In stages between 1914 and 1934, U.S. gold went from private hands, to bank hands, to central banks, to the Treasury. This paralleled the process that took place in the United Kingdom and other developed economies. Governments made gold disappear.
With the outbreak of the Second World War in 1939, gold convertibility, to the extent it remained, was again suspended. Gold shipments between nations mostly ceased.
The only major dealer in official gold during the Second World War was the Bank for International Settlements (BIS) in Basel, Switzerland. BIS did a brisk business as a broker in Nazi gold, including gold taken from Jews and other Holocaust victims. Proceeds were used to help finance the Nazi war effort, killing Americans and their Allies. During the war, BIS was run by an American, Thomas McKittrick. Today BIS remains the single most important agent for gold transfers between sovereign nations and major banks.
By the end of the Second World War, gold had ceased circulating as currency. The Bretton Woods Agreement of July 1944 reintroduced a gold standard, at least for nations, if not citizens. The value of each currency of the forty-four participant nations was pegged to the U.S. dollar at a fixed exchange rate. The dollar was pegged to gold at a value of one thirty-fifth of an ounce. Gold was still world money, yet it wasn’t circulating, the dollar was.
Over the next few decades, U.S. trading partners earned dollars selling prosperous postwar Americans everything from transistor radios to Volkswagen Beetles and French wine. These exporting nations converted their dollars into gold. In most cases, the gold didn’t go abroad. It stayed in the United States at the Federal Reserve Bank of New York vault on Liberty Street in lower Manhattan. Legal title was changed from United States to Japan as the case might be, yet the gold stayed in place. One exception was France, which demanded and got its gold physically transferred to Paris, where it remains.
By 1968, the Bretton Woods system was breaking down. The equivalent of a run on the bank emerged, except the bank was the gold depository at Fort Knox. Switzerland and Spain joined France in demanding their gold. Nixon shut the gold window to stop the run and preserve what was left of the U.S. gold hoard.
The years 1971 to 1974 were a muddle. Leading economic powers were uncertain whether to return to gold at new parities, keep fixed exchange rates without gold, or move to floating exchange rates.
The decline of Bretton Woods coincided with the height of influence for economist Milton Friedman of the University of Chicago. Friedman built his academic reputation with a monumental study titled A Monetary History of the United States, 1867–1960, coauthored with Anna Jacobson Schwartz. Friedman espoused a monetary policy based on the quantity theory of money (a theory articulated earlier by Irving Fisher and others). Friedman’s thesis was that the Great Depression was caused by overly tight Fed monetary policy prior to the 1929 stock market crash, and in the years immediately following.
Friedman’s solution was elastic money. By that he meant the ability of central banks to create money as needed to counteract effects of recession and temporarily depressed demand for goods and services. Elastic money meant abandonment of gold and fixed exchange rates because both regimes put limits on central banks’ ability to expand the money supply. Friedman’s views were influential in policy responses to the 2008 global financial crisis and its aftermath by Ben Bernanke, and later Janet Yellen.
Friedman’s scholarly research and theory of money were impressive. He earned the Nobel Prize in economics in 1976.
Yet Friedman’s assumptions were badly flawed. Policy recommendations based on his work proved defective. Friedman believed in efficient markets and rational expectations, two hypotheses since discredited both by data and by advances in behavioral science. In particular, Friedman, and Fisher before him, believed velocity, or turnover, of money was constant. Friedman failed to see that velocity was volatile due to recursive functions in emergent adaptive behavior of market agents. Without stable velocity, the quantity theory of money is useless as a policy tool, although the theory is useful for thought experiments testing outcomes in various states.
It is unfair to blame Friedman for this blind spot. Observed velocity was stable throughout the heart of Friedman’s career, 1950–90. It was only with the 1998 global financial crisis that velocity destabilized, a move accelerated by a subsequent crisis in 2008. Yet velocity plunged in the early 1930s also, a fact Friedman must have known. Friedman was too narrow, and ultimately incorrect in attributing the 1930s velocity plunge to gold and fixed exchange rates, which, according to Friedman, limited the Federal Reserve’s ability to stimulate with monetary ease.
