What makes the blow up so astonishing is that it is astonishing at all…
An emergency meeting of the U.S. President’s “Plunge Protection Team” must have been called Monday night. Any other group of chief executives, colluding to rig prices, would have drawn, say, 5 to 10 with time off for good behavior. But the fix was in. And the Fed announced the new price of credit and waited to see how the rubes would react. In the event… reactions were mixed. Asian stocks rebounded. The Dow ended the day down. Then, the following day… it looked like the fixers might have rearranged the whole deck; rumors of a deal to save Wall Street further losses sent the Dow up more than 300 points.
Thus the long-running spectacle continues. Today, for the benefit of those who haven’t been paying attention, we clarify the plot.
The dramatis personae are many. But they fit into two camps. In one is a whole line of Promethean protagonists — prominent economists and politicians, beginning with Fed chairman Arthur Burns … followed by the epic hero Alan Greenspan. Currently, the lead is being played by Ben Bernanke, supported by George W. Bush in the White house and colleagues Mervyn King in England and Jean-Claude Trichet at the European Central Bank. In the other camp are, well, the gods.
It’s an antique story but the current action began in 1971, when Richard Milhous Nixon snuck in and stole the gods’ golden fire. Not surprisingly, the gods were cheesed off. They had put the metal in the ground themselves. And gold’s record for maintaining steady prices was second to none. An ounce of gold would buy about as much in 1950 as it would have in 1800… or 1700, when Isaac Newton was Master of the Mint. But modern political economists turned their backs on number 79 on the periodic table. They wanted a different kind of price stability… a stability they could mess with. Henceforth, the Nixon team announced, the world financial system would dispense with gold entirely. They would control the value of money themselves. They no longer needed gold backing them up.
As to this proposition, David Ricardo spoke for the gods:
“Experience shows that neither a State nor a Bank ever had the unrestricted power of issuing paper money, without abusing that power: in all States, therefore, the issue of paper money ought to be under some check and control, none seems so proper for that purpose, as that of subjecting the issues of paper money to the obligation of paying their notes, either in gold coin or bullion.”
And thus were the lines drawn. Who would prevail? The gods or The Man? It would be a first for mankind. But in the 190 years since Ricardo wrote, had man evolved into a more perfect being? Given a once-in-a-lifetime opportunity to stiff foreign creditors by printing up dollars at will, would a nation of angels be able to resist?
You may guess the answer, dear reader. But what is extraordinary about this tale is that the telling has taken so long. And then, when it inevitably goes the way it always goes, people are astonished by it!
It looked as though the question would be settled quickly when prices ran wild in the ’70s. Inflation in July of ’71 was almost the same as it is today – about 4.4%. But then, Richard Nixon judged it such a threat to the nation that he imposed price controls. Still, without gold anchoring the dollar, prices rose. Ten years later, CPI was running over 10%…and gold had soared over $800. The gods were having their fun.
But then, into the Fed stepped a colossus of a man; “Tall Paul” Volcker moved quickly to rescue man’s paper money. He tightened lending and pushed up 30-year Treasury yields over 15%. The dollar advanced and the gods retreated. Man was proud again. The drama seemed to be over. The fellows with their feet on the ground had triumphed.
For the next 20 years, crises came and crises went. Each one was dealt with by softening up man’s money with more cash and credit. And each one seemed like such a success; man’s confidence grew. Consumer price inflation remained low and gold fell. By ’99, gold coins were practically the only thing you leave on the seats of your car in Baltimore… confident that no one would bother stealing them. And as recently as this past November, William Poole, president of the Federal Reserve Bank of St. Louis, speaking for the whole race and sounding like Scipio after the destruction of Carthage, announced:
“Macroeconomists today do not believe that policies to stabilize the price level and aggregate economic activity create a hazard… Investors and entrepreneurs have as much incentive as they ever had to manage risk appropriately. What they do not have to deal with it macroeconomic risk of the magnitude experienced all too often in the past.”
But this week, the macro-economic risk seemed as great as ever before. What had gone wrong? The gods had set a trap. Between the Nixon and the Bush II administrations, low rates of consumer price inflation caused our heroes to err. With the quality of their money in no apparent danger, they allowed themselves to print more and more of it. Money was available to anyone who asked for it. For 25 years, the cost of credit fell… leading Americans to borrow and spend … until they had borrowed and spent too much. And after the limp recession of 2001-2002, the quantity of paper money increased even faster – three or four times faster than GDP. Fancy new instruments – ARMs, SIVs, CDOs, Swaps and MBSs – gave him even more rope. And then, the gods roared with laughter.
Gold shot up to three times its price in 1999. Oil reached $100 a barrel. Housing markets wobbled… credit markets crunched… and then stocks fell.
And now Mr. Bernanke has panicked. He offers even more money and credit to a world that already has too much. Of course, we don’t know how the contest will turn out, but we bet on the gods.
Markets and Money