Against the gods
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The world held its breath on Tuesday morning. On the day after “Black Monday”, everybody wanted to know what would happen when the US stockmarket opened.
An emergency meeting of the US 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, five to ten with time off for good behaviour. But the fix was in. And the Fed announced the new price of credit and waited to see how the market would react. In the event, reactions were mixed. Asian stocks rebounded. The Dow ended the day down. Gold rose.
Thus the long-running spectacle continues. Today, for the benefit of confused spectators, we clarify the plot.
The dramatis personae are many. But they fall 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. 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 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 as a guarantor.
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? Man or gods? In the 190 years since Ricardo wrote, had mankind evolved into a more perfect being? Given a once-in-history opportunity to stiff foreign creditors by printing up dollars at will, would a nation of saints eschew taking advantage of it?
You may guess the answer. But what is extraordinary about this tale is that the telling has taken so long. It looked as though the question would be settled quickly when prices ran wild in the 1970s. Inflation in July 1971 was almost the same as it is today – about 4.4%. But then, 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 over 10% – and gold had soared over $800. The gods were having their fun.
But then, into the Fed stepped a Hercules 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 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. And each one was dealt with by softening up man’s money with more cash and credit. And yet, consumer price inflation remained low and gold fell. By 1999, gold coins were practically the only thing you could 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 is 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? Between the Nixon and the Bush II administrations, price stability had proved a trap worthy of the gods themselves. With no consumer price inflation to worry about, the quantity of money and credit had ballooned. People borrowed and spent, borrowed and spent – until they had borrowed and spent too much. And after the tiny recession of 2001-2002, the quantity of paper money increased even faster – three or four times faster than GDP. Man had committed the abuse Ricardo predicted. Now, there would be Hell to pay. 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’ money.
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