Chapter 9 of the Crash Course is now publicly available and ready for watching below.
Looking at the past 100 years of the US dollar's history, one theme becomes abundantly clear: in times of crisis, the US government has no issue with changing its own rules or breaking its own laws. And those "temporary" emergency measures have a nasty habit of quickly becoming permanent.
Among the more notable milestones of the past century, the Federal Reserve was created (and soon after took possession of most of the nation's gold reserves), the Bretton Woods agreement made the US dollar the world's reserve currency granting it extraordinary advantage (which America quickly began abusing, continuing to do so up to today), and Richard Nixon ended the currency's convertibility into gold.
Nixon's turning the dollar into something backed only by the "full faith and credit" of the US government ushered in a new era for our country. The fiat dollar we use today for trade and investment is really only an experiment a little more than 4 decades old. We don't have a national experience to draw from in knowing how well it will work over time.
But as we see the US money supply exponentially accelerating since the 1970s, and the Federal Reserve more than tripling its balance sheet since 2008, it's only prudent to ask the question: Without constraints, are we in danger of destroying the purchasing power of our currency by making too much of it?
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Coming next Friday: Chapter 10: Quantitative Easing
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Before we move on to current events, it’s vital that we know how we got here.
I will now present an extremely shortened version of recent US monetary history.
The purpose of this section is to show you that in the past the US government has radically shifted the rules during times of emergency and that our monetary system is really a lot younger than you might think.
After the great financial panic of 1907, when private banker J.P. Morgan stepped in as the lender of last resort, banks began agitating for a government solution.
What was finally decided upon in 1913 was a federally-sponsored cartel, called the Federal Reserve, which sounded governmental but really was not.
The stock of the Federal Reserve was to be held by its privately-owned member banks, not the US government nor the public, which remains the case today.
So what we call the Federal Reserve actually is a federally-sponsored banking cartel, licensed to lend money into existence.
One of the main arguments for creating the Federal Reserve was to have a more central bank able to step in and prevent losses from panics.
How did that work out?
Not very well. Instead of simply being a lender of last resort the Federal Reserve had helped provide the necessary fuel for a speculative bubble in stocks that burst in 1929 with devastating effects.
Among the financial consequences were numerous bank failures a shrinking the money supply by nearly a third in just three years and, in 1933, the US government effectively declared bankruptcy.
At that time, newly-elected President Franklin D. Roosevelt decided to counter the falling money supply in a most drastic manner.
He ordered the confiscation of all privately-held gold and immediately devalued the US dollar.
Up until this time in history, America was on the gold standard, which meant that each paper dollar in circulation was backed by a specific amount of gold, which it could be exchanged for upon demand.
Prior to the seizure it took approximately $21 to buy an ounce of gold and afterwards it took $35.
Soon after, contractual obligations of the U.S. government, such as bonds payable in gold, were nullified, with the approval of the Supreme Court.
This goes to show how governments, in a period of emergency, can change rules and break their own laws even if those laws are written into the Constitution.
All of this seized gold either ended up in the vaults of the Federal Reserve, at the International Monetary Fund or “on the books” of the Federal Reserve.
A grand total of $11 billion dollars was exchanged for all 261 million ounces of the nation’s gold.
In other words, complete control of the gold supply of the most powerful and prosperous nation on earth was exchanged for slightly more than $11 billion dollars literally printed out of thin air.
After just twenty years, a private banking cartel went from an idea to owning all of the wealth of a young, powerful and prosperous nation. Not bad!
Every one of these original 261 million ounces of gold still remain on the books of the Federal Reserve as a private asset, so technically it actually belongs to the shareholders of that corporation, not the American people.
In any event, to end the turmoil of depression and a subsequent world war, and to provide a foundation for global recovery, a conference was held at Bretton Woods, N.H, in 1944, with all the major allied powers attending.
Recognizing that the U.S. then represented nearly half of the global economy, the U.S. dollar was made the global reserve currency.
All other currencies had fixed rates of exchange to the dollar, which in turn was redeemable for gold at 35 dollars per ounce.
The Bretton Woods II system ushered in a period of prosperity and rapid economic recovery. But, there was a flaw in the system.
Nothing in the Bretton Woods agreement prevented the U.S. Federal Reserve from expanding the supply of Federal Reserve Notes as rapidly as it wished.
As this happened, the gold backing behind each dollar steadily declined, such that there was not enough gold to back all of the dollars.
