Thanks to the economic crisis of 1957-61, the U.S. economy entered the decade of the 1960s with high levels of unemployment and excess capacity. The millions of unemployed workers and idle plants and machines meant that industrial production could increase rapidly in response to rising demand.
Since supply was increasing almost as fast as demand, prices rose very slowly. At least according to the official U.S. producer price index, prices hardly changed between 1960 and 1964.
As is typical of the phase of average prosperity of the industrial cycle, long-term interest rates rose very slowly. Still, at around 4 percent or slightly higher they had risen significantly since the Korean War days. Back then, the Truman administration still expected to borrow money long term at less than 2.5 percent. Slowly but surely long-term interest rates were eating into the profit of enterprise.
The 1960s economic boom begins
During most of the early 1960s, the U.S. economy was passing through the phase of average prosperity that precedes the boom. But starting in 1965, the industrial cycle entered the boom phase proper.
The transition from average prosperity to boom is part of the industrial cycle. However, in the mid-1960s this transition was helped along by government economic policies. These were, first, the Kennedy-Johnson tax cut of 1964 combined with the rapid escalation the war against Vietnam. After remaining virtually unchanged through 1964, the official U.S. producer price index suddenly surged 3.5 percent in 1965. That was the year the escalation of the Vietnam War began in earnest.
Boom and inflation
The Vietnam War was far too small a war—from the perspective of the United States, not Vietnam, whose economy was set back by decades—to lead to the contracted reproduction of a full-scale war economy. However, the war did mean that a growing portion of the industrial capacity and labor power of the U.S. economy had to be devoted to meet the needs of the war against Vietnam and the other Indochinese peoples. This was on top of the already high level of “cold war” military expenditures.
When added to the effects of the the Kennedy-Johnson tax cut, the result was that U.S. industry had less excess capacity and unemployed labor power than at any time since the war against the Korean people in the early 1950s. From 1965 onward, U.S. industry could no longer increase production as fast as demand was growing at the existing price level. When this happens in a capitalist economy, demand is reduced to supply through a rise in prices. The boom of the 1960s was on!
It is important to realize that the rise in prices in the mid-1960s was a rise in prices in terms of gold, not just dollars. These price rises did not reflect any depreciation of the U.S. dollar against gold. The Bretton Woods international dollar-gold exchange standard was still in effect.
Indeed, in order to strengthen the dollar-gold exchange standard, the United States and its West European satellites had set up the London Gold Pool. The gold pool was a fund of gold bullion whose specific purpose was to keep the dollar price of gold from rising above $35.20 an ounce. Or what comes to exactly the same thing, to prevent the U.S. dollar from depreciating against gold.
The London Gold Pool
Shortly after the Kennedy administration took office, Under Secretary of Treasury Robert Roosa proposed that the United States and the West European central banks prevent the dollar price of gold bullion on the open market from rising above $35.20. That is, whenever the free market price of bullion threatened to hit $35.20 the United States and the West European central banks would sell gold. If the price of bullion fell below $35 an ounce, they would buy gold.
According to Roosa’s “suggestions,” the gold pool would be made up of the United States, Britain, West Germany, France, Switzerland, Italy, the Netherlands, and Luxembourg. (1) Essentially, this meant that the dollar would now be backed not only by the gold in Fort Knox but also by the gold of Britain, West Germany, France and the other members of the gold pool. Or what comes to exactly the same thing, America said to its European imperialist satellites, from now on your gold reserves will backing our currency. This is a good example of the nature of the “world order” that emerged from World War II!
Heyday of Keynesian economics
The 1960s were the heyday of Keynesian economics. Both presidents Kennedy and Johnson were surrounded by economists of the Keynesian school. According to the Keynesian analysis, the U.S. economy in 1965-66 was in a state of inflation. Remember, according to Keynes if the rate of interest is below the rate of profit—to use Marxist terminology—at “full employment,” industry will not be able to expand production in the “short-run.” (2)
That is, the industrial capitalists will be unable to expand production without undertaking major capital investments that will expand industry’s physical ability to produce. That, however, takes time. Therefore, any further increase in monetarily effective demand cannot be satisfied at the existing price level. If demand keeps growing anyway—which according to the Keynesian analysis it will as long as the long-term rate of interest remains below the rate of profit, prices will have to rise to reduce monetarily effective demand to supply.
