Because most governments find it harder morally to seize foreign-owned property, so they dilute the purchasing power of claim checks foreigners hold; that is, theft by stealth is preferred to theft by force.
The U.S., from WWII to the early 70s, operated like Thriftville; that is, we sold more abroad than we purchased.
Then, we invested the surplus abroad, so that our net investment, that is, the holding of foreign assets less foreign holdings of U.S. assets, increased from $37 billion in 1950 to $68 billion in 1970. Besides the fact that the U.S. was in a net ownership position with respect to the rest of the world, we also had net investment income on top of the trade surplus. This would be similar to an individual saving some from salary and reinvesting dividends from the existing nest egg.
Since 1970, the situation reversed, and deficits ran 1% of GDP, which was not a problem at first as the net investment income remained positive, and with compound interest, our net ownership hit a high of $30 billion in 1980.
Since then, it has been all downhill, so that by 2002, the annual trade deficit exceeded 4% of GDP. The rest of the world now owned $2.5 trillion more of us than the U.S. owned of the rest of the world. Some of the $2.5 trillion is in U.S. bonds, both government and private, and some is in assets such as property and equity securities.
This is like selling pieces of the farm and increasing the mortgage on what we still own.
To put the $2.5 trillion in perspective, contrast it with the $12 trillion value of publicly owned U.S. stocks, or the equal amount of U.S. residential real estate, or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show what’s already been transferred abroad is meaningful—around 5% of our national wealth.
If things stay the same, foreign ownership of our assets will grow at about $500 billion per year at the present trade deficit level, and the U.S. is paying ever-increasing dividends and interest to the rest of the world. We are now in negative compounding. This is very bad.
(I paraphrase the writing of Warren Buffett)
What have the trade deficits been since 2002? It goes up and down, but averages about $500 billion per year. Clearly, a plan to reverse this bad situation is desperately needed. Buffett suggested his idea of a plan. My thought is to return to operating under a gold standard. Is it mere coincidence that the reversal of the U.S. trade balance went from positive to negative in 1971? That was the year that Nixon took the U.S. off the gold standard, which was also when the high inflation period of the ‘70s started, and when the oil shocks began.
But most importantly, our politicians and national leaders need first to agree that this is a crisis. Until the problem is identified, articulated, and the electorate becomes informed, no action to correct the problem can take place. When the problem is obvious to most people, then and only then can the problem get the attention of the president and Congress. At that time, it will be up to the president and his/her administration, along with Congress, to devise a way out of this mess.
I am discouraged when a beacon for capitalism and wealth accumulation like TheWall Street Journal fails to recognize the danger to the country when we let foreign nations take away our national wealth. They do this in the name of free trade. But free trade must be fair trade, and without a worldwide standard upon which all nations’ currency is tied to, who knows what the value of trade is taking place? How can anyone, anywhere, know what the correct conversion of yen, pounds, or renminbi is to the dollar, and vice versa? They can’t. But the U.S. is the giant of commerce in the world, and if the U.S. returned to the gold standard, all worldwide trading would come to be settled in amounts tied to the market value of gold, which then would be acting as a tether between each country’s currencyrelative to all other countries. Why am I calling out TheWall Street Journal? The editorial of 1-17-17 panned Commerce Secretary Wilbur Ross, who said, “I consider running a trade surplus a sign of economic success.” The Journal said this opposes the fact the while running a trade deficit in the 1980s and 1990s, the U.S. had a high growth period. They alluded to Ross as being against free trade. Again, I advocate free, but also, fair trade. Anyone with any business sense only needs to look around and see all the transfer of factories and jobs from the U.S. to elsewhere, and their intuition should tell them we have not been trading with other nations fairly.
