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The Mind-Bending Ignorance of the Bretton Woods Years

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Published : January 21st, 2013
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One of the strangest things about “Triffin’s Dilemma” is not that Robert Triffin said something in the mid-1960s, but rather that people still take this stuff seriously a half-century later. It’s basically nonsense. But, it seems that, in fifty years, nobody has appeared to call a spade a spade. It just shows the very low level of understanding that has characterized these issues for over half a century.

For the last hundred and fifty years, some countries have operated gold standard systems using a “reserve currency” as a reserve asset. In practice, they don’t actually hold the currency – base money – but rather government bonds denominated in that currency. Before 1914, this was mostly British government bonds, and after 1944 it was U.S. Treasury bonds.

There is nothing particularly strange about this. Since 1700, and indeed earlier, banks operating a gold standard system have generally held some form of debt as a reserve asset. There isn’t really much difference between holding the gold-linked debt of the domestic government or the gold-linked debt of a foreign government.

Obviously, if a currency issuer (let’s assume central bank) holds British government bonds as a reserve asset, then it will have to purchase said bonds at some point. This is not inherently different that anybody buying a bond, such as a private investor. You buy it, and then you own it. Not too mysterious.

Does this cause a “current account deficit”? No, it does not. The current account deficit basically reflects capital imports and exports, or, to put it a slightly different way, the difference between domestic savings and domestic investment. Let’s take a specific example: The savings rate (financial capital generation) in Britain is 10% of GDP. Of this, 4% is used domestically, and 6% goes into foreign investments. Thus, Britain runs a “current account surplus” of 6% of GDP, which was actually the case in the pre-1914 era, when the British pound was the world’s premier reserve currency.

British investors end up with net financial and other assets (mostly bonds) equivalent to 6% of GDP. However, this is a net figure: the gross figures might be purchases of foreign assets of 10% of GDP, and sale of British assets of 4% of GDP. Some of those gross sales of British assets could be British government bonds purchased by foreign central banks. No problem with that.

Much the same thing was happening in the U.S. While Robert Triffin was wailing about the supposedly inevitable and horribly destructive U.S. current account deficit, the U.S. was actually
running a persistent current account surplus.

Robert Triffin couldn’t figure out the plus-or-minus sign on this basic statistic.

When the Bretton Woods system ended in 1971, the United States had run a current account surplus every year since 1960.

Nevertheless, legions of people, including serious economists, have talked about how the Bretton Woods system broke apart due to the “inevitable current account deficit” caused by “Triffin’s Dilemma.”

For fifty years.

This is so stupid, I just have to laugh.

Robert Triffin was reacting to some genuine problems in the Bretton Woods system. The problem had nothing to do with “reserve currencies” or the balance of payments, but rather with the fact that the United States was not properly operating a gold standard system to keep the value of the dollar at its promised $35/oz. Bretton Woods parity.

At the time, the United States had a “gold standard policy” – the $35/oz. parity – but it did not have a “gold standard system,” in other words, the proper automatic currency-board-like operating procedures to implement the policy.

Instead, the U.S. had a basically Keynesian interest-rate targeting system. The value of the dollar naturally varied from its gold parity. Until 1971, the U.S. didn’t get so aggressive with its discretionary “domestic monetary policy” that it couldn’t keep things more-or-less in line, typically with heavy-handed application of capital controls and various jiggering like the “London Gold Pool.”

That changed in February 1970. William Martin, who had been the governor of the Federal Reserve since 1951, was replaced by Arthur Burns. Burns was handpicked by Richard Nixon to resolve the minor recession of the time with an “easy money” policy.

Burns and the Nixonites decided that, to resolve the recession, nominal GDP should grow by 9%. It was “nominal GDP targeting,” which has become popular again among today’s generation of Keynesian economists, who think they invented something new.

This 9% nominal GDP growth was to come via the printing press. Burns ramped up money creation and lowered interest rate targets.

This “easy money” was totally contradictory to the policy of keeping the value of the dollar at its $35/oz. Bretton Woods parity. On August 15, 1971, Nixon resolved the conflict by effectively ending the U.S. gold standard policy. The floating currency era began.

It was supposed to be temporary. Burns, Nixon and others didn’t really understand that the money-printing strategy and the gold standard policy were contradictory.

This was no surprise – nobody else understood it either, including Robert Triffin. It was a time of incredible ignorance.

The main reason that we don’t have a gold standard today is not because it didn’t work, or because the floating fiat currency system is better. There was no rational decision-making involved. Mostly, I think it is the natural outcome of mind-bending idiocy.


(This item originally appeared in Forbes.com on January 18, 2013.)



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Nathan Lewis was formerly the chief international economist of a firm that provided investment research for institutions. He now works for an asset management company based in New York. Lewis has written for the Financial Times, Asian Wall Street Journal, Japan Times, Pravda, and other publications. He has appeared on financial television in the United States, Japan, and the Middle East.
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