Meanwhile, as the Vietnam War intensified, the U.S. was running budget deficits and flooding the world with paper dollars.
The French, under President Charles DeGaulle, became suspicious that the U.S. would be unable to honor its Bretton Woods obligations to redeem their excess dollars into gold.
As the French exchanged their surplus dollars for gold, the U.S. Treasury's gold stocks declined alarmingly. Finally, President Nixon declared force majeure on August 15th, 1971, and “slammed the gold window” ending its dollar convertibility.
The last ties of the US dollar to gold were severed. The days of a “gold standard” were over.
That's what governments do during wartime, they change the rules to allow them to print what they need rather than impose unpopular taxes trusting that it will all be paid back at some point in the future, and the U.S. followed that pattern to a "T".
But this time, it affected the whole world, because the removal of gold convertibility of the dollar destroyed the foundation of the Bretton Woods system.
Without a gold backing, there was no hard, physical limit to how many paper dollars could be issued.
Since we now know that all dollars are backed by debt, what do you suppose happened to US debt levels once the externally applied rigor of gold was removed? Let’s find out.
This is a chart of US federal debt from the period of 1949 to 2013. Note that it looks like any other exponential chart we’ve already reviewed.
But especially note what happens after Nixon slammed the gold window – that is, when Nixon removed the last vestige of external physical restraint from the system.
And also note how rapidly the debt levels have climbed recently – these past few years have seen the highest and most rapid accumulation of federal debt in our entire history thanks in large measure to a series of experiments never before attempted in our country’s history – the conduct of two foreign wars AND a tax cut at the same time while printing money out of thin air to finance the enormous structural deficits that resulted.
This rapid accumulation of debt is not a mysterious process at all; rather it is an entirely predictable consequence of the slamming of the gold window.
Remove politicians constraints and they will spend. As far as I know, that's happened in every country that's tried it.
How much longer can this continue? Unfortunately there’s no good answer to this besides “as long as foreigners let us”.
A second predictable, and related, consequence concerns the total amount of money in circulation. Remember, all money is loaned into existence so the shape of the federal debt chart should tip you off to the shape of this next chart of US money from the years 1959 to 2013.
The first thing we can note here is that it took our country over three hundred years, from the very first pilgrim until 1973 to generate our first trillion dollars of money stock.
Every road, every bridge and every marketplace on every corner of every town; every boat and every building from the first colony until 350 years later required one trillion dollars of money stock.
Now we are creating a trillion dollars in just under a year.
My question to you is: What will it be like to live here when our nation is creating a trillion dollars every 6 months? How about every 6 weeks? Every 6 hours? 6 minutes?
Where does it stop, if not in hyperinflation and the destruction of the dollar and, by extension, our nation?
If we view these events on a timeline, we can see that the Federal reserve was formed in 1913 and only twenty years later in 1933 our country had entered a form of bankruptcy during which it turned over its collective gold supply, under force of law, to the Federal Reserve.
Eleven years after that the US dollar was enshrined as the world’s reserve currency with an explicit backing by gold. That system was then unilaterally removed by Nixon 27 years later.
In effect, the current global monetary system of un-backed currencies is now roughly 40 years old.
It was not planned, but simply emerged out of a crisis. The unredeemable U.S. dollar remains a popular reserve currency as a matter of convenience, but nothing requires or guarantees that it will retain this role.
It is a safe bet that the next currency system will arise out of some future crisis too.
Only the U.S. is able to use its eroding reserve currency status to borrow and print dollars to pay for its trade deficits.
However, should this abuse create doubts about the dollar’s integrity as a sound reserve currency, the U.S. will be forced to either export more to pay for imports, or take on ever-heavier levels of debt.
If these actions cause the dollar to keep falling, other countries will be tempted to devalue their currencies to keep pace and remain competitive.
In fact, we have already seen such “currency wars” erupt among the major fiat currencies of the world.
The US Fed, the ECB, the Bank of England, the Bank of Japan – all have dramatically increased their sovereign money supplies over the past few years – and no end to the money printing remains in sight.
Every government wants the same thing - as much money as it desires to spend without resorting to increased taxes and a weak currency to keep their exporting businesses happy.
These money printing efforts go by fancy names, such as Quantitative Easing, or QE, and knowing how these work helps us understand why they are really traps that are very hard to get out of once begun.
At least without a lot of painful disruptions.
Please join me for the next chapter on Quantitative Easing.
Thank you for listening.