It's time for a new Bretton Woods
In July of 1944 the 44 nations of the free world sat down at a hotel in Bretton Woods, New Hampshire to design a new post-war financial system. The basis of the agreement was simple. The US dollar was tied to gold at an exchange rate of $35 per ounce and all other currencies were tied to the dollar with relatively fixed rates.
The system worked until the US tried to wage an expensive war without raising taxes to pay for it. (Why does that sound familiar?) The first sign of stress was when the US dropped silver out of our coinage in 1965 and went to slugs. We fought a long and expensive war in South East Asia without raising taxes to pay for it. Holding the world's reserve currency, the US was in the enviable position of writing checks without the intent or the ability to pay for them. The chickens have come home to roost.
Bretton Woods died on August 15th of 1971 when President Nixon went on television to announce Wage and Price controls in reaction to the unthinkable and unacceptable inflation rate of about 4%. As almost an aside, Nixon mentioned that gold would no longer be convertible into US dollars by foreign central banks.
The world now faces an economic crisis larger than any in history. A basic lack of financial discipline has lead to the creation of a derivatives monster ten times the size of the world's economy. It's no less than a giant crap game with the players taking real money off the table when they win and paying in Monopoly money when they crap out.
The US government is trying to sort out the issue of how to set up a stable financial system while using Monopoly money. The simple answer is that you cannot base a stable financial system around Monopoly money.
The root of the problem; the fatal flaw in the construction of the Bretton Woods agreement, goes back to the inception of the Federal Reserve System in late 1913. Prior to the US Central Bank created by the Federal Reserve Act of 1913, essentially there was no inflation in the United States between the adoption of the Constitution in 1787 and 1913.
During times of war, in 1812-1814 and during 1861-1865, the gold standard was suspended with inflation ensuing but there was no inflation until the Federal Reserve was created. Since 1913, the dollar has lost 96% of its value. It doesn't require a brain surgeon to realize the Federal Reserve created all the inflation we now face.
Governments love inflation. It's a quick and relatively painless way of taxing the citizens without their knowledge. The citizens may feel a sense of unease but rarely do they come to the conclusion the inflation is deliberate. It is deliberate; representatives gain power by handing out largess from the treasury so it continues until the cancer kills the patient.
The cancer has killed the patient. The United States is $56 trillion dollars in debt according the former Comptroller General of the United States, David Walker. I suspect David Walker is an optimist; the number is probably higher. Wikipedia shows it as $59 trillion and the number $100 trillion has been used. In comparison Wikipedia shows the total assets of US citizens at only $62.5 trillion.
Within the next year, I expect the United States to default on government debt. The country is bankrupt today; the stated national debt increased over $1 trillion in the last year. In the last month, in response to a minor market crash the US government has poured almost $2 trillion dollars into the US financial system in addition to the nationalization of Fannie Mae, Freddie Mac and the entire banking system.
While the numbers of dollars being created out of thin air are nothing short of incredible, the problems remain unsolved. The Federal Reserve and US Treasury are in the incredible position of attempting to put out a house fire by dumping kerosene on it. When the market realizes the impact on inflation of the money supply, the demand for "things" will go through the roof.
It all goes back to a Central Bank totally out of control and a currency based on debt. While the supply of highly paid bureaucrats is nearly unlimited, citizens are being smothered by unpaid taxes that reflect a future claim on assets.
I want to make an important point I have never seen addressed. The government and media focus our attention on "taxes" as if that number has some real meaning. In the last presidential debate, Candidate McCain expressed horror at the idea that Candidate Obama would increase "taxes." McCain wants the citizens of the United States to be as free of "taxes" as possible, at a time of financial crisis. But no one would ask the most important question. Who is going to pay for the trillions of dollars being thrown at the banking system? Someone has to.
We tend to talk about "taxes" as if they are the most important part of the equation. But it's not "taxes" we should worry about, it's government spending. All government spending represents "taxes" either collected now or collected in the future. Because all government spending has to be paid somehow; it can be paid today in the form of "taxes" or by our grandchildren in the form of inflation of the currency until it has no value. All government spending gets paid for; either at once in taxes or over the long term in debauched currency.