The Keynesian answer to this problem is to raise long-term interest rates. The central bank has much more influence on short-term interest rates, such as what is called in the United States the federal funds rate, the rate on overnight loans that commercial banks grant one another. (3)
For example, if a commercial bank finds itself short of reserves—deposits with its district Federal Reserve Bank plus vault cash—it borrows money very short-term from another commercial bank. In the United States, the rate of interest it pays is called the federal funds rate. If the Federal Reserve System nudges up the federal funds rate—by selling some of its portfolio of Treasury notes—the money market is tightened and long-term interest rates rise as well, though to a lesser extent.
Another possible answer to the problem of inflation, according to Keynesian theory, is a restrictive fiscal policy. The central government should if possible reduce its expenditures—or at least reduce their rate of growth, raise taxes and balance its budget. If the government runs a surplus while the central bank is “tightening,” demand is removed from the economy. With the “excess” demand removed, the Keynesian economists claim, supply will then be able to keep up with demand at current prices. The Keynesians boasted that their “tools” could deal not only with a shortage of demand—recession or stagnation—but an excess of demand—inflation as well.
In the 1965-66 period, however, a restrictive—sometimes called a deflationary fiscal policy—was out of the question for the Democratic administration of Lyndon B. Johnson. The administration had just convinced Congress to pass a huge regressive tax cut in 1964 in order to deal with the problem of high excess capacity and unemployment—caused by insufficient monetarily effective demand—that had affected the U.S. economy in the early 1960s. How could it turn around now and ask for a tax increase only a year or two later?
In addition, the administration was faced with a growing anti-war movement—unlike during the war against Korea, not to speak of World War II—and major unrest in the inner cities, especially among working-class African American youth. The last thing the administration wanted to do was to ask the American people to actually pay for the war in the form of higher taxes.
The credit crunch of 1966
In the light of this reality, the entire burden of slowing the inflationary boom fell on the Federal Reserve System. In 1966, the Federal Reserve Board moved to tighten credit. On Jan 19, 1966, the “fed funds” rate fell to 1.50 percent. But between September 9 and 11, the fed funds rate hit 6.13 percent, an extremely high level by pre-1968 standards.
This abrupt tightening of the money market led to a sudden freeze up of credit. It was the collision between the demands for credit by the federal, state and local governments, consumers, industrial capitalists and commercial capitalists that drove the federal funds rate up so abruptly. Or what comes to exactly the same thing, the demand for credit exceeded the supply of credit at current interest rates.
The U.S. federal government has the highest credit rating in the world. In a credit-crunch—a situation where the demand for credit exceeds the supply—like that of 1966, the U.S. government can always get credit even if at somewhat higher interest rates than before. But credit becomes unavailable or it is available only at extravagant interest rates to all but the most creditworthy borrowers such as the strongest—that is the richest—corporations.
From credit crunch to mini-recession
With credit drying up, the U.S. economy entered into the so-called mini-recession of 1966-67. While in the United States, the National Bureau of Economic Research refused to declare the 1966-67 episode a “contraction,” the economy of West Germany experienced its biggest recession since resuming growth after World War II. (4)
The Johnson administration and the Fed, fearing a major economic crisis, took fright, and The Fed quickly reversed its tight money policy. The last thing the beleaguered administration of Lyndon B. Johnson wanted was a recession on top of its other problems!
The Fed moved quickly to ease the money market by purchasing Treasuries, and the fed funds rate dropped back below 4 percent, falling as low as 3.25 on May 10, 1967. The economy resumed growing though at a lower rate, and while inflation continued, it was lower than it was in 1965, at least as measured by the official producer price index.
Guided by Keynesian economics, the Fed had apparently succeeded in slowing down the economy sufficiently to dampen inflation without throwing it into a full-scale recession and mass unemployment. (5) Indeed, by their “skillful” monetary policy hadn’t the Fed idled just enough industrial capacity to support the “war effort” against Vietnam while avoiding a really big economic downturn? But as it turned out the victory of Keynesian policies in 1966-67 was a Pyrrhic one.
The Tet Offensive and the end of the Bretton Woods dollar-gold exchange international monetary system
In January 1968, the Vietnamese resistance fighters launched a a massive offensive—remembered as the Tet Offensive—against the U.S. occupiers and the puppet “South” Vietnamese army. (6) In the countryside and the cities alike, the Vietnamese population rose up against the hated U.S. occupation. The U.S. “embassy” in Saigon (now Ho Chi Minh City) itself became a battleground.
Before the Tet Offensive, the Johnson administration and the U.S. media had claimed that the United States was winning the war against the Vietnamese resistance. Soon the resistance fighters—called the “Viet Cong” by the U.S. media—would be exterminated. (7) Victory was in sight.
