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Category: Soap Box

Soapbox: Janet Yellen’s humpty-dumpty fantasy

If someone last June said that US inflation (then 4.2%) was due to "transitory factors" , and less than a year later the consumer price index had doub...

26 April 2022

Gary Mead

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If someone last June said that US inflation (then 4.2%) was due to “transitory factors” , and less than a year later the consumer price index had doubled (to 8.5% ) then we might understandably be sceptical about their ability to see what lies ahead.

Janet Yellen, the US Treasury Secretary was wrong about the trajectory of inflation; it is not due to transitory factors. That hasn’t stopped her from floating a humpty-dumpty fantasy about the international monetary order.

Last week, Yellen told the Atlantic Council she would like to see “friend-shoring” replace the kind of dog-eat-dog system we now live with. What does she mean by “friend-shoring?” It seems to hark back to a kind of Bretton Woods system. Yellen said that “friend-shoring means… that we have a group of countries that have strong adherence to a set of norms and values about how to operate in the global economy and about how to run the global economic system, and we need to deepen our ties with those partners and to work together to make sure that we can supply our needs of critical materials”.

Yellen is echoing the words of October 2020 from Kristalina Georgieva, managing director of the International Monetary Fund (IMF), who then said “today we face a new Bretton Woods ‘moment’. A pandemic that has already cost more than a million lives. An economic calamity that will make the world economy 4.4 % smaller this year and strip an estimated $11 trillion of output by next year. And untold human desperation in the face of huge disruption and rising poverty for the first time in decades. Once again, we face two massive tasks: to fight the crisis today— and build a better tomorrow”.

Both Yellen and Georgieva are echoing the words of the former French President, Nicolas Sarkozy, who said at the height of the Great Financial Crash in September 2008: “we must rethink the financial system from scratch, as at Bretton Woods”. Neither Yellen nor Georgieva could have guessed that the Russian president would have a rush of blood to the head. The invasion of Ukraine has shown how some nations are uninterested in international co-operation.

Alas, Bretton Woods

In July 1944, when guns were still blazing in Europe and Asia, representatives of 44 Allies nations met at the Washington Hotel in Bretton Woods in the US state of New Hampshire. They agreed to establish rules, institutions, and procedures to regulate the international monetary system and thus discourage ‘beggar-thy-neighbour’ devaluations, whereby countries would devalue their fiat currency to make their exports relatively cheaper. In 1944, when the Nazi attempt to force on the world a warped empire was clearly going to be defeated, there was an appetite for international co-operation, a ‘never-again’ mood gripped the corridors of power.

Bretton Woods gave birth to the IMF and the International Bank for Reconstruction and Development (IBRD), which is now part of the World Bank. The US then controlled two-thirds of the world’s gold. It insisted that the Bretton Woods system rest on both gold and the US dollar. Notably, representatives of the USSR attended the conference but declined to ratify the final agreements, charging that the institutions they had created in fact represented the interests of capitalism. Certainly Bretton Woods reflected US interests. The Bretton Woods system required countries to guarantee convertibility of their currencies into US Dollars to within 1% of fixed parity rates, with the Dollar convertible to gold bullion for foreign governments and central banks at $35 per troy ounce of gold. The US Federal Reserve says that Bretton Woods was “an unprecedented cooperative effort for nations that had been setting up barriers between their economies for more than a decade”.

The Nixon coup-de-grâce

Alas, that mood of international co-operation and harmony did not last; essentially it died from twin evils that face us again today – inflation and a massive expansion of the amount of fiat Dollars in circulation, which the US needed to fund the Vietnam War (which cost about $1 trillion in today’s Dollars).

All fiat currencies in the Bretton Woods system were required to be convertible, which meant they could be exchanged for physical gold or for other currencies that could be exchanged for gold. Foreign central banks were willing to hold US dollars because, at the time, they were readily convertible into gold upon demand. But Bretton Woods did not regulate the price of gold as a commodity; its price could fluctuate due to variations in private industrial and financial demand. If the free market price rose above $35/ounce (the peg set by Bretton Woods), central banks had the incentive to redeem US dollars for gold and then sell the gold for a higher price in other markets.