In Friedman’s brave new monetary world, eliminating gold and fixed exchange rates enabled enlightened central bankers to carefully calibrate money supply to target maximum real growth consistent with low inflation. In 1971, Richard Nixon said, “I am now a Keynesian in economics,” a variation on Friedman’s more famous phrase, “We are all Keynesians now.” Nixon could as well have said, “We are all Friedmanites now.”
Keynes’s impact on fiscal policy, and Friedman’s on monetary policy, became a font of hubris in economics. There was no developed country macroeconomic problem that could not be solved with the right application of spending and money printing. Today, Keynes and Friedman hold hands in a hybrid theory called helicopter money.
Friedman’s views were decisive in the IMF’s decision to demonetize gold, and in unilateral decisions of major economies to abandon fixed exchange rates. By 1974, the last vestiges of the gold standard were gone. Floating exchange rates were the norm. Money was not anchored to gold; money was not even anchored to other money. Money had no anchor; in economists’ minds it did not need one.
After 1974, money was what central banks said it was. A de facto dollar standard emerged from 1980 to 2010 at the direction of two Fed chairmen, Paul Volcker and Alan Greenspan, and two treasury secretaries, James Baker and Robert Rubin. U.S. growth in the 1980s and 1990s during Presidents Reagan, Bush 41, and Clinton was robust under this strong dollar standard. By 2010, with the weight of Bush 43 war spending and Obama deficits, the dollar standard dissolved into currency wars that have been raging ever since.
In a brief sixty-year span, from 1914 to 1974, gold progressed from people’s money, to bank money, to sovereign money, to no money at all. This last condition is anomalous from the perspective of world history. That fiat money is based in part on Friedman’s flawed assumptions should at least give pause.
A seventy-year lacuna for world money is ending. Substitution of fiat for gold since 1974 was always overreliant on academics posing as central bankers, compliant trading partners, and trusting populations. Those three pillars are now fractured. Stagnant growth, asset bubbles, income inequality, financial panics, and currency wars are foreseeable results of the absence of world money. Global elites prefer order.
The next collapse will see world money’s reemergence. The elite plan is to rewrite the “rules of the game” of the international monetary system as was done in 1922, 1944, and 1974. The chosen instrument is neither the dollar nor gold, but SDRs.
SDRs were created by the IMF in 1969 to remedy a decline in confidence in the U.S. dollar. Countries that earned dollars from exports were dumping dollars for gold. There was not enough gold to support world trade at the $35 per ounce fixed price. Solutions were to ignore the shortage, revalue gold, or abandon it. Each path was unpalatable to one or more major economic power at the time. A fourth solution was devised: the SDR. The goal was to create a reserve asset that was neither a dollar, nor gold, but a hybrid. The SDR simultaneously alleviated the dollar glut and the gold shortage. The SDR was a paper claim on the IMF’s combined resources linked to a fixed gold quantity. The name “paper gold” attached to SDRs from the start.
By 1973, the original SDR link to gold was dissolved. SDRs were now just another form of paper money printed by the IMF. Still, the SDR remained. Some observers believe the SDR is back
ed by a basket of hard currencies. It is not. The basket is used solely to determine the SDR’s foreign exchange value. There is no hard currency backing. SDRs are printed at will by the IMF subject to the concurrence of the IMF’s executive board.
SDRs are issued infrequently. There have been only four issuances in the forty-seven years since SDRs were invented. The most recent issuance was in August 2009, near the depths of the global recession that followed the 2008 panic; the last issuance before that was in 1981. By September 30, 2016, SDR204.1 billion were outstanding, equal to about $285 billion at then-current exchange rates.