But the Tet Offensive gave the lie to this, though the Vietnamese resistance fighters did pay a heavy price in terms of dead and wounded, a fact that U.S. histories of the war still gloat over. These pro-war histories claim that the extremely high price that the Vietnamese people were forced to pay in terms of dead and wounded showed that the United States and its South Vietnamese puppet collaborators were the real victors of the battle. What the results of the Tet Offensive really showed was how high a price the Vietnamese people were willing to pay for their freedom.
In the wake of Tet, General William Westmoreland, the U.S. commander in Vietnam, requested hundreds of thousands of new troops. Westmoreland assured Johnson that this “troop surge” would finally enable him to crush the Vietnamese resistance once and for all. Like he had always done up to this time, Johnson approved Westmoreland’s request.
Tet and the end of the London Gold Pool
From February 1962. the gold pool was in full operation. Starting in 1965—the year that the United States greatly escalated its war against the people of Vietnam—the gold pool began to lose gold. In 1967, with the war against Vietnam still escalating and the Fed and other central banks again easing credit in order to stave off the threatening economic crisis, the British pound was devalued. However, the final blow to the London Gold Pool was the Tet Offensive followed by U.S. President Lyndon B. Johnson’s decision to agree to Westmoreland’s proposed “troop surge.”
By continuing to sell off their gold reserves to support the U.S. dollar, which they were required to do under the London Gold Pool, the West European imperialist satellites of the United States were, in effect, financing the war against Vietnam—which the Johnson administration had refused to do by raising taxes.
Finally, in 1967 with the collapse of the gold pool clearly approaching, France under de Gaulle pulled out of the pool. But not West Germany. Hitler’s heirs announced that they would not only remain in the gold pool, they would not be cashing in the dollars that were accumulating in their central bank for gold. The successors of the Third Reich were willing—or forced—to keep financing the U.S. war against Vietnam, not only with their gold bullion but through the devaluation of their dollar reserves once the gold pool finally collapsed.
But after all, these heirs of the “thousand-year Reich” that had terrorized all of Europe just a quarter of century before had little choice. They were, after all, an occupied country, and were not—and still are not—permitted to have their own nuclear weapons, unlike France and Britain.
France under de Gaulle retained a little more room for maneuver. France was, after all, a nominal “victor” in the war, and had acquired its own nuclear weapons. So a few months before the gold pool collapsed, they got out. However, it is telling that France stayed in the gold pool as long as she did. The French government and central bankers under de Gaulle had also thrown away French gold to finance the dirty genocidal war against the Vietnamese people.
On March 5, 1968, as word spread about the Democratic administration’s latest “troop surge” in Vietnam, the gold pool was forced to dump 100 tons of gold on the market to keep the free market dollar price of gold at or below $35.20. On a “normal day, perhaps five tons would have been dumped on the market. After consultations over that weekend, a special statement was issued: “the London Gold Pool re-affirm their determination to support the pool at a fixed price of $35 per oz.”
The chairman of the Federal Reserve Board of Governors, William McChesney Martin, declared that the United States was prepared to defend the $35 an ounce gold price “down to the last ingot.” The problem for Johnson, McChesney Martin, and the other war makers in Washington was that the market was more than willing to take that last ingot of gold, and the last ingots of Washington’s West European satellites in the bargain. In a last ditch attempt to save the gold pool, a huge air lift was organized to ferry gold bullion to London to dump on the open market.
The London Gold Pool collapses
One March 15, 1968, British Chancellor of the Exchequer Roy Jenkins announced that upon “the request of the United States,” the London gold market would be temporarily shut down. The gold pool was dead. During the two weeks that the London gold market was closed, the pool was officially dismantled.
The end of the London Gold Pool and a few other things as well
The gold pool wasn’t the only thing that came to an end that March. Lyndon B. Johnson was forced to inform General Westmoreland that his decision to grant Westmoreland’s request for hundreds of thousands more U.S. troops to crush the Vietnamese resistance was rescinded. Instead, Johnson was forced to announce that he would open up peace talks with the representative of the Vietnamese people.
In addition, Johnson told a nationwide television and radio audience that he would not be a candidate for the Democratic Party nomination for re-election in the upcoming 1968 U.S. presidential race. For all practical purposes, the post-World War II prosperity was over too, though it took a number of years before this became apparent, as we shall see in next week’s post. And though it was not official, the Bretton Woods System was at death’s door. Though the U.S. war against Vietnam was far from over, the way was being prepared for the victory of the Vietnamese people over U.S. imperialism.
