Gold and the end of ‘dollar hegemony,’ part I

The following speech was delivered to the U.S. House of Representatives on Feb. 15, 2006.

A hundred years ago it was called “dollar diplomacy.” After the Second World War, and especially after the fall of the Soviet Union in 1989, that policy evolved into “dollar hegemony.” But after all these many years of great success, our dollar dominance is coming to an end.

It has been said, rightly, that he who holds the gold makes the rules. In earlier times it was readily accepted that fair and honest trade required an exchange for something of real value.

First it was simply barter of goods. Then it was discovered that gold held a universal attraction, and was a convenient substitute for more cumbersome barter transactions. Not only did gold facilitate the exchange of goods and services, it served as a store of value for those who wanted to save for a rainy day.

Though money developed naturally in the marketplace, as governments grew in power they assumed monopoly control over money. Sometimes governments succeeded in guaranteeing the quality and purity of gold, but in time, governments learned to outspend their revenues. New or higher taxes always incurred the disapproval of the people, so it wasn’t long before kings and Caesars learned how to inflate their currencies by reducing the amount of gold in each coin — always hoping their subjects wouldn’t discover the fraud. But the people always did, and they strenuously objected.

This helped pressure leaders to conquer other nations in search of more gold. The people became accustomed to living beyond their means, and enjoyed the circuses and bread. Financing extravagances by conquering foreign lands seemed a logical alternative to working harder and producing more. Besides, conquering nations not only brought home gold, it brought home slaves as well. Taxing the people in conquered territories also provided an incentive to build empires. This system of government worked well for a while, but the moral decline of the people led to an unwillingness to produce for themselves. There was a limit to the number of countries that could be sacked for their wealth, and this always brought empires to an end. When gold no longer could be obtained, their military might crumbled. In those days, those who held the gold truly wrote the rules and lived well.

That general rule has held fast throughout the ages. When gold was used, and the rules protected honest commerce, productive nations thrived. Whenever wealthy nations — those with powerful armies and gold — strived only for empire and easy fortunes to support welfare at home, those nations failed.

Today the principles are the same, but the process is quite different. Gold no longer is the currency of the realm; paper is. The truth now is: “He who prints the money makes the rules” — at least for the time being. Although gold is not used, the goals are the same: compel foreign countries to produce and subsidize the country with military superiority and control over the monetary printing presses.

Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people — just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.

The pressure at home to inflate the currency comes from the corporate welfare recipients, as well as those who demand handouts as compensation for their needs and perceived injuries by others. In both cases, personal responsibility for one’s actions is rejected.

When paper money is rejected, or when gold runs out, wealth and political stability are lost. The country then must go from living beyond its means to living beneath its means, until the economic and political systems adjust to the new rules — rules no longer written by those who ran the now-defunct printing press.

‘Dollar diplomacy’

“Dollar diplomacy,” a policy instituted by William Howard Taft and his Secretary of State, Philander C. Knox, was designed to enhance U.S. commercial investments in Latin America and the Far East. McKinley concocted a war against Spain in 1898, and (Teddy) Roosevelt’s corollary to the Monroe Doctrine preceded Taft’s aggressive approach to using the U.S. dollar and diplomatic influence to secure U.S. investments abroad.

The significance of Roosevelt’s change was that our intervention now could be justified by the mere “appearance” that a country of interest to us was politically or fiscally vulnerable to European control. Not only did we claim a right, but even an official U.S. government “obligation” to protect our commercial interests from Europeans.

This new policy came on the heels of the “gunboat” diplomacy of the late 19th century, and it meant we could buy influence before resorting to the threat of force. By the time the dollar diplomacy of William Howard Taft was clearly articulated, the seeds of American empire were planted. And they were destined to grow in the fertile political soil of a country that lost its love and respect for the republic bequeathed to us by the authors of the Constitution. And indeed they did. It wasn’t too long before dollar “diplomacy” became dollar “hegemony” in the second half of the 20th century.

This transition only could have occurred with a dramatic change in monetary policy and the nature of the dollar itself.

Congress created the Federal Reserve System in 1913. Between then and 1971, the principle of sound money was systematically undermined. Between 1913 and 1971, the Federal Reserve found it much easier to expand the money supply at will for financing war or manipulating the economy with little resistance from Congress — while benefiting the special interests that influence government.

Dollar dominance got a huge boost after the Second World War. We were spared the destruction that so many other nations suffered, and our coffers were filled with the world’s gold. But the world chose not to return to the discipline of the gold standard, and the politicians applauded. Printing money to pay the bills was a lot more popular than taxing or restraining unnecessary spending. In spite of the short-term benefits, imbalances were institutionalized for decades to come.

Bretton Woods

The 1944 Bretton Woods agreement solidified the dollar as the pre-eminent world reserve currency, replacing the British pound. Due to our political and military muscle, and because we had a huge amount of physical gold, the world readily accepted our dollar (defined as 1/35th of an ounce of gold) as the world’s reserve currency. The dollar was said to be “as good as gold,” and convertible to all foreign central banks at that rate. For American citizens, however, it remained illegal to own. This was a gold-exchange standard that from inception was doomed to fail.

The U.S. did exactly what many predicted it would do. It printed more dollars for which there was no gold backing. But the world was content to accept those dollars for more than 25 years with little question — until the French and others in the late 1960s demanded we fulfill our promise to pay one ounce of gold for each US$35 they delivered to the U.S. Treasury. This resulted in a huge gold drain that brought an end to a very poorly devised pseudo-gold standard.

It all ended on Aug. 15, 1971, when Nixon closed the gold window and refused to pay out any of our remaining 280 million oz. gold. In essence, we declared our insolvency and everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the
printing presses for the world reserve currency with no restraints placed on it — not even a pretense of gold convertibility! Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread.

Realizing the world was embarking on something new and mind boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence “backed” the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.

This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971. Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo gold standard under Bretton Woods. It certainly was less stable than the gold standard of the late 19th century.

During the 1970s, the dollar nearly collapsed, as oil prices surged and gold skyrocketed to US$800 per oz. By 1979, interest rates as high as 21% were required to rescue the system. The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s. The markets were not fooled by Lyndon B. Johnson’s claim that we could afford both “guns and butter.”

Once again the dollar was rescued, and this ushered in the age of true dollar hegemony lasting from the early 1980s to the present. With tremendous co-operation coming from the central banks and international commercial banks, the dollar was accepted as if it were gold.

Recently retired Fed Chair Alan Greenspan, on several occasions before the House Banking Committee, answered my challenges to him about his previously held favourable views on gold by claiming that he and other central bankers had gotten paper money — i.e. the dollar system — to respond as if it were gold. Each time I strongly disagreed, and pointed out that if they had achieved such a feat they would have defied centuries of economic history regarding the need for money to be something of real value. He smugly and confidently concurred.

Next week: part II.