Signs of the Times – part 5


Signs of the Times – part 5


Quote of the Day:

“The rich rule over the poor, and a borrower is a slave to the lender” Proverbs 22:7.

Those of you who have heard David Gates speak, may remember him telling about one of his enduring childhood memories. In 1971, his father was listening to the radio, and he called out in an urgent voice, saying: “David, David come and listen! – the United States has just gone bankrupt!”

To understand what happened to the U.S. economy (and the world economy) in 1971, we need to go back to 1944, to a place called Bretton Woods in the state of New Hampshire, in the U.S. By 1944 it was clear (at least to the Allies) that they were going to win WWII. So they assembled at Bretton Woods to decide what sort of economic system would prevail after the war. Prior to the war most countries had some kind of link between their national currencies and gold. In other words, it was gold that gave their paper money value. This changed at Bretton Woods. For the purposes of our story the most important decisions made at Bretton Woods were:

  1. The allied nations (the Western Alliance) would go off the gold standard (except America). In other words, the currencies of each nation (except America) would no longer have to be backed by reserves of gold.
  2. Instead of being linked to gold for their value, the currencies of the Western Alliance would be linked to the American Dollar for their value.
  3. The American Dollar would be the only currency that would remain on the gold standard. In other words, the American Dollar “would be as good as gold.”
  4. This did not mean that ordinary citizens could trade in their American dollars for gold. However, the arrangement was that, the nations of the earth, could exchange their American dollars for gold. In other words, America guaranteed that it would settle its debts with gold.

This system prevailed until 1971, when President Nixon, announced that America was “shutting the gold window.” Which was a euphemistic way of saying, “we’ve run out of gold” – or – “we still have some gold, but you’re not getting it.” Either way, when someone says they are not going to pay their debts (for whatever reason) we normally call that bankruptcy. And so it was in this case. The rest of the financial world swallowed hard and accepted it – because this was the height of the Cold War and America was the only nation able to stand up to the communist threat. The immediate effect of this decision was to introduce great instability into the financial system –instability that has increased over time and it has a direct link with the situation we find ourselves in today. [When the history books are written we may find that President Nixon’s announcement to “shut the gold window” will be one of the most momentous decisions of the 20th Century].

So America started paying its debts with paper money. However, a problem soon arose – the American dollar began to lose its value. It began to lose its value because of a natural economic law. Every new banknote that is issued into circulation will devalue all the existing notes in circulation – it is a simple equation of supply and demand. The more there is of any particular item in the marketplace – the less valuable it will be. If something is scarce in the marketplace the more valuable it will be. And there were too many American dollars in the marketplace therefore the American dollar lost its value.

The proper solution to the problem would be to withdraw some of the American dollars from circulation. The only institution able to do that is the institution that issued the dollars in the first place – the American Government (technically the Federal Reserve – the privately owned American central bank). However, every dollar coming back to America represented a debt that America had to pay. And as we have already learned America was unwilling to pay its debts. [The reason why the world was awash with American dollars at this time was because America was printing dollars to pay for the Vietnam War – does this sound familiar?]. So another solution had to be found to lift the value of the American dollar. The solution was a stroke of genius – it is a revelation into how creative and inventive the current economic system is, when it is focused on preserving its power. However, it had to be kept a secret, so the people behind the scheme never got the recognition they deserved (or the infamy).

Seeking to bolster the value of the American Dollar, the American Government went to the Saudi Arabians (the most important exporting oil country) and made them an offer “they could not refuse.” The offer was: “we will guarantee your national security, and in return you will only ever accept American dollars for oil.” There was an additional caveat, the Saudi Arabians had to agree to persuade their OPEC colleagues (Organization of the Petroleum Exporting Countries) to do the same. The Saudis agreed and the deal was done. This was in the early 1970’s. Do those of you who are old enough, remember what happened to oil supplies and oil prices starting in 1973/74? Oil prices increased fourfold [this increase was exacerbated by the Israeli/Arab, Yom Kippur War – the Arab nations used restrictions on oil production as a retaliatory weapon against America, for American support of Israel].

Since oil was priced in American dollars, and since there was a huge fourfold rise in the price of oil, this meant that there was a fourfold increase in the demand for U.S. dollars, this meant that there was a fourfold increase in the value of American dollars. Prior to the Yom Kippur War a barrel of oil cost a lowly US$3 – after the war a barrel of oil cost US$12 [and prices kept rising peaking in 1979, before dropping again]. So, the world was not just competing for oil, it was competing for American dollars to purchase the oil. The decline in the value of the American dollar was over (temporarily).

Thus the “petro-dollar” phenomena, was born. Petro-dollars was the term coined for the vast amount of dollars that flowed into the coffers of all oil exporting countries – especially Middle East nations – and especially Saudi Arabia – the largest exporter of them all. This vast flow of American dollars caused a problem. The economies of these countries could not absorb all this new found wealth. So, looking for investment opportunities, much of this money was simply deposited in American banks. Completing the petro-dollar cycle, because, basically this is where the money originally came from.

So, now the banks have a problem. They are awash in large amounts of new deposits and they are expected to return a profit to those who deposited them. How do you get someone or something to borrow not just millions of dollars but billions? The answer was: lend to the nations of the world – South American and Third World nations where considered especially ripe for “plucking.” So these nations were inundated with “economic hitmen” offering loans to corrupt regimes that were only too willing to take them – after all they needed the American money firstly to buy oil, and secondly to salt away in secret bank accounts for their own private use, while the people of the nation got stuck with the bills. When most of these nations were unable to pay the interest on these loans let alone the principle, the debt was simply “rolled over” [financial jargon for, give them more money to cover the debt that they cannot pay – as long as it looks like its paid on our books –everything is sweet]. This resulted is a series of crises throughout the 1980s and 1990s as country after country defaulted on their debts [probably the most severe case being Argentina – with the largest sovereign debt default in history (to date), US$93 billion in 2002– and Argentina is still suffering today]. [Technically, Greece and the other nations in similar trouble today have not defaulted yet – when they do they will surpass Argentina by many billions].

Thus, the “Empire of Debt” was created. And because all this debt was denominated in American dollars, this meant that American dollars had to be earned, in order to pay off the debt. This of course created further demand for American dollars, which in turn creates more value for the American dollar.

Thus, America finds itself in the happy situation of simply having to create American dollars [which it produces out of nothing, costing nothing, backed by nothing], and the rest of the world produces real goods and services in order to earn American dollars. And Americans seem surprised that everyone wants to live in America – even if they live there illegally. At the height of the Roman Empire everyone wanted to live in Rome too – that’s where everyone got free bread and free circuses – now we have McDonalds and Television.

I am well aware that there all sorts of modifying and extenuating circumstances that people could seize upon and use as an objection to the above scenario. For example, someone might say: “That’s not right! America doesn’t just produce dollars, it produces goods and services too – in fact, it, still has the largest economy in the world.” And this extenuating circumstance voiced as an objection, is absolutely correct. But this still does not remove the fundamental relationship that America has with the rest of the world. Yes, America does have a large economy – but in addition to the world’s largest economy it also has this “captive economy” which has been captured by the dominance of the American dollar in world trade– especially trade in oil.

Of course this system could not continue forever. Remember, when a thesis expands and grows an antithesis would rise to counteract the threat. The person who tried to fulfill that role, the person who became the fly in the ointment was Saddam Hussein.


To be continued…

God bless, Bruce Telfer.

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