After the gold pool
After suspending gold trading in London for two weeks, a so-called two-tier system was set up. The dollar price of gold on the free market would now be set by supply and demand. The central banks and governments, however, could still convert their dollar reserves into gold at the rate of $35 for an ounce. In form, this was a return to the situation that had prevailed in the early years after World War II, when the dollar price of gold bullion on the free market was usually somewhat higher then the official $35 an ounce dollar gold price. Indeed, it wasn’t until the gold pool started operation in February 1962 that Washington and its West European satellites formally promised to keep the free market dollar price of gold between $35.00 and $35.20 an ounce.
The U.S. government denied that the dollar had actually been devalued. But in fact the dollar was devalued. After World War II, a free market dollar price of gold significantly above $35 an ounce was viewed as temporary; now there was no real limit on how how much above $35 an ounce gold would be allowed to rise. At the time of this writing, 41 years later, the dollar price of an ounce of gold is about $1,000, a long way from $35!
As I explained several weeks ago, the Bretton Woods international monetary system could only work if the free market price of gold did not rise significantly above $35 an ounce. If it did, the central banks would have little choice but to “purchase” gold from the U.S. Treasury at $35 and either hold it in their reserves or sell on the free market for whatever was the going price. If they sold the gold for dollars, they could present even more dollars to the U.S. Treasury demanding one ounce of gold for every $35. The U.S. gold reserve would then melt away like the snow on a hot day in early spring.
From March 1968 to the final end of the dollar-gold exchange standard
As I will explain next week, Washington actually took some deflationary measures that temporarily caused the dollar price of gold to fall back to $35 on the open market. So formally speaking, the Bretton Woods dollar-gold exchange system didn’t actually die in March 1968 but rather entered its death agony. But by May 1970, the U.S. domestic money market was close to panic, the stock market was crashing, and the giant Penn Central Railroad went bankrupt—the most significant industrial bankruptcy of the postwar era up to that time. The deflationary actions were quickly reversed, and the dollar price of gold began its relentless rise on the “open market.” The clock was ticking on Bretton Woods.
Gold begins its climb
In February 1970, with the deflationary actions that were taken after March 1968 still in effect, the closing dollar price of gold on the London market averaged $34.99, one cent below the par value of $35. If the free market price of gold had stayed at these levels, the Bretton Woods System would have continued to function. But by August 1971, the dollar price of gold exceeded $42 and was rising.
At that time, nobody knew how high and, just as important, how rapidly the dollar price of gold would rise—or more properly, how rapidly the dollar would fall against real money—on the “free market,” where the amount of gold that one dollar actually represents at any given instant is determined.
In the summer of 1971, with the dollar price of gold now well above $40 an ounce and rising, the central banks—at least the central banks of those countries that retained enough independence within the American empire to make such a request—began to present their dollars to the U.S Treasury, demanding payment in gold bullion for every $35 they presented. The U.S. Treasury faced a full-scale run on its gold reserves.
The real cause of the crisis
“Because of the excess printed dollars,” Wikipedia writes, “and the negative U.S. trade balance, other nations began demanding fulfillment of America’s ‘promise to pay’—That is the redemption of dollars for gold.” Wiki continues:
“Switzerland redeemed $50 million of paper for gold in July. France, in particular, repeatedly made aggressive demands, and acquired $191 million in gold, further depleting the gold reserves of the U.S. On 5 August 1971, Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against foreign price-gougers. Still, on 9 August 1971, as the dollar dropped in value against European currencies, Switzerland withdrew the Swiss franc from the Bretton Woods system.”
The international gold-dollar exchange system dies
“To stabilize the economy,” Wiki goes on, “and combat runaway inflation, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 per cent import surcharge, and, most importantly, ‘closed the gold window’ [emphasis added—SW], reneging on the promise to exchange gold for dollars.”
With due respect to the on-line editors of Wikipedia, I must observe that allowing the dollar to plunge against gold was an odd way of “combating inflation.” More on this next week.
Various explanations have been put forward by both Marxists and bourgeois economists for the end of the dollar-gold exchange system—at the time and since. “By the early 1970s,” Wiki explains, “as the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. was running a balance of payments deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, which, because of foreign arbitrage of the U.S. dollar, caused governmental gold coverage of the paper dollar to decline 33 percentage points, from 55 percent to 22 percent. That, in the view of Neoclassical Economists and the Austrian School [the two main schools of marginalism—SW] represented the point where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits.”
