Posted on 04/19/2014 4:36:32 PM PDT by BfloGuy
Foreign individuals and businesses long ago cut back on their purchases of U.S. bonds. Their place was taken by foreign central banks. The central banks simply created money in their own currency and used it to buy our bonds.
The Federal Reserve always knew that we couldn’t rely on foreign central banks to buy our bonds forever. This may be the main reason it began the program called quantitative easing, in which the Fed created money out of thin air specifically to buy back U.S. debt.
Quantitative easing may have been intended to be a kind of insurance policy. If foreign central bank buying of U.S. bonds collapsed, the Fed would already have a program in place to buy them back itself.
The Fed said that quantitative easing was meant to create U.S. jobs, but this never made much sense. Even a hard core proponent of QE, Fed official William Dudley ( formerly of Goldman Sachs), admitted that the Fed’s own economic models could not explain how creating money out of thin air and using it to buy U.S. bonds would increase employment. Some link to rising stock prices could be demonstrated, if only through the cheap financing of corporate stock buy-backs, but then rising stock prices could not be shown to create jobs either.
One inference from this was that chairman Ben Bernanke, and now new chairman Janet Yellen, were just taking wild stabs in the dark. A more reasonable inference is that they had another reason for QE, one which they did not want to acknowledge.
Viewed in this way, the 2008 bail-out should be viewed not as a bail-out of Wall Street, but rather as a bail-out of Washington. The Federal Reserve feared that the market for government bonds was about to collapse, which would lead to soaring interest rates, and a complete collapse of our bubble financed government.
The Fed did not have the option of creating money and buying debt directly from the Treasury. That would be illegal. The Treasury must first sell its bonds to Wall Street, after which the Fed can then use its newly created money to buy them back. Hence, in order to rescue the Treasury, the Fed felt it had to rescue Wall Street.
This is a simplification of what happened, and only part of the story, but it is the untold part of the story, and in all likelihood the most important part. The Fed was in a panic in 2008, but not primarily about what might happen to Wall Street, and certainly not about what might happen to Main Street. It was in a panic over what might happen to government finance.
This interpretation is strengthened by new information contained in former Treasury secretary Hank Paulson’s recent book. He revealed that Russia tried in 2008 to persuade China to join in a collaborative effort to dump U.S. bonds in order to bring down the U.S. financial system. Although China refused to do so at the time, its government would clearly like to end dollar dominance, and has been paring U.S. bond purchases.
At the moment, Janet Yellen’s worries about finding buyers of government bonds can only be getting worse. For much of last year, foreign central bank purchases of U.S. bonds in aggregate fell. As of October of 2013, they had been negative for three and six months. Then they turned up a smidge, only to fall again, so that the last three months show a decrease of just over 12%.
It is known that Russia withdrew its U.S. bonds from custody of the Fed after the Crimea invasion, and has either been selling or could sell at any time. It will no doubt try again to persuade other countries to join in undermining the U.S. bond market and replacing the dollar as the mainstay of world trade.
Under these circumstances, it should not be surprising that the Fed is today taking only baby steps to reduce its program of creating new money to buy U.S. bonds. This program is probably not just meant to revive the economy, which it has not done and cannot do. It is more likely designed as a desperate and in the long run counterproductive effort to finance the U.S. government and save today’s dollar dominated financial system.
Moreover, even then, the gold standard and the related use of silver as specie at times forced Britain into what in retrospect are odious decisions and policies. For example, a principal cause of the First Opium War (1839–1842) was that the Chinese imported little and insisted on silver as payment for their exports of tea and porcelain to Europe. This precipitated a decline of gold and silver stocks in Britain and Europe.
The remedy fashioned by the British was to force China to admit opium as a trade good. Soon, the demand for opium from millions of addicts in China was enough to reverse China's accumulation of silver.
The crux of the problem is that under the gold standard, shifts in national gold reserves impact the supply of money in circulation, which in turn affects the wider economy. It cannot be assumed that shifts in national gold reserves will always be managed wisely.