One interesting property of the SDR is that it solves Triffin’s dilemma. This economic conundrum was posed by Belgian economist Robert Triffin in testimony to the U.S. Congress in 1960. Triffin observed that the issuer of a global reserve currency had to run persistent deficits to supply the world with sufficient reserves for normal trade. Yet a nation that runs deficits long enough goes broke. In this context, going broke means trading partners lose confidence in the stable value of the reserve currency and reject it in favor of alternatives. SDRs solve this problem because the issuer, the IMF, is not a country and does not run deficits. There is no confidence boundary on the amount of SDRs issued. The IMF has no trading partners to reject its money. The IMF encompasses all trading partners.
SDRs are not issued in the conduct of normal monetary policy. They are not issued to bail out individual firms or even countries. SDRs exist primarily to provide liquidity from thin air when there is a liquidity crisis or lost confidence in other money forms. SDRs are a world money fire brigade to douse financial infernos.
SDRs are the perfect complement to ice-nine. In the coming collapse, the financial system will first be frozen because central banks are unable to reliquefy the system as in the past. The G20 will convene an emergency meeting, as happened in November 2008, and direct the IMF to reliquefy the system with SDRs. If successful, banks and brokers will gradually reopen. Customers will be allowed to access cash. Transactions in cash and securities will still be denominated in dollars, euros, and yen. Behind this curtain of success, the world will be a different place. The SDR, not the dollar, will be the reference point, or numeraire, for world trade and finance.
Dollars will serve as a local currency not unlike Mexican pesos. All local currency values will be measured in SDRs controlled by the G20. Direction will come collectively from China, the United States, Germany, Russia, and a few other members. This will be a seamless transition that few will understand. Sooner than later, a robust SDR bond market will emerge to absorb global reserves.
This transition has been under way for decades. SDR issuance in 1970-2, 1979-81, and 2009 exemplifies the slow, steady social engineering advocated by Soros and his ilk. On March 25, 2009, Tim Geithner, then U.S. treasury secretary, said he did not oppose expanded SDR use. “We’re actually quite open to that” was Geithner’s response to a reporter’s question about increasing SDR issuance. This remark was not considered radical: just another small step on the slow path to the dollar’s demise.
Another step on the road to world money was a November 2015 decision by the IMF executive board to include the Chinese yuan as a reference currency in the SDR basket. The other currencies are dollars, euros, yen, and sterling. This decision was purely political. The yuan did not meet the criteria for a true reserve currency and is unlikely to meet them for at least a decade. A reserve currency requires a deep, liquid sovereign bond market, with hedging instruments, repo financing, settlement and clearing facilities, and a good rule of law. China has none of these. Without bond market infrastructure, reserve holders have little to invest in.
Still, the political symbolism of the IMF’s yuan decision is important. The effect is to anoint China as a full member of the international monetary system. Just a few weeks after the IMF decision to include the yuan in the SDR, Paul Ryan, Speaker of the U.S. House of Representatives, slipped a provision into a budget bill that increased China’s voting rights at the IMF. This further validated China’s membership in the exclusive club of countries that run the world money system.
These triumphs for Chinese power went hand in glove with China’s manic efforts to acquire gold since 2006, best understood as an initiation fee for this exclusive club. Publicly U.S. officials and those of the other major economic powers disparage gold. Yet, these powers hoard it as proof against the day confidence in paper money dies. The United States has more than eight thousand tons of gold, the Eurozone has more than ten thousand tons, and the IMF has almost three thousand tons. China’s stealth acquisition of four thousand tons, with more on the way, gives China a seat at the table with the other gold and SDR powers.
A curious aspect of the SDR’s rise as world money is that individuals can’t have any. SDRs are issued by the IMF to its member nations. The IMF also has authority to issue SDRs to multilateral organizations including the United Nations and World Bank. In turn, the UN and World Bank can spend the SDRs on climate change infrastructure and population control. SDR recipients can use them to pay one another or swap them for other hard currencies as needed. Individuals cannot have them—not yet.
