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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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You can get rich from inflation by buying goldWhy? Because the rising inflow of dollars into foreign central banks forced those governments to issue more of their own currency than was prudent. Furthermore, a nations foreign exchange reserves are supposedly held in the most secure investments possible, and Bretton Woods forced governments abroad to stuff their treasuries with an asset whose value was declining because U.S. inflation was higher than rates abroad. The result was inflationary stimulus to European economies. The prodigal son only repented of his spendthrift ways and came home when hed run out of money and out of creditors willing to support his dissipation. But in effect, the United States was able to draw on seemingly limitless lines of credit abroad because those central banks had to keep issuing their own currency to absorb the endless flow of dollars. In the 1960s the United States had the license to print moneyhardly a stimulus to discipline. Since the newly recovered nations of Western Europe had vivid memories of the horrific effects of uncontrolled inflation, they had reason to fear the apparent unconcern of the U.S. government about the gradual revival of inflation. In fact, President Kennedy was surrounded by liberal academic stars who thought the threat of inflation was greatly overdone. Keynesianism academics were followers of John Maynard Keynes, the brilliant British economist who had correctly analyzed the terrible effects of the terms imposed on the Germans after World War I and who had written the classic work about dealing with deflationary depressions. During the Depression, Keynes asserted that governments should abandon their fear of deficits when the economy wasnt functioning properly. If anyone argued that his policies of government stimulus would lead in the long run to inflation, he would reply with his famous assertion: In the long run, we are all dead. To him, the threat to the allied economies in the postwar era was not inflation, but deflation. He knew that deflation had hit after past wars had ended, and he feared that the weakened democracies of Europe would be at risk if their societies were engulfed by a new depression. He was a leading intellectual force behind the Bretton Woods Agreement that enthroned the dollar. He wanted to get rid of gold in currency management, terming it a barbarous relic. Keyness followers used his arguments for government stimulus policies even when the economy was quite strong and when inflation levels were rising. They believed that sustained government intervention would achieve continued economic growth, thereby preventing unemployment. They had arguments to prove a direct trade-off between inflation and unemploymentwhat became known as the Philips Curve. In the 1960s, the Kennedy circle did not ridicule de Gaulles inflation concerns: As weve seen, JFK launched all-out attack on the steel industry when it raised steel prices, triggering the 1962 Teddy Bear stock market plunge. (Republicans joked about the new Washington drinkthe Kennedy Cocktail: Stocks on the Rocks.) Nor did President Kennedy and his economic advisers ignore the weakening dollar. They just didnt want to support it by eliminating the economic and monetary stimuli that were eroding its value. Instead they chose a dramatic new form of interventionism: a penalty on those who contributed to the dollars falland the outflow of goldby investing abroad. This was the Interest Equalization Tax, a punitive tax on Americans who bought foreign assets. The administration also promoted a Buy American program on international trade. Pan American World Airways, one of the nations flagship foreign carriers, eagerly responded to this new nationalism, running full-page ads asking Americans to fly abroad on Pan Am, rather than on foreign airlines, thereby protecting Americas reserves of gold. Those interventionist and protectionist policies were, of course, doomed to failure. The dollar continued to struggle. In 1971, with U.S. gold reserves dwindling rapidly as foreign central banks, led by France, kept cashing in their dollars for gold, President Nixon shut the gold window, decreeing that Fort Knoxs gold was no longer for sale. By breaking the dollars last link to golddelivery to foreign central banks in exchange for dollarshe in effect decreed that the covenant of Bretton Woods had been unilaterally repudiated. The dollar had become mere fiat moneynot backed by anything real. That unilateral violation of a 27-year-old promise set the stage for double-digit inflation, which Nixon tried vainly to control through wage and price controls. In justification for his breach of promise, Mr. Nixon exclaimed, We are all Keynesians now. Keynesian economic theories were proclaimed as universally accepted just when events would prove that the theories were in fact inapplicable except in deflationary recessions. Stagflation arrived, a new problem in which both prices and unemployment rose sharply during a deep recession. The stagflation of the 1970s put paid to the liberal economists arguments that inflation was the trade-off for job creation: Unemployment and inflation soared together, even as the recession across the industrial world was the worst since the 1930s. Those problems werent supposed to go together. A whole new concept of macro policymaking was needed. Fortunately, no policymaking vacuum survives long. Gradually, other voices were heard. The first call was to give American citizens the right to protect themselves against inflation: Let them own gold. Then the government could not cynically continue to be the big winner from inflationbecause it reduced the value of the outstanding national debtwhile not letting citizens protect themselves. Before the Republicans were driven from office in the Watergate fiasco, they repealed the ban on Americans ownership of gold. The Comex in New York soon became the worlds leading trading center for gold futures, and coin and bullion dealers sprang up across the land. What began as the right to be able to own protection against inflation soon evolved into a new investment concept: You can get rich from inflation by buying gold (and other precious metals). Investors saw lurid advertisements telling them of the riches to be gained with gold because the government would never do anything to stop inflation. A real debate about the effects of currency depreciation was inevitable. Monetarism, 1975-1989 Keynes died in 1946, but he retained a special hold among economists for three decades, partly because no new giant had emerged to replace him. (Speaking in Chicago last year, Francis Fukuyama delivered a puckish quote: