It is strangely apt that the stock market this week has been experiencing turbulence, in the wake of Standard & Poor’s downgrade of U.S credit and fears of a double-dip recession. After all, this week marks the 40th anniversary of Nixon’s removal of the United States from the last vestiges of the gold standard, an action that ushered in 40 years of fiat monetary instability. For four decades we’ve been in a state of almost constant financial crisis, from the stagflationary ‘70s through the savings and loan debacle and stock market crash of the ‘80s to the more recent dot-com and real estate bubbles and their messy aftermaths.
And now this. After 40 years of a “new normal,” the nations of the West are exhausted and bankrupt. Debt in Europe and the United States is spiraling out of control while economies stagnate, and all central bankers can think of is what they’ve been doing since the Nixon years (and, in truth, a lot longer than that): print more money.
Against the backdrop of price inflation reaching six percent, the unemployment rate touching five percent, the increasingly large holdings by foreign governments of dollars (that at the time were convertible into gold upon demand) and his desperate need to get reelected, in August, 1971 President Nixon conferred with his economic advisers about how to solve the inflation problem without taking any blame for it.
The meeting was precipitated by the demand from the British ambassador “who showed up at the Treasury Department to request that $3 billion [of paper dollars] be converted into gold. At that moment in time, the amount of “cover” — the amount of gold held in Fort Knox as a percentage of outstanding paper dollar claims against it — had declined from 55% to 22% — leaving the Treasury desperately close to default. The economic advisers surrounding Nixon knew that “shutting the gold window would weaken the dollar against other currencies, thus adding to inflation by driving up the price of imported goods,” but they moved ahead anyway. And so was born the Nixon lie, delivered just as the Asian markets were opening on Sunday night, August 15, 1971. Here are the relevant parts of the lie:
The latest report from the Board of Governors of the Federal Reserve System confirms what every sentient being already knows: The economy is in the dumper, with little improvement expected. The report used words like “considerably slower,” “deterioration,” “flattened out,” “weak,” and “depressed” to describe current conditions, and it even noted that excuses such as bad weather and the earthquake in Japan “appear[ed] to account for only some of the current weakness in economic activity.” (Emphasis added.)
In other words, the Board had a BFO (blinding flash of the obvious) and finally had to come clean and admit that after two years of trying to stimulate the patient back to health, nothing has worked, and the patient is getting sicker.
The stock market is in freefall once again, evoking specters of 2008. As one fund manager told the Wall Street Journal on Monday, “the sense of déjà vu is almost sickening.” The storied Dow lost more than 600 points Monday following huge declines late last week, appeared to get its footing yesterday, then plunged more than 500 points today. All over the world, markets are taking stock, so to speak, of the burgeoning debt crisis in the United States and Europe, and fearing the worst.
Despite the parallels with the autumn of 2008, the Wall Street Journal views the two crises as stemming from entirely different causes. Wrote the Journal’s Franceso Guerrera on Tuesday:
"The Fed spoke and financial markets rallied," began the Associated Press report on how the stock market responded after the policy-making panel of the Federal Reserve Board issued a statement Tuesday, saying the federal funds rate (the interest banks charge other banks for borrowed money) would be held to 0 to 1/4 percent through the middle of 2013. The Dow Jones industrial average surged more than 429 points, just one day after its biggest decline since 2008.
But the Fed's influence over the volatile stock market is of short duration and its ability to bolster a sagging economy is illusory. The Federal Open Market Committee's promise of low interest rates was accompanied by an assessment of current market conditions that look anything but promising. "Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed," the committee reported. On the plus side, "business investment in equipment and software continues to expand."
With gold bouncing up from $1,668 an ounce on Friday, August 5 to $1,778 on Tuesday, August 9, it was the biggest three-day rally since the start of the great recession in 2008. At the same time, the equities markets were falling precipitously, losing over 600 points on the Dow on Monday alone. What is the connection?
The easy answer is fear, loss of confidence, and uncertainty. A credit rating agency has taken away the United States' top-tier AAA rating on its bonds, the spreading debt crisis in the Eurozone has now reached Italy and Spain, and the assumptions tying the financial system together are beginning to be questioned. In its report entitled “On the Coming Gold War,” Redburn Partners says a “rising gold price is a warning signal: it casts doubt on the US economy…. Gold is the only asset to outperform in periods of either uncontrollable inflation or deflation: the US economy is on the knife-edge between the two … gold is a vital barometer.”
The communist Chinese dictatorship blasted the U.S. government for endangering its massive dollar holdings, calling for America to rein in its out-of-control debt by slashing military spending and welfare. The regime also demanded international supervision of the dollar and even suggested the creation of a new global reserve currency.
The attack came in the form of an editorial from Xinhua News Agency, one of the dictatorship’s official propaganda arms, following the downgrade of American debt last week by Standard & Poor's (S&P). It immediately made headlines around the world.
“China, the largest creditor of the world's sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China's dollar assets,” read the commentary. “To cure its addiction to debts, the United States has to reestablish the common sense principle that one should live within its means.”
Former Federal Reserve Bank Chairman Alan Greenspan came up with a novel way to claim the U.S. government would never default on debt: print the difference. Greenspan told NBC's "Meet the Press" August 7, in response to a question about the recent downgrade in the U.S. bond rating by Standard and Poor's:
This is not an issue of credit rating. The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.
Analysts ask, Zimbabwe-like inflation of the dollar is not default? They say that Greenspan won't find that argument very persuasive to bond-holders, who won't be able to buy anything with their bonds when they come due.
As fears over global markets grow, the European Central Bank (ECB) signaled that it would start buying more European-government bonds in an effort to prop up the economies and governments of beleaguered nations and the region as a whole. In other words, it will print even more money to temporarily bail out reckless regimes drowning in debt.
But rather than calming investors, the announcement only sparked more confusion and turmoil. Follow-up reports added fuel to the fire.
Citing traders, several news outlets claimed that the central bank bought Irish and Portuguese bonds on August 4 — not Spanish or Italian debt as was expected. Ireland and Portugal, of course, have both received hundreds of billions in bailouts already.
Claiming that presidential candidate Ron Paul leads the “economic suicide wing” of the Republican Party, Brent Budowsky, writing for The Hill, says that Paul is the “worst possible role model” for Republicans because he suggested that a default by the government “would be OK.” Budowsky calls Paul a “Banana Republican,” claiming that Paul is taking an extremist position, adding that keeping the debt ceiling in place and putting the government on a diet would “literally crash American and global markets … that would do grave damage to our nation.”
The extreme hard-line attitude of many Republicans [including Paul] has significantly raised the prospects for a national default and rating agency downgrades that would sweep across the nation and many states, causing an economic cataclysm and public outrage unlike anything ever seen in the history of the republic.