by Steve Forbes
France and other nations did not have mines brimming with precious metal; instead, Colbert believed, they could generate such riches through trade. He declared, “Fashion is to France what the gold mines of Peru are to Spain.” And just as Spain’s vast mineral riches helped finance that nation’s military, Colbert and his fellow mercantilists saw the riches generated by commerce as benefiting the cause of economic nationalism. Colbert wrote in his “Memorandum on Trade” that French goods would “bring us returns in money—and that, in one word, is the only aim of trade and the sole means of increasing the greatness and power of this State.”
Colbert and mercantilist leaders throughout Europe did everything in their power to increase exports that would bring in ever-greater quantities of bullion. They limited or banned imports thought to deplete their economies of the money they saw as equating wealth and strength. Their regulatory regime also included capital controls, which in those days meant prohibitions on the export of gold or silver intended to bolster the domestic money supply.
Colbert’s brand of mercantilism took this to an extreme, combining protectionism with a suffocating system of central planning and taxation intended to boost exports by increasing domestic production. Colbertisme’s staggering regulations and harsh enforcement tactics have been compared to communism and fascism.
Mercantilism, in many respects, reflected the fortress mentality inherited from the feudal era, when people lived behind castle walls and strength was equated with self-sufficiency. Colbert’s draconian policies may have succeeded in financing the splendor of Louis XIV, the Sun King. But by the end of Louis’s reign, France was suffering from a crushing burden of debt.
Mercantilism’s monetary policies and its adversarial vision of trade were eventually discredited by Adam Smith and the philosophers of the Enlightenment. They pointed out that, whether it takes place within a country or across national borders, trade is the very opposite of war: it is a reciprocal exchange through which everyone benefits.
The veracity of Smith’s perceptions has been borne out by the explosion of prosperity that has accompanied the loosening of trade barriers after World War II. According to one widely cited study published in 2006, overseas trade has added between $800 billion and $1.4 trillion in annual income to the U.S. economy—a total gain in products, goods, and services of about $7,000 to $13,000 per household. Global trade in the modern era is why, despite two world wars, there has been a long-term decline in military conflict since the feudal period.
Like their mercantilist forebears, our Keynesian policy makers persist in seeing trade as war, with monetary policy as the primary weapon. This thinking is as fallacious today as it was in Colbert’s time. Worst of all, it has created our current perilous global system of fiat money in which nations seek to gain a trade advantage by lowering the value of their currencies.
Countries that do not know how to defend their monies and maintain their value risk attacks by speculators that can mean the collapse of a currency. Exacerbating global rivalries and antagonisms, this needlessly volatile environment gives new meaning to Colbert’s vision of commerce as combat. Worse, it has held back the global economy and destroyed untold wealth.
Decades of Schizoid Monetary Policy
When it comes to money and trade, politicians are conflicted. Free trade has long been the official mantra. Policy makers may not talk about winning in combat—the more politely stated objective is usually to correct a trade deficit or achieve a so-called balance of trade. The bureaucratic euphemisms, however, boil down to Colbert-style protectionism: promoting exports that bring in more dollars or other hard currencies while limiting money- and “job-draining” imports that are believed bad for the economy.
Under the spell of this mercantilist mindset, a weak dollar—one that is cheap in relation to other currencies—is considered good because it makes foreign imports more costly and our exports more attractive. A strong dollar worth more than other currencies is considered bad because it makes imports cheaper and U.S. exports more expensive.
Since World War II, governments have wanted both cheap money and sound money. They face a quandary: weak money policies are considered a plus domestically because they encourage exports and are believed to stimulate the domestic economy, but too much money printing undermines one’s currency and can incur the enmity of one’s trading partners.
When he first took office, President Obama, who has done more to weaken the dollar than any other president in recent history, signaled through his soon-to-be treasury secretary Timothy Geithner that he was in favor of a strong dollar.
This is typical. Most administrations declare their intention to support a strong dollar—until they don’t. Former Obama economic advisor Christina Romer conceded as much in a candid piece in the New York Times. She recounts that, after joining the administration, former treasury secretary Larry Summers advised her that in public statements the official line should always be that “the United States is in favor of a strong dollar,” even though officialdom really considers a weak dollar more desirable.
Ambivalence over the issue of a weak-versus-strong dollar has long caused countries to lurch back and forth between loose and tight money. It was this widespread confusion, along with ignorance of the importance of sound money, that led to the breakdown of the Bretton Woods gold standard in the early 1970s and the fiat monetary system we have today.
Richard Nixon and the Triffin Dilemma
Richard Nixon and others at that time were worried about the consequences of what was known as the Triffin dilemma. In the early 1960s, the influential Belgian economist Robert Triffin wrote that with governments and large corporations around the globe relying on U.S. dollars as the world’s foremost reserve currency too many dollars would flow overseas. This would create a balance of payments deficit for the United States that he and other neo-mercantilists believed was dangerous.
