their surprise, though, unemployment did not fall.  It just raised prices.  Including oil prices.  Which increased gas prices.  The US was suffering from high unemployment and high inflation.  Which wasn’t supposed to happen in Keynesian economics.  Even their Phillips Curve had no place on its graph for this phenomenon.  The Keynesians were dumfounded.  And the American people suffered through the malaise of stagflation.  And if things weren’t bad enough the Iranians revolted and the Shah of Iran (and US ally) stepped down and left the country.  Disrupting their oil industry.  And then President Carter put a halt to Iranian oil imports.  Bringing on the 1979 oil crisis.

This crisis was similar to the previous one.  But not quite as bad.  As it was only Iranian oil being boycotted.  But there was some panic buying.  And some gas lines again.  But Carter did something else.  He began to deregulate oil prices over a period of time.  It wouldn’t help matters in 1979 but it did allow the price of crude oil to rise in the US.  Drawing the oil rigs back to the US.  Especially in Alaska.  Also, the Big Three began to make smaller, more fuel efficient cars.  These two events would combine with another event to bring down the price of oil.  And the gasoline we made from that oil.

Actually, there was something else President Carter did that would also affect the price of oil.  He appointed Paul Volcker Chairman of the Federal Reserve in August of 1979.  He was the anti-Keynesian.  He raised interest rates to contract the money supply and threw the country into a steep recession.  Which brought prices down.  Wringing out the damage of a decade’s worth of inflation.  When Ronald Reagan won the 1980 presidency he kept Volcker as Chairman.  And suffered through a horrible 2-year recession.  But when they emerged it was Morning in America.  They had brought inflation under control.  Unemployment fell.  The economy rebounded thanks to Reagan’s tax cuts.  And the price of oil plummeted.  Thanks to the abandonment of Keynesian inflationary policies.  And the abandonment of oil regulation.  As well as the reduction in demand (due to those smaller and more fuel efficient cars).  Which created a surge in oil exploration and production that resulted in an oil glut in the Eighties.  Bringing the price oil down to almost what it was before the two oil shocks.

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