From August 15, 1971, the U.S. dollar ceased to be credit money as far as the central banks and foreign governments were concerned just like it had ceased to be credit money for American citizens in March 1933. The U.S. dollar had become token money pure and simple, both for the person on the street and the ministries of finance and central banks alike. The post-World War II international monetary system based on the dollar-gold exchange standard was dead.
But why did the dollar-gold exchange system that had lasted for 31 years after the end of World War II finally die in August 1971 and not some other time? The problem with the “neoclassical and Austrian school explanation” is its superficiality. The immediate cause of the collapse of the dollar-gold exchange standard was that the U.S. Treasury faced a run, much like a bank run where the depositors demand cash in exchange for their deposits. But was the U.S. government in the summer of 1971 really in the position of an insolvent commercial bank? If so, how did America manage to maintain its world empire?
Growing economic competition from Europe and Japan
Up until around 1970 the United States ran a persistent surplus in its balance of trade. As first as Western Europe and then Japan began to recover from the devastating effects of World War II, they needed commodities produced by America’s vast industrial machine to carry out the necessary reconstruction. As the post-World War II prosperity unfolded, the economies of Western Europe, with the exception of Britain, grew consistently faster than did the U.S. economy. The economy of Japan grew faster still. Indeed, the economies of West Germany and Japan grew so rapidly that it became something of a cliché to observe that the two defeated axis powers were economic giants but political midgets.
I explained in an earlier post that after World War II, in contrast to the post-World War I period, the United States finally opened up its huge home market to the Europeans and Japanese. The U.S. would allow the German and Japanese capitalists to compete economically with the American capitalists but not politically or militarily. This agreement has lasted up until the present.
In the first quarter of a century after World War II, the U.S. trade surplus showed a gradual tendency to shrink. Around 1970, it disappeared completely. On the other hand, the huge U.S. military expenditures, necessary to maintain its world empire, meant that the United States ran a balance of payments deficit even when it was still running a surplus in its balance of trade.
But the Bretton Woods system actually required such a U.S. deficit. Even when the U.S. trade surplus was large, American capitalists extended credits to the Europeans and Japanese as they rebuilt their economies. The United States ran a huge balance of payments deficit when it came to foreign investment—the U.S. was exporting capital—and the huge expenditures for military operations that the U.S. government carried out abroad, such as the Korean War. That deficit was almost but not quite covered by the U.S. trade surplus and the flow of interest payments and dividends that the U.S. capitalists “earned” on foreign investments.
In this way, the quantity of dollars grew in the world economy, and under the Bretton Woods dollar-gold exchange standard, these dollars constituted the primary backing for the local currencies of Western Europe and Japan. Or what comes to exactly the same thing, in the absence of a U.S. balance of payments deficit, the West European and Japanese economies would have faced much the same kind of deflationary pressure that they faced after World War I.
Why therefore did the U.S. balance of payments deficits become a source of crisis in 1968 and 1971 when they were a requirement for the Bretton Woods System to function in the first place? Was it simply that the U.S. payments deficits had become too large, or was something else involved? What would have happened if the dollar was the only currency?
A hypothetical alternative history
In my opinion, even if the United States had completely abolished all currencies other than the dollar after World War II, the currency crisis that erupted in 1968 would have occurred anyway. Suppose the U.S. had forced all countries at Bretton Woods to adopt the dollar as their official currency. Or what comes to exactly the same thing, the entire capitalist world have been completely “dollarized”. (8) The foreign central banks would have ceased to be banks of issue, much like the central banks of France, Germany, Italy, Ireland and other countries of the euro zone have ceased to be banks of issue since the adoption of the Euro. But in exchange for this, let’s suppose the U.S. government had promised to redeem dollars that the central banks and governments of other countries held for gold at the rate of $35 an ounce.
In this alternative world, there would be no question of devaluing the dollar against other currencies. There would be no other currencies, and the dollar could not of course be devalued against itself. One dollar at any instant in time will always equal one dollar. However, a “London Gold Pool” could still have been organized by the United States and its West European satellites under my assumptions.
But what if the private money capitalists had decided at a certain stage that the dollar—the sole currency in the world—was likely to be devalued against gold in the near future. The fictional gold pool, just like the real one, would have been forced to sell more and more gold on the open market to keep the dollar price of gold at or below $35.20.