In time, a private market for SDRs will develop. Large corporations like GE, IBM, and Volkswagen will issue SDR-denominated bonds. Large banks like Goldman Sachs will make markets in those SDR bonds and write derivative contracts in SDRs for hedging. SDR bank deposits will expand in the same way that eurodollar deposits expanded in the 1960s. Imperceptibly, the dollar will become just another local currency. Important transactions will be counted in SDRs. World money will arrive on tiptoe.
Hedge fund and high-tech billionaires will discover they are billionaires in dollars only. The dollar itself will be devalued against SDRs, controlled by a small clique of countries beyond the reach of the billionaires and their bankers. World money means the dollar is worth what the G20 and IMF decide. Only gold is immune.
World Taxation
For a decade at the start of my career, I was international tax counsel to Citibank, then the world’s most powerful private bank. Citibank had branches in more countries than the U.S. Foreign Service had embassies. The bank, under the direction of legendary CEO Walter Wriston, was a bigger platform than the Department of State.
In the early 1980s, my colleagues and I prepared a U.S. income tax return that showed zero liability at a time when Citibank was highly profitable. Wriston objected. He said it was unseemly for the largest bank in the United States to pay no U.S. tax. He instructed us to pay a small amount. “You don’t need to pay a lot; just two or three percent. It looks bad if we pay nothing.”
We mastered the art of paying no taxes, but paying some tax was a challenge. There were many levers at our disposal. We used foreign tax credits, investment tax credits, or depreciation on Boeing 747s and the Alaska pipeline, which we legally owned and leased to users.
We also used tax-free municipal bonds and discretionary loan loss reserves to dial down tax liability. The third floor of our corporate headquarters at 399 Park Avenue featured a plastic palm tree in one corner. That symbolized Citibank, Nassau, our zero-tax Bahamas booking center operating at nearby desks. The Cayman Islands and Netherlands Antilles also came in handy.
Our challenge was that Citibank’s tax return was a finely tuned machine. Once you moved one lever, another lever might move on its own due to the complex interaction of credits, deductions, and elections in the Internal Revenue Code. We spent an entire year tuning the machine; now we needed to dismantle one small part without ruining the works. We had time and talent to pay the tax. Yet the lesson was not lost on me. For large, complex companies, paying taxes is not a requirement; it’s optional.
For developed highly indebted nations, paying their debt is not optional. Sovereign debt must be serviced or the global economy is thrown into chaos. Taxes are the primary way that developed economies maintain the façade of solvency. With that façade intact, countries c
an repay maturing debt with new debt.
This mismatch between a country’s need to collect taxes and a company’s ability not to pay has led to a shadow struggle between sovereign and corporate power. Sovereign power always wins in the end because countries have decisive tools, including violence. Still, corporate capacity to corrupt a country through lobbying is sufficient in the short run to fend off state power.
In a decentralized system of high-tax developed countries and low-tax haven countries, global corporations easily find ways to avoid taxation. Standard techniques include the transfer of intellectual property like patents and software to tax havens. Once there, intellectual property earns royalties without paying tax to the new host nation.
Another technique is transfer pricing. Corporations in high-tax nations pay inflated costs to their affiliates in low-tax nations. This shifts income to the low-tax nation and creates tax deductions in the high-tax nation. Other more sophisticated techniques include netting centers in high-tax countries where global purchases and sales are booked. Profit and loss from these activities nets out close to zero, which means no tax is due to the host country. Gross profits are spread around to counterparties in low-tax jurisdictions.
Cross-border tax treaties are a fertile area for corporate tax avoidance. Corporate payments as interest, dividends, and royalties move across borders based on the location of payer and payee. Nations impose withholding taxes on these payments because they have no other way to collect taxes from the recipient. The payer is required to withhold the tax; the payee receives its payment net of taxes.
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