Economics progresses one funeral at a time.) With inflation out of control, it was the time for the Chicago School of Economics, led by the brilliant Milton Friedman, to challenge liberal orthodoxy. His argument that inflation is always and everywhere a monetary phenomenon had been ridiculed by those who claimed governments could control inflation through interventionism. The double-digit inflation of the 1970s led to a national sense of foreboding and helplessnesswhat President Carter termed a malaise. It was time to try Friedmanesque monetarism and Friedmanesque tax-cutting and deregulation. Monetarism came first, when it was implicitly adopted as the basis of Federal Reserve monetary policy by Chairman Paul Volcker in October 1979. Previously, Fed policy was loosely targeted toward inflation experience and/or to levels of interest rates. By decreeing that growth in monetary aggregates would be the basis of policymaking, Volcker, in effect, said that the Fed would let interest rates do what the market chose. He thereby implicitly stated that the Fed would not be dissuaded by the onset of towering interest rateswhich is exactly what happened, producing a recession. Volcker made the switch to monetarism in response to the anguished pleas of other leading central bankers at the Belgrade IMF Conference. They said they could no longer keep acquiring dollars in their foreign exchange reserves, and warned of a global inflationary blow-off that would ensue from the coming collapse of the dollar. Next came the tax cutting and deregulation under President Reagan. The recession ended. Inflation peaked and began to decline. The bond market rallied powerfully, igniting (on Friday the thirteenth of August 1982) a new equity bull market that would last, with brief bearish pullbacks, until March 2002by far the longest bull market on record. The dollar naturally entered a major bull market in 1982 as foreign investors rushed to acquire Treasury bondsthe longer term, the better. So successful was Volckers implementation of Friedman monetarism that the dollar once again became the almighty dollarsoaring against foreign currencies despite soaring fiscal and trade deficits. It became greatly overvalued on a trade basis, putting much of U.S. manufacturing in peril. The dollar had become the new Swiss franca currency that traded on its financial, not its economic, value. In the late 1970s the gold-backed Swiss franc took off against all other currencies, as investors rushed to acquire income-producing assets that were totally protected against inflation. Result: Swiss industry was seriously wounded, including the nations jewelsits renowned watchmakers. These companies were incurring their manufacturing costs in a high-cost zone, making them uncompetitive with watchmakers based in other currency zones. It was beginning to look as if only oil sheikhs could afford to wear Omegas or Rolexes. The Swiss resorted to an astounding policy: They imposed negative interest rates on foreign holdings of Swiss franc bank deposits. Instead of the bank paying the depositor some rate of interest, the bank deducted part of the account value regularly and paid those sums to the government. This had the desired effectthe franc once again began to be valued more closely to its economic rather than its financial value. The novelty of an overvalued dollar was heartily enjoyed by those Europeans who had for so long fretted about American financial indiscipline and the problems created by a continuously depreciating global store of value. They noted that falling rates of inflationwithin the United States and internationallywere the natural consequence of a rising dollar. The problem was, not everyone rejoiced about the rising dollar and falling inflation. Although few in Washington shed tears for the most obvious losersthose Triple Waterfall victims of the inflation-hedge crashesthe plight of U.S. manufacturing certainly caught attention. Established U.S. manufacturers of such globally traded products as steel, automobiles, machinery, ball bearings, TVs, washing machines, computer chips, and electrical products found themselves in more desperate conditions with the nation in economic recovery than theyd experienced during the recession. Foreign producers whose costs were incurred in rapidly cheapening currencies flooded the U.S. market. Export-driven companies, such as Deere and Boeing, found that their high costs were pushing them out of foreign markets. To deal with the economic fallout from this now-expensive novelty, the Reagan administration decided on a jointly managed devaluation. Treasury Secretary James Baker organized a private meeting of finance ministers from the leading Western nations at New Yorks Plaza Hotel on September 21, 1985. They agreed to a managed realignment of the dollar, to be achieved through massive currency intervention in the open markets. It worked. The stock market soared, correctly anticipating a surge in profits. The economy strengthened. Those who would rule unruly markets always come a-cropper. The Plaza agreement worked all too well. Driving the dollar down at a time of rising U.S. Current Account deficits turned out to be easier than the finance ministers realized, but stopping its descent at some theoretical level of fair value was quite another matter. By late 1986, fears of a comeback in global inflation from a falling dollar had revivedalong with gold pricesand central bankers began searching for a new strategy that would keep the U.S. economy humming without reviving global inflation. By now the world was focused on Americas twin deficitsfiscal and Current Account. After further bargaining, a deal was struck to jointly stabilize the falling dollar. This agreement was reached in the majestic environs of the Louvre in Paris, in February 1987, allowing U.S. media to announce the deal alongside pictures of the Victory of Samothrace. The Louvre agreement (discussed in The Nikkei Crash: 1985 to ? in Chapter 3) was a last-ditch maneuver that ultimately led to the 1987 crash, which devalued the dollar anew. For eight years following that crash, the dollar traded up and down, mostly down, but in 1995 it entered the most powerful bull market in decadesa run that raised its value by a range of 33 to 45 percent, depending on which currency teeter-totter comparison you choose. Naturally, the dollars new strength was to a significant degree the result of problems other currency zones experienced that led to serious weaknesses in those currencies. (See Charts 6-1 and 6-4.) Strength is relative: If your economy is booming and most of the rest of the world economies are struggling, then investors from most of the rest of the world will be clamoring to invest in yoursdriving up your currencys value. |
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