There would be a run on gold, and the fictional London gold pool would still have collapsed—just like the real one did. Like happened in the real world, the capitalist government and central banks would have begun to redeem their dollars for gold at the U.S. Treasury as the dollar price of gold began to rise on the “free market.” This would have forced the U.S. government to break its promise to redeem gold at the rate of one ounce of gold for every $35 presented to it.
The only difference would have been that there would be no question of devaluing the dollar against other currencies, or what comes to exactly the same thing, revaluing other currencies against the dollar, since their would be no other currencies.
While the existence of currencies other than the dollar complicates the situation, I believe that in order to understand the crisis of March 1968 and the final crisis of the dollar-gold exchange system that occurred in August 1971 it is best to abstract the existence of currencies other than the dollar.
In an article dated December 1968 Ernest Mandel, considered alongside Maurice Dobb and Paul Sweezy to be one of the leading Marxist economists in the capitalist world after World War II, came close to grasping the true nature of the March 1968 crisis:
“For thirty years … all prices have risen (in paper money) while the price of gold has remained stable.” [That is, prices expressed in terms of gold, the money commodity in whose use value the exchange value of all other commodities are measured, had risen for 30 years. Or as Mandel might have said, the prices of commodities in terms of real money—gold—have been rising since the end of the Depression.—SW] “They forget rather quickly that in the same period there has been a prodigious upsurge in labor productivity in virtually every industrial branch, while nothing equivalent to this has happened in the gold industry. [Emphasis added—SW] … [T]he relationship between gold and other goods [Mandel means commodities, perhaps a bad translation here—SW] has therefore developed strongly in the direction of a drop in value for goods, as expressed in terms of gold.” (“The Crisis of the International Monetary System,” International Socialist Review, March-April 1969)
In other words, the general price level of commodities had once again risen above the underlying labor values of those commodities. Just like the situation right after World War I, though not to the same degree, the prices of commodities had risen above their values.
Value and price
However, the basic economic law that regulates the capitalist economy, the law of value of commodities, does not allow such a situation to persist indefinitely. The law of value of commodities does not state that market prices equal values—or prices of production—at any given point in time. Marx emphasized already in his early work “The Poverty of Philosophy” that on the contrary they almost never do.
Rather, the law of value states that market prices are constantly fluctuating around values—or prices of production—now rising above them, but then compensating by falling below them. During the Depression, market prices had fallen below values—or prices of production—but by 1968 market prices had once again risen well above their values. The law of value dictated that sooner or later market prices—in terms of gold—would once again have to fall below their underlying labor values.
How the dollar-gold exchange standard could have been saved
Could the dollar-gold exchange standard have been saved? Technically not only could this have been done, it would have been quite easy. All that would have been necessary to save the Bretton Woods System would have been for the Federal Reserve to raise interest rates sufficiently to break the demand for gold by private money capitalists.
Remember, all things remaining equal, the demand for gold moves inversely to the rate of interest. The higher the rate of interest the lower the demand for gold. In England in Marx’s time, there was a saying that 6 percent could draw gold from the moon.
Dumping gold on the market like the gold pool did could not quench the thirst for gold at the prevailing rate of interest. At the then-prevailing rate of interest, all the gold that then existed in the world would not have been enough. But raising interest rates sufficiently would have depressed the demand for gold by the private money capitalists back to the amount they already held. The run on gold would have been broken.
That this is indeed true is shown by the fact that the dollar price of gold did fall back to $35 an ounce when interest rates were raised—prolonging the death agony of the gold-dollar exchange system by more than three additional years.
The problem was that a rise in interest rates also meant that the crisis of overproduction that was being held at bay by the “expansionary policies” of the U.S. government and Federal Reserve System—on a global scale the growing U.S. balance of payments deficit being simply a part of the expansionary policy—would break out. However, the deflation and depression that would have followed, though perhaps not as extreme as that the 1930s, would still have been far worse than the economic crisis of 1957-61.
And that is exactly what the U.S. government, already facing a mass movement against the war in Vietnam, rebellions in the working-class Afro-American inner cities, and the general mood of rebellion that characterized the late 1960s and the beginning of the 1970s, feared most of all. What would happen if a major new depression led to the radicalization of the heavy battalions of organized labor? The ghost of the Depression, and the subsequent unionization of basic industry haunted the American—and the world—capitalist class then just as it does even today.
Therefore, during the international monetary crises of 1968-71 the U.S. government and Federal Reserve System never even considered raising interest rates sufficiently—and for a sufficient period of time—to save the Bretton Woods international dollar-gold exchange standard. Remember, the gospel of the bourgeois economists since the Depression has been that the general price level must never be allowed to fall.