Here is how I summarize the trade imbalance dilemma. When we import more that we export, a capital flow comes back into the country, and this may be foreigners buying either our debt or our assets (which mostly are equity or stock in our corporations or real estate). The former is helpful. Besides, we have run up such a high federal debt, and this tends to keep our interest rate lower. The latter is what concerns Buffett (like selling off pieces of the farm so we can live better). Following WWII where most of the world was destroyed except for the U.S., we profited handsomely by exporting our goods and services widely. It didn’t help matters much when we abandoned the gold standard, and this probably made it easier for other countries to manipulate their currency to our disadvantage. The post-war legacy also left us with a situation where a lot of countries’ tariffs were much higher than ours. For example, Germany could freely import cars into the U.S., but held up high tariffs for our cars trying to get into Germany. In more recent times many countries developed sovereign investment funds, and with government subsidies benefiting their position, sold to the U.S. at our disadvantage. Then along came countries like China (and some others) spying on our corporations or in other ways figuring out how to steal trade secrets and the like, and putting our corporations wanting to sell overseas at a disadvantage. Finally, China and some other countries’ governments would subsidize an industry they targeted to grab a larger market share elsewhere. I believe it is only right that the present Trump administration has made the decision to negotiate better trade policy with a lot of countries, and especially to change the trade situation with China.
U.S. Trade in Goods and Services - Balance of Payments (BOP) Basis
Value in millions of dollars 1960 through 2015
12 - BARRIERS TO ECONOMIC GROWTH
4. DEPRIVING MONEY AS A STORE OF VALUE
AND THE NEED FOR A GOLD STANDARD
When President Nixon took us off the gold standard in 1971, I didn’t even know we’d been on one. I didn’t know of anyone who had ever talked about it, and of course, I was totally unprepared for the terrible consequences that followed. I daresay that the president and his many learned advisors didn’t have a clue either.
Laffer and Stephen Moore, write about that time in their book, Return to Prosperity.Lafferwrites, “When I was the chief economist in the White House Office of Management and Budget in August, 1971, Richard Nixon assembled his key economic advisors for a panicked weekend retreat at Camp David. On August 14, 1971, President Nixon brought down from the mountain a series of decisions reflecting radical change in economic policy. The impetus for the Camp David meeting was a bad inflation number; I think the number came in one month at 4.6% annualized rate, which was just below 4% in January 1968, and slowly rose to a little over 6% in January 1970, then declined to about 3% by July 1972. Then it went crazy and rose to 12% on October, 1974…Nixon devalued the U.S. dollar and took the dollar off the gold standard. He imposed a tax surcharge up to 10% on products imported into the United States. He also proposed something called the Job Development Credit, which was an investment tax credit that applied only to American-made goods. And last but not least, President Nixon imposed severe price controls on a huge cross-section of U.S. products, and wage controls on U.S. labor…the 1971 Camp David edict was a perfect example of a panic decision made in haste with far reaching deleterious consequences that would last for years to come—inflation surged and unemployment rose as output fell. And for what?A silly one-month inflation number. Seriously, do you think it was worth it?”
Steve Forbes writes in a Forbes magazine editorial (2-28-18) that it was Treasury Secretary John Connally who talked Nixon into
closing “the gold window.” Connally, the other person shot in the Kennedy motorcade, Governor of Texas with a law background, became Nixon’s Treasury Secretary. (Note Connally’s law background, not economics background).
President Jimmy Carter first appointed Paul Volcker to the Federal Reserve, and Reagan kept him on as the head of the Reserve during his administration.
In the early 1980s under Paul Volcker (1979-87), the U.S. once again returned to a price rule. (What Laffer means when he says “the U.S. returned to a price rule” is that the dollar is tied to something that doesn’t change, that is a constant. Gold typically was the constant, but gold is just a commodity that doesn’t change much, and using a basket of other commodities works very similarly to gold). Laffer cowrote an editorial with a Charles Kadlec on how this worked, which is also relevant today. Volcker essentially said, “I have no idea what prices are today, or what inflation is today, but I do know what spot prices of commodities are.” It was very similar to a gold standard, except Volcker used 25 commodities. If spot commodity prices rose above their cyclic adjusted long-term level or outside a band, the Fed then would then start selling bonds in the open market, thus removing monetary base (bank reserves plus currency in circulation) from the banking system, thereby taking money out of the economy. The Fed would keep selling until spot commodity prices came back in line with their historical level (money again being in balance with goods). If the commodity prices fell, the Fed would then buy bonds. This policy was meticulously adhered to by Alan Greenspan. Laffer hoped Bernanke would follow this method, but he didn’t. He presented a chart showing how stable inflation was during the Volcker years, and how erratic it was starting in 2000 (and the late ‘70s).