Keeping that $35/ounce peg was tricky – the price of gold on the private market often exceeded that. In 1961, eight nations decided to pool their gold reserves to defend the $35/ounce gold peg and stop the price rising – the Gold Pool was born. The US allocated 120 tonnes to the pool, half the total. Germany supplied 27 tonnes. The United Kingdom, France, and Italy each provided 22 tonnes. Belgium, the Netherlands, and Switzerland each put in 9 tonnes.

Inflation of the money supply in the US, partly to fund the Vietnam War, led the US by 1965 to lose a cumulative $3 billion from supporting the London Gold Pool. France was repatriating US dollars to America to obtain physical gold. In 1967, France withdrew from the Pool. When the UK devalued the pound by 14.3% on 18 November 1967 the run on physical gold reserves in the London Gold Pool accelerated.

The Gold Pool fell apart as the widening US deficit meant increased speculation against the Dollar; central banks became increasingly reluctant to accept Dollars in settlement. The US government continued to ramp up inflation of the money supply, leading West Germany to withdraw from the Bretton Woods system in May 1971 and Switzerland and France to do so in August 1971. So many US dollars were being repatriated to the US Treasury that gold reserves fell to their lowest levels since 1938. The value of the US dollar was falling even faster against other currencies.

In August 1971, President Richard Nixon announced to the nation the “temporary” suspension (which became permanent) of the Dollar’s convertibility into gold. It was the end of the Bretton Woods system; by March 1973 all the major currencies started to float against each other. An era of fixed exchange rates, of financial certainty… of international cooperation, was over.

This isn’t 1944

There may be parallels with the lead up to 1944 – the appeasement of a vicious bully, the drift into war, the slaughter of innocents, all come to mind. There is one especially alarming similarity with 1944.

Then there were voices who wanted to reduce Germany to one large farm, believing that would prevent it from rising again. Stalin wanted to see 50,000 alleged National Socialists executed. Fortunately those policy mistakes, which would have thrown grit into the post-war world, didn’t happen. Yet the US Secretary of Defense, Lloyd Austin, now says that US policy is to see Russia’s military capabilities “weakened to the degree that it can’t do the kinds of things that it has done in invading Ukraine”. It’s unthinkable that Russia will ever knuckle under to that, much as the West might yearn for it. Painting enemies into corners is never sensible.

But this isn’t 1944 and any hope of re-building the kind of international co-operation that resulted in Bretton Woods is just a humpty-dumpty fantasy; he fell off a wall, became broken, and all the king’s horses and king’s men couldn’t put him together again. Currencies – the US Dollar especially – has been weaponised and weakened by the imposition (necessary no doubt) of sanctions against one nation that clearly isn’t interested in international co-operation. Countries unhappy with the US hegemony of money and power are scratching their head trying to find ways of transacting and storing value that circumvent the currencies and financial markets of the US and its allies. The digitisation of value via cryptocurrencies, the growth of stablecoins, the development of Central Bank Digital Currencies, makes the creation of a Bretton Woods mark 2.0 so much more complicated, as does the spread of ownership of gold.

Martin Wolf, the Financial Times chief economics commentator, wrote a recent column speculating what might replace “today’s globalised national currencies”. He thought there might be four candidates: “private currencies (such as bitcoin); commodity money (such as gold); a global fiat currency (such as the IMF’s special drawing rights); or another national currency, most obviously China’s”.

China’s Yuan doesn’t hack it for Wolf because “China’s financial system is relatively undeveloped, its currency is not fully convertible and the country lacks a true rule of law… While holders of the dollar and other leading western currencies might fear sanctions, they must surely be aware of what the Chinese government might do to them, should they displease it”.

As for gold, which for centuries has been used as a universal medium of exchange, Wolf dismissed it because it is “hopeless in making transactions”. He’s clearly never encountered Glint, which has made transactions in gold as simple as falling off a wall.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.


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