The only other possibility was a major devaluation of the U.S. dollar and to varying degrees the other capitalist currencies that were linked to it. (9)
If the amount of real money—gold—represented by each dollar has fallen—and this is what is really meant by the economic slang expression “the price of gold has risen”—each individual dollar represents less gold than before. Back in the late 1960s, a dollar meant 1/35th of an ounce of gold; currently it means about 1/1,000th of an ounce of gold.
Now, if the dollar is devalued against gold—the dollar price of gold is allowed to rise to a greater or lesser degree on the “free market”—and if the prices of commodities in terms of dollars remain unchanged, then prices in terms of gold—real money—will fall.
Keynes, who had represented Britain at the Bretton Woods conference, had never really liked the Bretton Woods dollar-gold exchange system that emerged from the conference (10) He even proposed a world-wide paper currency that would be administered jointly by the “victorious” imperialist powers. But in reality there was only one victorious imperialist power—the United States—and Keynes was turned down.
Since at least the 1920s, Keynes had dreamed of a “managed currency” that would finally end the monetary role of gold—or any other commodity money—once and for all. Keynes believed such a monetary “reform”—a reform that Marx demonstrated was impossible under the capitalist mode of production—would enable the “monetary authorities” to drive the rate of long-term interest below the rate of profit no matter how low the rate of profit fell.
Keynes imagined that with gold “dethroned,” the monetary authorities would be able to create sufficient demand to guarantee “full employment.” He believed this could be done using deficit spending if long-term interest rates fell so close to zero that it would be difficult to lower them further. The threat of “general gluts”—crises of overproduction—which Keynes admitted, in contrast to the “orthodox marginalists,” were possible under the capitalist system—would finally be ended once and for all.
Under the old international gold standard, as Keynes saw it, gold had gotten in the way of the “monetary authorities” creating sufficient monetary demand to ensure “full employment.” Instead, the monetary authorities, such as the Bank of England, found their hands tied by their obligation to pay out five gold sovereigns for every five pound banknote that was presented to it. Hence, according to Keynes, the crises.
Therefore, Keynes believed the gold standard in any form—even in the form of a gold-exchange standard—should be abolished. But Keynes failed to convince the United States authorities of the wisdom of this at Bretton Woods.
True, the Bretton Woods System was designed to be considerably more flexible than the old pre-World War I international gold standard had been. But even under the Bretton Woods System, gold could still get in the way of “expansionary policies.”
For example, the gold drain that the United States suffered in the wake of the 1957-58 recession forced the Federal Reserve System to raise interest rates so rapidly in order to save the dollar-gold exchange system that the U.S. economy was thrown into the double-dip recession of 1960-61. It was no coincidence that the right-wing Republican President Richard Nixon declared himself a Keynesian. He believed that the Fed’s “tight money” policy in 1960 had cost him the White House in the 1960 U.S. presidential election.
But with Nixon’s decision to finally close the gold window, the Keynesians were convinced that gold would no longer get in the way. The Federal Reserve System and other central banks would now be free to create whatever amount of money was required to maintain the effective demand necessary for full employment. Gold’s long reign was finally over, the managed currency of Keynes’s dreams was at hand! Crisis-free capitalism had arrived.
The Keynesians weren’t alone among the bourgeois economists in applauding Nixon’s decision to finally end what remained of the dollar’s convertibility into gold. Another supporter of Nixon’s decision to “close the gold window” was a certain University of Chicago economics professor named Milton Friedman. Professor Friedman had little use for Nixon’s other moves announced on August 15, 1971, such as the wage-price freeze, or the temporary 10 percent tariff. To the end of his days, Friedman complained that Nixon was the most “socialist” president in the history of the United States, even worse than that notorious semi-red Franklin D. Roosevelt! (11)
But Friedman did approve of the decision to end the last trace of the convertibility of the U.S. dollar into gold. According to Friedman, since gold coins had stopped circulating in the United States in 1933, gold was no longer money but simply “another commodity.” Under the dollar-gold exchange standard, the government was “supporting” the price of gold. This was in violation of the most sacred law of the free market, government must not interfere with commodity prices, including the price of gold. Anything else was socialism! Prices, including the dollar price of gold, must be determined only by supply and demand on the free market.