This chart shows the Fed Funds Rate rising from 5% in January ‘75 to about 19% by January ‘80, and the DJ Spot Commodity Index moving from 100 to 220 (paralleling each other on the chart). From about ‘83 to January ‘90, the Fed Funds rate stayed in a band of about 6-11% and paralleled the DJ Commodities Index of 100-140. After January ‘90 the two lines diverged with the Fed Funds rate moving down from about 9% to zero, while the Commodities went up, increasing from about 110 to 230.
This scenario shows the U.S. moving from the price rule of a gold exchange standard to an unhinged paper currency and then back to a rock-solid price rule based on spot commodity prices. The next chart shows the 10-year T-Note Yield of 3% in 1953, slowly rising to about 17% in 1981, then slowly declining to 3% in 2009.
My interest is, where are we today, and then what steps I need to take to protect myself. From 1966 to 1982, the Dow fell 22% in nominal terms, but after inflation adjustment, it was a real loss of 74% or 7.9% a year for 16 years. At my age today, I can’t wait through another 16 years for a recovery.
My first real paying job started in Kearney, Nebraska in 1972. The stock market hit its low at the end of 1974, and beginning of 1975. The PE (price to earnings) ratio for the Value Line Investment Survey of their 1700 stocks was 4.5, or extremely low, and has never been seen again. That was when I incorporated and started a pension program. I rode that pension fund upward then, and I’mstill riding it up (my good fortune). But when do I bail out and where will I go? I’ve learned to move money in small increments, and to keep it up as long as what I perceive continues to show warning signs. I may go to cash, or maybe to an exchange traded fund for gold. What I need now is to plan what signs to believe that will kick off this reversal.
Back to Laffer’s book. For changes in supply, prices and quantities move in opposite directions. Conversely, for changes in demand, price and quantities move in the same direction. If the quantity of money increases because of an increase in supply, this gets associated with higher inflation, higher interest rates, higher gold prices, and a weaker currency. If the quantity of money increases as a result of an increased demand for money, things start getting a little weird. Inflation, interest rates, and the price of gold will fall, and the currency will strengthen as quantities of money grow faster.
Bernanke, starting in 2008, radically increased the monetary base by about $1trillion. The Fed controls the monetary base 100% by buying and selling in the open market. This was the largest increase in the past 50years by a factor of 10, and the monetary base has increased by less than 10%, while bank reserves have increased twenty-fold. The currency in circulation component of the monetary base has fallen to 50% of the monetary base. To this, Laffer says, “Yikes.” What the Fed should do to mitigate the consequences of its unwarranted increase in the monetary base, it should contract the base back to where it would have been, plus a small increase for economic expansion. Absent doing this, the Fed should increase reserve requirements on member banks to absorb the excess reserves. Laffer doubts the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell $1 trillion in bonds. This would put the Fed in direct competition with the Treasury’s planned issuance of $2 trillion worth of bonds; (2010) failed auctions would become the norm, and bond prices would tumble (which happened in 2000 and 2001). The last time the Fed contracted the monetary base, the economy quickly dipped into recession. While the short-term pain would be quite sharp, the long-term consequences of double-digit inflation are devastating. Laffer says that his issue now is how to protect assets for his grandchildren.
Incidentally, Laffer told me that the gold standard works really well when the monetary system goes awry and the monetary system when working well is good when the gold standard goes awry, as happened when the new world was discovered and huge new amounts of gold were taken back to Europe, which then experienced massive inflation. He also said it doesn’t take much gold to do a gold standard.
For historical perspective, I offer the following:
In her excellent 2007 book, The Forgotten Man, historian Amity Shlaes describes an early morning meeting at the Roosevelt White House… here’s how she set a typical morning scene in 1933 as Franklin D. Roosevelt still lay in his pajamas:
They met in his bedroom at breakfast. Roosevelt sat up in his mahogany bed. He was usually finishing his soft-boiled egg. There was a plate of fruit at the bedside. There were cigarettes. Henry Morgenthau from the Farm Board entered the room. Professor George Warren of Cornell came; he had lately been advising Roosevelt. So did Jesse Jones of the Reconstruction Finance Corporation. Together the men would talk about wheat prices, about what was going on in London, about, perhaps, what farmers were doing.
