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Aggregate Demand Dominance: Reaping the Whirlwind

The Utter Failure and Stupidity of the Gold and Silver Standards: Part 9

Once again, I write a posting about the failure of the gold standard without mentioning gold. That was, again, intentional—describing what Nixon’s explicit price controls and the implicit, hidden controls within Bretton Woods’ gold standard were supporting necessitated delving into why 1969 to 1973 involved an immense increase in the use of American economic resources, specifically to do this:

https://i2.wp.com/www.nationalmuseum.af.mil/shared/media/photodb/photos/061127-F-1234S-017.jpg

One of the “Big Belly” B-52Ds releasing its 60,000-pound bomb load of bombs on enemy targets in Vietnam. It could carry up to 84 500-pound bombs or 42 750-pound bombs internally and 24 750-pound bombs externally on racks under the wings. (U.S. Air Force photo)

1973 especially saw an incredible increase in B-52 BUFF bombing, specifically a volume of firepower leveled against Cambodia that made the tiny Southeast Asian nation the most heavily bombed in the Earth’s history:

https://i2.wp.com/walrusmagazine.com/images/2006.10/l/cambodia03.jpg

Over 2.7 million tons leveled the Cambodian people out of the 7.6 megatons directed at Southeast Asia in general. In the above data strip, on five different occasions the BUFFs in the course of a single day dropped more explosive power of the Hiroshima atomic bomb. At least 6 million tons fell due to President Richard Nixon’s orders, three times what FDR and Truman ordered expended from 1941 to 1945. Roosevelt had the OPA (Nixon’s wartime employer) to contain the inflationary effects of the largest war in human history. Three decades later, Nixon had the faltering remnants of the gold standard to contend with.

BUFFs Meet Bretton Woods

On the fortieth anniversary of Nixon’s ESA price controls, Bruce Bartlett zeroed in on the weakest link:

Nixon’s advisers knew that the Federal Reserve could stop inflation by tightening monetary policy, but that would likely bring on a recession going into an election year. Nixon desperately needed to keep inflation bottled up until after the election.

It would also trigger a recession during wartime, disrupting the SAC B-52s bombing Laos in Operation Barrel Roll and Cambodia in Operation Freedom Hand, but no matter.

Another concern was that the international monetary system was falling apart. Established at Bretton Woods in the aftermath of World War II, its foundation was having the dollar convertible to gold at $35 per ounce, with other currencies fixed to the dollar. But inflation was putting severe pressure on the exchange rate system and for 10 years American presidents had been fending off European demands to trade their dollars for our gold.

Bretton had already been done in by Operation Rolling Thunder three years prior, but discarding the centuries-long system of price controls (the gold standard) was out of the question…until the British forced Nixon’s hand:

In mid-August, 1971, a crisis arose when Great Britain demanded $3 billion worth of gold (worth $150 billion at today’s gold price). This led Nixon to call a special meeting of his economic advisers at Camp David on Friday, August 13.

Years later, Sid Jones, who was McCracken’s assistant at the CEA, told me he knew something big was going on because McCracken came to him just before leaving for the weekend and gave him a letter designating him as acting CEA chairman for the weekend. Not only had McCracken never done such a thing before, but it wasn’t even appropriate because Jones wasn’t a member of the CEA; just a staffer. My guess is that McCracken wanted to be able to say later that he wasn’t technically chairman of the CEA when the ensuing events transpired.

At Camp David, Treasury Secretary John Connally, former governor of Texas (as a Democrat), was very much in charge. His main argument was that Nixon needed to be bold and do as much with one dramatic action as possible.

On Sunday, August 15, Nixon announced the imposition of wage and price controls throughout the U.S. economy, making dubious use of emergency presidential authority. He also closed the gold window and set the dollar free to float, destroying in one fell swoop the international monetary system that had existed for 25 years.

I’m still stunned to read the above passage. How unaware are economists of momentous economic history? The dollar wasn’t floated in 1971. If it had been, the U.S. would have been able to devalue that December:

A series of meetings of the “Group of Ten Industrial Countries” and IMF took place in Washington from September to December 1971, culminating in the so-called “Smithsonian Agreement”, which is a “currency realignment”. The United States devalued her dollar on 18 December 1971 by 7.89 per cent; the official price of gold was increased from US$35 per ounce fine to US$38. The surplus countries, like Japan, West Germany, Belgium and the Netherlands revalued their currencies upward.