Hence the Triffin dilemma: if the United States were to restrict the outflow of dollars, Triffin and his supporters believed this would lead to a money shortage and less global growth. On the other hand, if the United States printed the dollars needed by the global economy, Triffinites thought the result would be a trade imbalance along with greater difficulty in maintaining the dollar/gold ratio.
The United States was also concerned about Japan and Germany, at that time America’s foremost trade rivals. Both Japan and Germany had trade surpluses and were thought to possess dangerous levels of U.S. dollars, though they had very little by today’s bloated standards. Americans were convinced that both countries were manipulating their currencies to boost exports and gain a trade advantage over the United States, which had begun to run a trade deficit by the early 1970s.
The dollar was indeed weakening, but not because of Triffin’s scenario. The United States and other nations may have agreed to a gold standard as a result of Bretton Woods, but they did not understand the mechanics of how to maintain it and, subsequently, the importance of strictly adhering to it.
Both the administrations of Nixon and of his predecessor, Lyndon Johnson, were violators. Johnson ballooned U.S. spending to pay for the new entitlement bureaucracies of the Great Society, and also to wage the Vietnam War. His administration kept pressuring the Federal Reserve to keep interest rates low. There were more dollars circulating than the markets wanted. Moreover, the feeling was growing that the United States wouldn’t, or couldn’t, defend the Bretton Woods parity of $35 an ounce.
Seeing the world from the blinkered perspective of old-time mercantilists, Nixon and his advisors believed that the problem was a merchandise trade shortfall—the fact that the United States was buying more from countries overseas than those nations were buying from the States. This was a supposed signal of national weakness that they believed was depressing the dollar. Nixon and his advisors were convinced that keeping the greenback fixed to gold at its then-current ratio meant an overvalued dollar, allowing nations such as Germany and Japan to maintain a trade advantage. To
them the answer was clear: the dollar had to be devalued.
The thinking was that freeing the values of currencies to “float” would give the United States and other governments more leeway to cheapen their money to correct such trade imbalances. Believers in floating exchange rates convinced themselves that fluctuations would be mild.
President Nixon’s announcement on August 15, 1971, closed the “gold window.” No longer would the United States redeem dollars for gold, in effect ending the gold standard. Temporary tariffs would be imposed on imports to turn around America’s balance of payments, and a 90-day wage and price freeze was announced to control inflation.
The Bretton Woods system was formally pronounced dead in early 1973. The ending of the dollar’s link to gold also ended fixed exchange rates for the world’s currencies that had been pegged to the dollar. For the first time ever, there was no country on a gold standard.
Nixon insisted that his act of recklessness was necessary to help the economy by boosting exports. The Fed’s money printing achieved its desired objective—at first. A false boom propelled Nixon to an easy win in 1972. The stock market peaked the following January.
Nixon’s declared intent, as he put it, was to “stabilize” the dollar. In fact he had cut the world’s monetary system loose from its anchor, giving the United States and other nations license to create money at will. A global money-printing binge ensued, further weakening the dollar as well as other currencies. Inflation took off.
Nixon likely came to regret the destructive forces that his policies had unleashed. Between 1973 and 1974, the Dow Jones Industrial Average lost 45% of its value. The Nixon Shock was responsible for the disastrous economic malaise of the 1970s, characterized by stagflation, a toxic combination of inflation and economic stagnation.
Nixon’s ending of the Bretton Woods monetary system also helped give the United States and other countries the energy crisis. After the 1973 Yom Kippur War, Arab oil producers raised prices by 70%, followed by the Arab oil embargo. The rise in oil prices caused some people at the time to insist that the world was running out of oil. The cause, however, was the weak dollar. Nixon’s price controls on gasoline, meanwhile, resulted in lines and rationing.
Seeing the surge in inflation, the Federal Reserve sharply raised interest rates. The gold price fell as the monetary base contracted. The economy stalled; unemployment shot up. Nixon came under political fire and ultimately was forced from office under the cloud of the Watergate scandals. (His political position, though, had also been profoundly weakened by the economy.)
The ending of fixed exchange rates was a supreme act of mercantilism that ushered in a decade of stagnation and monetary chaos and laid the groundwork for the biggest economic disasters of recent times. It helped to bring on the stock market crash of 1987. And it gave us the destructive cheap dollar policies of the past decade that set the stage for the 2008–2009 financial crisis.
Floating exchange rates allowed the United States to gradually weaken the dollar under the George W. Bush and Obama administrations in the name of boosting exports and stimulating the economy. Those policies, in turn, fueled the catastrophic real estate and commodity bubbles—and eventual busts—that resulted in a debilitating drop in people’s real incomes over the last decade.
The ending of the Bretton Woods standard forever changed the global financial system. But it wasn’t just Nixon who was at fault. Almost all political leaders and economists of the time shared in the blame.
Post Bretton Woods: A More Dangerous World
The neo-mercantilists of the twentieth century may have thought that floating exchange rates would allow countries to correct perceived imbalances with their rivals and bolster their domestic economies. But the monetary system they created was more volatile than the one they had destroyed, with balance harder than ever to achieve.