Gold versus ‘monetarism’
As long as the U.S. dollar—or other currencies—were still convertible into gold, the need to redeem currencies in gold could get in the way of the steady growth in the money supply that the “monetarist” Friedman held was the key to a crisis-free capitalism. For example, after the 1957-58 recession, the Fed should not have moved to restrict the growth of the “money supply” but was forced to do so by the need to maintain the price of the gold at $35 an ounce. The “socialist” policy had caused the recession of 1960-61, which led to the defeat of the Republican presidential—and future “socialist,” according to Friedman—Richard Nixon.
Next week I will examine the consequences of the decision to allow the “price of gold” to soar on the free market.
3 Commercial banks often find themselves short of reserves—deposits at the central bank plus vault cash. When this happens, they either have to borrow at the central bank’s discount window—something the commercial banks normally try to avoid because its can raise questions about their solvency—or from other commercial banks. If commercial banks have extra reserves, lending out these reserves for brief periods to other commercial banks that find themselves short of reserves allows them to “earn” interest on funds that would otherwise lie idle.
4 This is an example of how the NBER reduces the number of recessions. For early decades, where statistical data is limited, the NBER counts as “contractions” any hint of slower than average business activity. But for more recent decades, the NBER only considers business to be in a “contraction” if the evidence for an economic downturn is overwhelming. This enables the ideologues of capital to claim that the capitalist economy is becoming more stable as recessions become less frequent.
6 During the Vietnam War, both sides observed ceasefires during the Christmas-New Year’s-Tet holidays. Right after the holiday ceasefire ended in January 1968, the Vietnamese resistance launched the massive uprising that is known as the Tet Offensive.
7 There was in fact no organization called the “Viet Cong” in Vietnam. The term Viet Cong, meaning Vietnamese Communists, was used by the U.S. government and media and the puppet South Vietnamese government. It is still used by the bourgeois historians and the U.S. media when referring to the “South” Vietnamese resistance in the 1960s and 1970s.
In reality, Vietnam, especially “South” Vietnam, was a peasant country where the great majority of the population were peasant small property owners, not proletarians. While there were some Communists in “South” Vietnam, and they of course played a leading role in the resistance, the resistance in Vietnam went far beyond Communists. Only the large landowners, the top layers of the puppet military and bureaucracy and the relatively few other collaborators who had been aligned with the French and Japanese colonizers supported the U.S. occupation. The use of the term “Viet Cong” hides the basic fact that the war against Vietnam was a war against the Vietnamese people as a whole and not just a war against the “Vietnamese Communists.”
8 A country’s economy is considered “dollarized” when the U.S. dollar circulates extensively within its economy—as opposed to simply being held as a reserve in a country’s treasury or central bank. In the case of Panama and Ecuador, the U.S. dollar has become the official currency. The “monetary authorities” of these countries no longer issue their own currencies. Their economies have become completely dollarized.
9 The currencies of the countries—especially the two defeated axis powers Japan and West Germany—that were running large balance of trade and payments surpluses with the United States were less devalued against gold than the U.S. dollar was. Against the U.S. dollar, they were repeatably revalued.
In the case of Britain, whose industry was still steadily losing market share on the world market and was consequently running much larger deficits in its balance of trade and payments, its currency was devalued against gold even more than the U.S. dollar was. The pound was therefore devalued against the dollar as well as against gold.
But all the capitalist currencies without exception were massively devalued against the money commodity gold in the years that followed 1968-71. Not coincidentally those countries that devalued their currencies not only against gold but also the U.S. dollar, such as Britain, experienced even higher rates of inflation than the United States did. Conversely, those countries like West Germany and Japan that devalued their currencies less than the U.S. dollar was devalued experienced lower rates of inflation than the U.S. did.
10 The dollar-gold exchange system did not really begin at Bretton Woods but arose after World War I when countries began to hold dollar-denominated U.S. government securities alongside gold in their reserves.
11 In the wake of the Watergate scandal, Nixon had to resign the U.S. presidency, the only president in U.S. history to do so. To underline the completely corrupt nature of the Nixon administration, his “law and order” vice president, Spiro Agnew, had earlier resigned when it was revealed that “Mr. law and order” had been taking kickbacks when he was governor of Maryland—a felony.
Many other officials of the Nixon administration also had to resign and serve prison sentences, including John Mitchell, Nixon’s “tough law and order” attorney-general, who was forced to spend time in prison for some of the felonies that he had committed while he was serving as the chief law-enforcement officer of the United States. Nixon thus became the most discredited president in U.S. history.
Milton Friedman, who consistently supported the most right-wing Republican candidates, had his reasons for trying to disassociate himself from Richard Nixon.