The United Kingdom, France, Australia and New Zealand decided to maintain their gold parities, implying an appreciation of 8.57 per cent against the dollar. The new parity rate was 2.6057, the old one being 2.40.

Parity rates? Those are hallmarks of the system of fixed exchange, not floating currencies. Bretton Woods was alive at the end of 1971, though the gold standard fell off a cliff in June:

Sterling had continued to be weak after World War Two. There were two devaluations, 1949 and 1967, and at least six major crises of sterling from 1945 to 1972. In June, Britain lost a large amount of gold and foreign exchange by supporting the pound to parity, so much so that she decided to let the sterling float in the market on 23 June. The objective was to let sterling find its level according to market forces in order to achieve equilibrium in the balance of payments and to encourage export of goods and services and above all to further avoid the depletion of gold and foreign exchange.

Uh-oh. After centuries at the center of the monetary universe, the pound sterling is set free on 23 June 1972; though the PM apparently didn’t get the message and close the damn gold window. Why this occurred is anyone’s guess, but I’m betting on the downstream effects of three weeks of Operation Linebacker bombing. Britain’s bust became an American boom. For a few months:

There was hope that the Smithsonian currency alignment in December 1971 would work for some time.  The U.S. dollar gained strength in the second half of 1972.  Unfortunately, after a heavy speculative attack on the dollar it was suddenly devalued on 12 February 1973 for the second time after World War Two.  This time, it was devalued by 10 percent, as the official price of gold was increased from US$38 per oz fine to US$42.22.  Soon after the second devaluation, there was another heavy speculative attack on the dollar so much so that foreign exchange markets all over the world had to be closed from 2 March for seventeen days.  When the exchange markets were reopened, the major currencies of the world including the US dollar, Deutsch Mark, Japanese Yen, Pound Sterling, French Franc, Dutch Guilder etc. were all floating.  The world was now in a floating exchange rate system as a revolt against the IMF fixed exchange rate system.

The B-52 had finally bombed Bretton Woods into extinction. It was the only SAC success story of the entire war.

The Whirlwind

The death of the gold standard on 19 March 1973 sent inflation racing immediately:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1973 3.65 % 3.87 % 4.59 % 5.06 % 5.53 % 6.00 % 5.73 % 7.38 % 7.36 % 7.80 % 8.25 % 8.71 % 6.16 %

The effects of Freedom Hand almost doubled inflation before Congress finally forced the BUFFs’ annihilation of the Cambodian population to cease on 15 August 1973. The respite from the end of nine hard years of South-East Asian war lasted merely two months before the Arabs retaliated for Operation Nickel Grass and the oil embargo began:

Nixon reacted in a manner befitting a twenty-first century European central banker—austerity:

Phase IV was to be a move “from the freeze to the squeeze”; companies were to be forced to absorb cost increases at the expense of profits before passing them along in the form of increased prices.

How well did these function? Umm…

Historical Data Chart…they didn’t work at all. Most of the population agreed:

This bitter legacy — shortages of gasoline, heating oil, red meat, soybeans and numerous other products — together with ruinous price increases, finally discredited price controls in the eyes of the American people. By February 1974, when Dunlop appeared before the Senate Banking Committee, there were sixty Amendments proposed to the Economic Stabilization Act aimed at providing relief from controls to one segment of the economy or another. Dunlop told the Committee that the Administration did not favor continuing price controls after April 30 1974, except in the health care industry (and except in petroleum where authority to administer price controls and allocation regulations had been transferred to the Federal Energy Office in early January 1974) . In the end, the Congress simply allowed the Economic Stabilization Act to expire on April 30, 1974. Thus, the only peacetime experiment with direct economic controls in U.S. history came to an inglorious end.

Inglorious, yes. Direct price controls expiring in April 1974 thirteen months after the final demise of gold price controls was long overdue, but calling any of this a peacetime experiment is nuts. Nixon was bomb-crazy; the legislative branch finally had to cut him off. In the forty-one years since Phase IV ended, the misunderstandings surrounding 1973 have wrought immeasurable economic harm.

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One thought on “Aggregate Demand Dominance: Reaping the Whirlwind

  1. Pingback: The Wrong Turn | In The Corner, Mumbling and Drooling

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