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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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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The Obama Reelection Strategy: Increase Gas Prices to Crash Economy to Lower Gas Prices

Posted by PITHOCRATES - April 29th, 2011

The 2nd Largest Oil Reserves in the World

Saudi Arabia has the largest oil reserves in the world.  Take a guess who has the 2nd largest oil reserves in the world.  Kuwait?  Iraq?  Iran?  Libya?  Nigeria?  Venezuela?  Qatar?  Angola?  Algeria?  Ecuador?  United Arab Emirates?  No.  No.  No.  No.  No.  Uh…um, no.  No.  No.  No.  No.  No.  Could it be the United States?  It could be.  But it’s not.  With so much U.S. land off limits to drilling who knows how much oil they have.  So who has the second largest oil reserves in the world?  Here’s a hint.  Think Wayne Gretzky.  Who used to play on a team called the Oilers.  In the city of Edmonton.  In the province of Alberta.  In, of course, Canada.

Yes, Canada has the second largest oil reserves in the world.  But this oil reserve isn’t in pools underground waiting for someone to pump it up.  It’s in the Athabasca oil sands.  Think of hot oil spilled into sand which then cools into a thick tar.  Once upon a time this type of oil was worthless.  Because you just couldn’t drill for it and pump it.  You have to process this tar into useful oil.  And the cost to do this used to be prohibitive.  But with the price of oil today, this once worthless tar is now a very valuable form of crude oil.

America, the world’s largest economy, imports the majority of her oil from Canada.  In fact, the Canadians export more oil to the U.S. than they consume themselves.  Which is rather interesting when you consider Canadian gas prices are higher than American gas prices.  Now oil is oil.  And one would assume that the Canadians make their gasoline from the same oil we make our gasoline from.  Canadian oil.  Yet their gas prices are higher than in the U.S.  Why?  Because when it comes to their gasoline, they’re a lot like the Europeans.  They tax the bejesus out of it.  Taxes average about a third of the price at pump.

Even with all that Oil Canadian Gas Prices are High

With the world’s second largest oil reserves, one can’t blame the lack of supply for high prices.  They have supply.  So much that they export more than they use.  Could they have a refinery shortage?  If they did, they could fix that easily by building more refineries.  I mean, with the domestic oil reserves, the Canadians are in the driver’s seat when it comes to their gasoline prices.  It would be pretty darn hard for their gas prices to be ‘too high’ to affect their economy.  So how are the little guys doing in Canada?  The small business owners (see Rising fuel costs hit small businesses by Anita Elash posted 4/29/2011 on The Globe and Mail)?

Steak is off the menu, comfort food is in and prices are up by as much as 20 per cent at the Yellow Belly Brewery in St. John’s, Nfld., this spring, partly because of rising fuel costs.

Owner Brenda O’Reilly says her expenses have increased steadily since she opened her micro-brewery and gastro pub three years ago, but the sudden price hike at the gas pumps this year has been “the straw that broke the camel’s back.”

In addition to coping with higher labour costs and escalating commodity prices, her main supplier has slapped a steadily rising fuel surcharge, now up to $3.50, on every delivery – a cost that significantly cuts into profits.

I guess the price of Canadian gas can be ‘too high’. 

Forced menu changes and higher restaurant prices are just one of the ways record-high fuel costs are affecting small business this spring. Surveys for the Canadian Federation of Independent Business show that fuel costs are now the biggest concern for small business owners. Seventy-five per cent of members said they’re worried about rising fuel prices, compared to 50 per cent who were worried two years ago.

CFIB chief economist Ted Mallett said wide fluctuations in fuel prices over the past few years have created a lot of uncertainty for business owners and make planning especially difficult. Many have signed contracts or service agreements based on costs several months ago, and “if they guessed wrong about fuel prices, it comes out of their bottom line.”