When the world’s currencies were pegged either to gold or to the gold-linked dollar, foreign exchange markets traditionally were like the money changers of old, converting currencies for governments, financial institutions, multinationals, and individuals transacting business across national borders. In the words of foreign exchange strategist Callum Henderson, “Between 1945 and 1970, currency speculation to all intents and purposes did not exist.”
That all changed after the end of the Bretton Woods system. Bigger and more violent foreign exchange markets have seen a succession of monetary crises, shaking the economies not only of the United States and South America but also of Russia, Asia, and southern Europe.
In a 2000 study, researchers from Rutgers University, the University of California at Berkeley, and the World Bank analyzed data spanning 120 years of financial history and found that the “crisis frequency since 1973 has been double that of the Bretton Woods and classical gold standard periods and is rivaled only by the crisis-ridden 1920s and 1930s.” This study was published eight years before the financial crisis.
The turmoil of the post–Bretton Woods era is what sent European nations scurrying for the shelter of a stable currency, setting the stage for the euro. The explosion of currency trading it has wrought has become a huge source of fees for banks. It has helped produce the market swings and giant windfalls so decried by Occupy Wall Street and others. In this dangerous world, monetary policy is deployed as a frequent weapon, nearly always with destructive consequences.
The Cudgel of Money
In his 2013 State of the Union address, President Obama talked about achieving trade that is “fair and free” through major initiatives with Asia and the European Union. In previous speeches, he made clear his underlying objective: to double exports within five years to revive a stagnant U.S. economy. Obviously the president isn’t a dictator like Mao Zedong, who can simply command the economy to make a “Great Leap Forward.” Such statements are generally understood as declarations of monetary policy. Obama was signaling that he would continue the strategies of lower interest rates and quantitative easing that have produced a dramatic drop in the value of the dollar.
Obama is only the latest American president to use currency as a weapon. Over recent decades, many of his predecessors, usually goaded by Congress, have similarly sought to increase exports by weakening the dollar.
Monetary protectionism even cropped up during the Reagan years. Egged on by an increasingly protectionist Congress, treasury secretary James Baker steadily drove down the dollar, a result of his obsession with U.S. trade deficits with Germany, Japan, and other countries. Following the announcement of a large U.S. trade deficit on October 14, 1987, Baker declared that the answer was that the dollar would have to decline further. His remarks were followed by a sickening slide in the stock market that culminated in Black Monday on October 19, 1987, when the Dow Jones Industrial Average lost 508 points, more than 22% of its value, in a single day. Congressional legislation and a weaker dollar nearly did to equities what the Smoot-Hawley Tariff with its sweeping trade protections did 58 years before, triggering a world trade war that set off the Great Depression. This time, however, the United States backed down and a crack-up was avoided.
Apocalypse When?
Given the violence of the post–Bretton Woods environment, it’s no surprise that the worldwide monetary expansion and financial crises of the past decade have increased anxieties to new levels. This has been reflected not only in the high price of gold, but also in the recent spate of disaster predictions. Even some seasoned observers see the potential for a crisis more devastating than the meltdown of 2008. A few have gone so far as to predict the monetary equivalent of a world war.
Forbes.com contributor Eamonn Fingleton has envisioned such a doomsday scenario. Quoting economist Paul Craig Roberts, he writes that the collapse of the dollar could create an apocalyptic situation in which “shoppers in Walmart will feel they are in Neiman Marcus.”
In his book Currency Wars, investment strategist James Rickards reveals that the Pentagon actually brought together academic and financial experts to explore how suc
h a scenario might unfold. The group was instructed that “the only weapons allowed would be financial—currencies, stocks, bonds, and derivatives.” Attendees were asked to imagine “a global financial war using currencies and capital markets instead of ships and [planes.]” Rickards describes today’s monetary environment as “a new version of seventeenth-century mercantilism in which corporations are extensions of state power,” and in which nations like China, Russia, and others will use devaluations and financial instruments such as derivatives as “financial weapons of mass destruction.”
Noted investor Jim Rogers is so worried about the possibility of a new inflationary disaster and credit collapse that he moved himself and his family to Singapore.
The fears of Rogers and others have been prompted not only by the global environment, but also by developments in the United States. Many are legitimately alarmed by the United States’ unprecedented level of government debt, its momentous money-printing initiative, and its economic stagnation. They are concerned as well by political contention at home and the appearance of weakness abroad. These anxieties have translated into mounting concerns about the future of the dollar.
Could the dollar really come under attack and suffer a total or near-total collapse like the Thai baht or more recently the Turkish lira?
The Chinese are sufficiently worried to have called for the “de-Americanization” of the world financial system and for abandoning the dollar as the primary reserve currency. In the last several years, they have virtually stopped adding Treasuries to their reserves.
Chinese officials also proposed jettisoning the dollar in favor of a little-used global currency called special drawing rights (SDRs)—known informally as “paper gold.” SDRs were created by the International Monetary Fund in the 1960s as an alternative to the dollar and gold to deal with the Triffin dilemma. Their value today derives from a market basket of four currencies: the U.S. dollar, the yen, the euro, and the pound.