We have reached the point of no return. A combination of globalization, greed, Central Banks, a fiat currency, 9000 hedge funds and $600 trillion worth of derivatives has brought the crisis to a boiling point. At this time, governments around the world are throwing $100 bills at the fire. It will have no effect; you cannot solve a financial problem caused by easy money by making money still easier. You can, however, create hyperinflation.
The banking system has been frozen for weeks to the point banks simply would not loan money to each other. Commerce is ceasing. Libor and the Ted Spread hit a peak a week ago. Those financial instruments measure willingness of banks to loan to one another.
It's possible that the sum of all government actions have dynamited the banks into action, which is a good thing. If we had had a banking holiday, the riots in the United States would have started about 18 hours after the first bank closed.
The crisis is not over. A careful listen to all the shrill uttering from Washington and New York City reveals an interesting fact. There isn't a single person talking about who is going to pay these trillions of dollars being created with great abandon. Where is the money going to come from?
We are going to print it.
When eventually even the densest bureaucrat realizes there aren't enough trees to make the paper required to print enough money to cover the $600 trillion dollars worth of derivatives fraud, we will be up to our ears in Zimbabwe dollars.
The world has endured hyperinflations and financial fraud throughout written history. This time it's different. This time it's going to affect every single person on earth. The world's financial system is collapsing and it will end badly.
It's time to start thinking solutions. As usual, Europe is light years ahead of the United States. Calls for a new Bretton Wood have come from sources as varied as Gordon Brown, British Prime Minister, to European Central Bank President Jean- Claude Trichet.
We need more than a Bretton Woods II. We need to fix the most basic problems never solved by Bretton Woods.
We need to go back to honest money. You cannot build an honest monetary system around money backed by nothing. Gold gives a financial system discipline and nothing else. But discipline has been missing in the United States since the inception of the Federal Reserve System.
Not a single currency in the world is based on anything but hot air. We are all going to realize that shortly as hyperinflation stalks the entire world; when businessmen cannot make rational business decisions because they don't know what the value of the currency will be tomorrow.
If a Martian landed on earth today and went to Chairman Ben Bernanke of the Federal Reserve and asked him how often the value of the US currency changes, the correct answer would be 10,000 times a day. Any sane Martian would be as astonished as I am. How can something that should be fixed change value 10,000 times a day? If a gram or a pound of measure changed 10,000 times a day, would we think that sane? I think not.
We need to eliminate all Central Banks. Central Banks simply cannot be the solution because they are the root problem. Central Banks are captive to the desire of whatever despot rules the country be it president or democracy out of control. We don't need Central Banks; the world has thrived without them and will again.
Governments should never again be in charge of money. Under a gold system any bank of a certain size should be allowed to print money backed by either silver or gold. Should that bank default when a holder of the currency wants to exchange it for specie, severe penalties must be imposed as was always done with counterfeiters. At least until governments became the biggest counterfeiters.
We don't need exchange rates between countries. Under a gold system, the currency should represent standard quantities of gold. We would need coins of copper and silver reflecting their weight in grams to be used for common commerce. There would be minor fluctuations of value between silver and gold but the market would determine what the correct relationship would be.
We should have a 3 gram copper coin that would serve as an in between coin similar to the cent and the nickel. Silver coins should be 90% silver for durability and start with a 2.5 gram silver coin similar to our dimes up until 1964, a 6.25-gram coin serving a role similar to the quarter, a 12.5-gram half-dollar size coin and a 25-gram dollar size coin.
Most gold would remain in vaults representing a reserve to back paper money. Gold bills would be in units of grams from all countries and as such would be fully convertible. Common bills would be 1/10th gram, 1/3 gram, 2/3 gram, 1 gram, 2 gram and 5 gram.
We have thousands of institutions of higher education throughout the world discussing economic issues of substance. Yet the number of people addressing the simple issue of how to have an honest financial system with honest money is tiny. It needs to be discussed and then implemented.
In the end commerce and citizens would flourish. We would have a lot less need of bureaucrats and government but maybe that would be a good thing. Under a gold standard, you cannot afford dead weight.