The world is turning into a very nasty and scary version of itself, but WHO is REALLY pushing the buttons????????
by Robert Blumen
The current international monetary system, based on floating fiat currencies, brings about tremendous distortions which inevitably must be corrected. This much has been known to Austrians for some time. Awareness is now starting to spread to mainstream economists. To understand how we got here requires some historical background.
Under the international gold standard, the flow of gold in and out of countries responded to relative prices between countries. A country with net imports, for example, experienced gold outflows as their gold was exchanged for goods to make up the difference.
Because a country's gold reserves were finite and could be increased only by becoming a net exporter, the process of gold loss had a natural limit. But even before the gold supply was drawn down to zero, a decrease in the quantity of gold circulating within the importing country would in result in falling prices. There would at the same time be an opposite effect within the countries of the trading partners—the exporting countries would accumulate more gold over time, causing a rise in prices.
Eventually, a point would come where there was a discrepancy in prices between the two countries such that the goods of the chronic importer became more attractive as exports to the chronic exporter. The flow of gold thus worked to maintain rough purchasing power parity of an equivalent quantity of gold between nations and prevented perpetual trade imbalances from accumulating.
Where trade occurs between nations, imports must ultimately be paid for with exports. This is a special case of the general principle that consumption must be funded by production. Within a country that had accumulated gold through the sale of past exports, imports could be funded by the loss of gold for a finite period of time.
Following World War II, instead of returning to the pre-war implementation of the gold standard, a new system known as the Bretton Woods system was devised. This system designated the U.S. dollar as the international reserve asset, replacing gold in this role. A system of fixed exchange rates between national currencies was instituted. Under this system, the dollar alone was to be fully convertible to gold, and then only by foreign central banks. Other currencies would be convertible to dollars at fixed exchange rates.
Under the gold standard existing prior to Bretton Woods, exchange rates were fixed in the sense that each currency was defined as a definite quantity of gold, so exchange ratios followed directly from the definition of the currency itself. Tthe Bretton Woods agreement posited fixed exchange rates, but in practice they turned out not to be as fixed as intended.
Under Bretton Woods, countries pursued their own inflationary policy, then adjusted rates ex-post when the fixed rates became untenable. Economic journalist Henry Hazlitt forecasted the demise of this arrangement in the title of his book From Bretton Woods to World Inflation. "The system not only permits and encourages but almost compels world inflation," he wrote in 1949.
At the dawn of the new post-war monetary order, the rest of the world suffered from a "dollar shortage". The European countries had great difficulty in building up their supply of the reserve asset. Hazlitt argued that this situation came about because the fixed exchange rates overvalued the European currencies and undervalued the dollar. "Marshall, the President, and Congress completely misunder[stood] the real situation . . . and poured billions of the American taxpayer's dollar into the hands of European governments to finance the trade deficits that they themselves were bringing about by their socialism and exchange controls with overvalued currencies."
The policy response to this imbalance was "to let loose a world scramble for competitive devaluation far beyond anything witnessed in the ‘30's." After the avalanche of devaluations, the situation had been reversed: the dollar was overvalued in terms of purchasing power parity relative to its trading partners in Europe.
Americans could import more than they exported with the willing cooperation of Europe and Japan. In the '70s the U.S., suffering severe inflation from the deficit financing of the Vietnam war and an expanding agenda of social programs, racked up enormous budget deficits and trade deficits. The Bretton Woods system reached a crisis when it became clear that there was a run on the U.S. gold supply as foreigners sought to exchange their dollar reserves which were convertible to gold at the fixed price established by the Bretton Woods system.
As Hazlitt forecasted in 1949, an overvalued dollar would result in the loss of U.S. gold reserves. At this point, there were far too many dollars in the world for all of them to be exchanged for gold at the official price.
The system collapsed when Nixon suspended convertibility by "closing the gold window." The current monetary order, which stems from the demise of the Bretton Woods system, consists of market-determined exchange rates between floating fiat currencies, entirely lacking any commodity backing.
The current international monetary system, like a bad horror movie, is a sort of return of the living dead Bretton Woods. A vestige of the agreement placing the dollar at the center of international finance, securities denominated in fiat U.S. dollars are the most widely held reserve asset. Dollars that were accumulated under the promise of convertibility are now held in such large quantities by most major central banks that they cannot be sold without destroying the value of the remaining asset.