Then, still from his bed, FDR would set the target price for gold for the United States—or even for the world. It didn’t matter what Montagu Norman at the Bank of England might say. FDR had nicknamed him “Old Pink Whiskers.” It did not matter what the Federal Reserve said.
In 1933, FDR made the decision to devalue the dollar from 1/20th of an ounce of gold to 1/35th of an ounce. Forgetting the lesson of the early 1920s, when the integrity of the dollar was maintained, Roosevelt devalued the dollar and thereby defaulted on its debt.
As Carmen Reinhart and Kenneth Rogoff describe in This Time Is Different (2009), “The abrogation of the gold clause in the United States in 1933, which meant that public debts would be repaid in fiat currency rather than gold, constitutes a restricting of nearly all the government’s domestic debt. With the United States heavily in debt thanks to spending that was logically failing to stimulate the economy, FDR reduced the value of the dollar being returned to holders of U.S. debt.
Importantly, what Roosevelt did was much bigger than a default. I have already said it several times, but when investors invest, they are buying future dollar’s income streams. The dollar is the measure used in all such commercial contracts, yet by the proverbial stroke of a pen, those contracts and investments meant something quite a bit different.
As Peter Thiel once said, “The value of a business today is the sum of all the money it will make in the future.” There are no companies and no jobs without investment first, yet FDR devalued the
capital commitments made by investors that are so crucial to economic progress. Perhaps even worse was the on-the-fly way in which FDR played around with the most important price (the dollar) in the world. Schlaes describes one morning meeting with FDR and brain trust this way:
One morning, FDR told his group he was thinking of raising the gold price by twenty-one cents. Why that figure? his entourage asked. “It’s a lucky number,” Roosevelt said, “because it’s three times seven.” As Morgenthau later wrote, “If anybody knew how we really set the gold price through a combination of lucky numbers, etc.; I think they would be really frightened.”
All of this is worth bringing up for revealing, if nothing else, the terrible policymaking that needlessly elongated a downturn that, if left alone by Herbert Hoover and Roosevelt, would have been the source of a healthy economic rebound. Recessions, like market corrections, are an economy’s way of clearing out all the debris on the way to boom times. The Great Depression did not have to be…. So incensed was Fed Chairman Eugene Meyer by FDR’s decision that he resigned. From John Tamny’s Who Needs the Fed?
What started the “Great Depression”? Smoot-Hawley ended the “Roaring Twenties” (by setting off a worldwide trade war), and FDR’s downgrading the dollar’s value (which short-changed all the creditors who’d issued debt). The first was stupid and the second, arrogant. Stupidity followed by arrogance set up the whole world for, and brought us the cataclysm summarized by one name: Adolf Hitler.
Let me restate that. The Great Depression didn’t need to happen, and neither did WWII. Both came about secondary to stupidity and arrogance; what a tragedy!!!
Thought it couldn’t get any worse; well, stupidity followed by arrogance repeated itself under guidance by George W. Bush and was followed up by Barack Obama. Ignorance of past government behavior never seems to be clearly understood. For example, a new book by Marc Levinson, An Extraordinary Time, “…takes us back to the whirlwind of the very early 1970s, when a plunging-dollar crisis was soon followed by even worse shocks: oil and gas prices going through the roof; the global economy shuddering; the collapse of banks and firms; and then (here the author is very good) the half-hearted recovery that would defy the policy prescriptions of one administration after another.” This author then goes on to say we entered a new economic era. That the boost from our country being the main surviving economic power after the WWII was over, on top of the end of the conversion of an agrarian society to an industrialized country; that we now were a mature society, and despite all the technical advances (communication, etc.) concludes that the end of a golden age of economic progress was over, as described by the Nobel laureate economist, Paul Samuelson. Samuelson wrote the book we studied in college for economics. He was a true Keynesian who never believed in the gold standard. And ends with the notion “that modernizing societies like America have one special period of great productivity growth and then return to normal.”This from the book’s review by Paul Kennedy, TheWall Street Journal, 11-29-16.
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