Notably, there is a line of reasoning and evidence that attributes the severity and worldwide scope of the Great Depression to a policy of gold accumulation by France and, to a lesser extent, by the US, without equivalent new issues of national currency. The result was that the supply of money declined as well, which prompted a decline and then a collapse in world trade.
On balance, the gold standard offers a critique of our current monetary system and a hedge against it but not an alternative to it.
No. Actually, I was referring to the period from 1873 to 1913 when the U.S. had rejoined the world gold standard after having left it during the Civil War and was ascendant economically and politically.
Notably, there is a line of reasoning and evidence that attributes the severity and worldwide scope of the Great Depression to a policy of gold accumulation by France and, to a lesser extent, by the US, without equivalent new issues of national currency. The result was that the supply of money declined as well, which prompted a decline and then a collapse in world trade.
But surely you understand that Europe never returned to a true gold standard [though, they insisted on calling it one] after WWI. It was an ersatz gold standard that permitted nations to redeem their reserves for gold in London but not individuals.
Such a sytem could never be counted on to function because, if individuals cannot redeem specie for gold when inflation threatens, the monetary system becomes completely political -- and did.
In addition to which, the Europeans [the English foremost amongst them] returned to the gold standard at their pre-war values vastly overvaluing their currencies. Sterling, for example, had inflated by about 10% to 15% during the war.
To save face, though, the British re-entered the gold system at the pre-war value which immediately caused a grinding deflation to take place which saw the economy crushed as British exports became exhorbitantly expensive.
Now, while the British maintained the illusion of a gold standard with the U.S., the European countries used Sterling as their reserves allowing them to balloon their paper currencies.
In short, none of this had anything to do with gold but with the machinations of government to get around the discipline the classical gold standard imposed.
As you point out:
It cannot be assumed that shifts in national gold reserves will always be managed wisely.
There is no cure for corrupt and ignorant politicians.
The true test of a monetary system is whether it can withstand the stresses of wars and economic crises. And the record there is mixed at best.
(2) Your argument ignores the point that even the modified gold standard after WW I had major economic and financial consequences. As it was, Britain returned to the gold standard in 1925 the form of convertability to bullion instead of the prior policy of convertability to more accessible specie (coin). As predicted, this put Britain and her Empire economies into a painful deflation.
(3) My point remains: France's policy of gold accumulation in the 1920s and 30s without issuing additional currency helped cause the collapse in the world's gold-backed money supply that made the Great Depression so severe and global in scope. The US went off the gold standard during the Depression in order to issue additional money so as to counteract the severe deflation that the country had experienced.
On balance, whatever the merits of the gold standard in the abstract, it made the world vulnerable to the errors of a single country. As bad as our politicians may be, I prefer to be governed by them than by those of other countries.
(4) Although convertability was suspended, Fort Knox continues to hold a massive stock of gold as implicit backing for the dollar. In a supreme emergency, that gold would be available.
And your denying the influence of a stable currency during that time is to make the entire purpose of this discussion null. Telling.
Your argument ignores the point that even the modified gold standard after WW I had major economic and financial consequences.
Nonsense. The fact that Europe adopted a modified gold standard which had major economic and financial consequences was my point. How could I have possibly ignored it.
As predicted, this put Britain and her Empire economies into a painful deflation.
Yes. That is what I said. Did you even read it?
On balance, whatever the merits of the gold standard in the abstract, it made the world vulnerable to the errors of a single country. As bad as our politicians may be, I prefer to be governed by them than by those of other countries.
As do I. But your analysis is wrong, though I'm sure you'll cling to it. It was the last period in which individuals owned their money and governments were constricted [even by a bit] to debauch it.
Once the Federal Reserve had been created and WWI begun, government took over the "responsibility" for managing the currency and it's been downhill ever since.
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Worth a watch in my opinion. It will answer your question.
Moreover, your preferred measure -- price stability -- can be and often is accomplished by a fiat currency combined with sound economic policies. The supposed advantages of the gold standard are not unique to it.
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