These are the kind of problems they’re having in the U.S.  Because the Americans have no control over gas prices.  They are at the mercy of the oil exporters.  Exporters like Canada.  Which begs the question.  How can both the United States and Canada have such high gas prices?  If the Canadians are getting rich off of the Americans, they should be able to lower their own gas prices.  If they’re giving the oil away, then the Americans should be able to lower their gas prices.  It’s hard to imagine how the second largest oil reserves in the world results in high prices in both the U.S. and Canada.  Unless they’re both taxing the bejesus out of their gasoline.

High Gas Prices Kill Anemic Economic Recovery

The Canadian consumer is making things hard for Canadian small business.  And it’s no different in the U.S. (see Gas costs siphon off much of March rise in incomes by Martin Crutsinger, Associated Press, posted 4/29/2011 on USA Today).

Consumer spending had been expected to post solid gains this year, helped by stronger employment growth and a two percentage-point cut in Social Security payroll taxes. But Americans are paying more for gas, prompting economists to scale back their growth forecasts…

“The increase in prices is absorbing pretty much all of the windfall from the payroll tax cut,” said Paul Dales, an economist with Capital Economics. “If gasoline prices were to stop rising, real consumption could bounce back in the second quarter. But even then, jobs growth and wage growth are not strong enough to result in a significant and sustained acceleration in consumption growth. This economic recovery is going to continue to disappoint both this year and next.”

Consumers are spending more.  But they’re getting less.  Any extra disposable income is just paying for the higher cost of gasoline.  Which means consumer spending is flat.  And will remain flat.  For another two years.  Or more.  Because of the cost of gasoline.  The environmentalists may be happy.  But high gas prices are making the rest of us make a lot of sacrifices we’d rather not.  And it’s killing off what anemic economic recovery there was.

The Weak U.S. Dollar Increases World Oil Prices

There is a reason gasoline prices are soaring.  And it’s just not demand outpacing supply.  Though that is a huge part of it.  But it’s another government policy that is compounding the supply problem (see Oil edges up, but choppy, as weak dollar supports by Robert Gibbons posted 4/29/2011 on Reuters).

“Oil is reacting to the dollar…,” said Richard Ilczyszyn, senior market strategist at Lind-Waldock in Chicago.

Higher interest rates in Europe compared to the U.S. have undermined support for the U.S. dollar, pushing up the euro by 11 percent so far this year.

The weak dollar also helped push spot gold to a new record as investors continued to seek alternative assets to hedge against inflation.

Thursday’s report that growth in the U.S. gross domestic product slowed more than expected to an annual rate of 1.8 percent in the first quarter from a fourth-quarter pace of 3.1 percent, reinforced the perception that the U.S. central bank will continue with its loose monetary policy.

It’s not the greedy oil companies.  Or their record profits driving up prices.  It’s Federal Reserve policy.  All that quantitative easing.  Printing money.  They just increased the money supply so much that they devalued the dollar.  Which gives us price inflation.  Where everything costs more because our money is worth less.  And we price oil in U.S. dollars in the international markets.  Which means American monetary policy is increasing world oil prices.  Not the oil companies.  Their getting obscenely rich is just a byproduct of loose U.S. monetary policy.

Oil’s price rise could be tempered by increasing evidence that high prices will erode demand.

U.S. consumer spending rose as households stretched to cover the higher cost for food and gasoline as inflation posted its biggest year-on-year rise in 10 months.

But all is not lost.  Oil prices will come down.  Like they did in 2008.  Because that’s what recessions do.  They lower prices.  When people don’t have jobs they don’t buy gas.  Which lowers demand.  And this lower demand will bring down gasoline prices.

If you Like Stagflation and Misery, Vote Obama

Perhaps this is the Obama reelection strategy.  Ramp up inflation to crash the economy.  Thus lowering gas prices.  It may work.  If people don’t mind another ‘worst recession’ since the Great Depression.  As long as gas is more affordable.  It’s a risky plan.  And it hasn’t had a successful track record.  It made Jimmy Carter a one-term president.  But perhaps Obama can succeed where Jimmy Carter failed. 

Interestingly, stagflation and economic misery are not the only things these presidents have in common.  Both were/are engaged in the Middle East, too.  Carter brought peace between Israel and Egypt while Obama has…

Perhaps they should consider another reelection strategy.

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