Episode #7 - The 50th Anniversary of the Nixon Shock
On August 15, 1971, President Richard Nixon suspended the convertibility of the U.S. dollar into gold. This effectively ended the Bretton Woods Agreement, which had been put in place in the mid-1940s to stabilize the post-WWII economy. Jim Grant, founder and editor of Grant’s Interest Rate Observer, joins host Ed Coyne to look back at this significant event in monetary history. In this lively conversation, Jim and Ed dig into Nixon’s motivations and explore where we are today, 50 years into the fiat currency era.
Ed Coyne: Welcome to Season 1, Episode #7 of Sprott Gold Talk Radio. I'm your host, Ed Coyne, Senior Managing Director of Sprott Asset Management. On this podcast, we are turning back the pages of time to 1971. 50 years ago, on August 15, 1971, President Richard Nixon suspended the convertibility of the U.S. dollar into gold, effectively ending the Bretton Woods Agreement that had been put in place after the Second World War to stabilize the postwar global economy. The significance of this act was far reaching, but no other asset was more affected than gold.
We are joined today by a special guest who perhaps understands the full ramifications of this historic event better than most. I'm pleased to have Jim Grant, founder and editor of Grant's Interest Rate Observer, join us today. Hello, Jim, thank you for joining us.
Jim Grant: Ed, it is my pleasure. Nice to be with you.
Ed Coyne: Before we go back to the events of 1971. Can you give our listeners a brief history of your background and your work at Grant's Interest Rate Observer?
Jim Grant: Let's see. I was born in 1946, which, as you know, was the first full year, I guess, of the implementation of the Bretton Woods regime. As my mother told me at the time, I was born in month four of the great bond bear market of 1946 to 1981. Those are my bona fide days. I was present at the creation. And since 1983, I have edited something called Grant's Interest Rate Observer, which you were kind to mention. It's a twice-monthly journal of the financial markets. And what I do for a living is a type!
Ed Coyne: Jim, you were kind enough to forward me the most recent one that you just produced on August 6th, Paper Money Golden Anniversary. And I thought that was really a great segue into our podcast today. As a longstanding proponent of sound money and rational economic thinking, we at Sprott see you as a kindred spirit. Today, we're not exactly celebrating the Nixon shock, but with 50 years in our rearview mirror an acknowledgment or recognition is certainly in order. In your view, what factors led up to Nixon's decision to end the convertibility of dollars to gold and what was the immediate fallout?
Jim Grant: To take the immediate fallout first, the effect over the next 10 years was great inflation that ripped and finally ended in the double digits and the ascension to the chairmanship of the Fed of Paul A. Volcker, to a brutal regime of towering interest rates and a deep recession. And then decades and decades of paper money, with which we live today.
What led up to the abrogation of Bretton Woods was the simple fact that America was not prepared to subordinate its domestic monetary and economic interest to the exchange rate. America was losing gold it had promised to redeem. You could, if you were a central bank, present 35 dollar bills and the Treasury under the Bretton Woods System was committed to hand over one ounce of gold. Thirty-five bucks to the ounce. That became a burdensome and very awkward situation when America was losing gold and the French, for one, were insisting upon the right of redemption.
For the ten years or so leading up to the Bretton Woods announcement, America did everything it could to postpone the day of reckoning. We helped us set up something called the London Gold Pool, which tried to manipulate the gold price lower in free-market trading. We implemented something called Operation Twist, which jiggered interest rates to attract overseas dollar deposits by lifting short rates. We imposed quotas, and the president lectured us on the patriotic duty of not to travel abroad. All these things, all these shifting makeshift devices were unsuccessful, as of course they would be in postponing what was in fact the necessary culmination of a constellation of economic facts.
Those facts had to do with America emitting more dollar bills into the world than it earned, and you cannot keep giving up gold for dollars when you don't have the gold and that was the basic problem. The Bretton Woods System was not really a gold standard. Keynes, in a moment of candor, called it the very opposite of the gold standard. It's kind of a mercy killing was the cessation of Bretton Woods. It really was not working as a monetary technique. Nixon pulled the plug and we look back on Bretton Woods, it's kind of an orthodox and rigorous monetary setup. The U.S. dollar, after all, was anchored by gold. It was convertible by foreigners, not by American citizens, but by foreigners. And in particular, foreign governments, what could be more orthodox than that? But in reality, it lacked the essential features of a classical gold regime and was kind of the Keynesian idea of a gold standard. In fact, Keynes himself was the principal author.
Ed Coyne: On one side, it sounds like Nixon really had no choice but to do this. And on the other side, many said it was just really a political stunt for Nixon to get reelected. Not to weave politics into this, but I suspect today that's probably more true than ever before with modern monetary theory and QE (quantitative easing) and interest rates lower for longer and all those things that are happening. What do you make of that? I mean, do you think there were any political ramifications to it, or was it really a purely economic decision at the time?
Jim Grant: It was purely political. Nixon was running for election in 1972. Imagine yourself as a counselor to the President. "Mr. President, we have two choices. You can reduce federal spending and cut short the war in Vietnam and tell the Federal Reserve to cut back on monetary stimulus and can save the Bretton Woods gold convertibility feature, or you can let the money supply rip and keep spending and get reelected." What do you select? And the President selected option B.
Ed Coyne: Certainly much has changed in the last 50 years, but in some ways nothing's changed, right?
Jim Grant: Correct!
You know, a proper gold standard is all about the subordination of domestic considerations to the exchange rate, to the integrity of the currency as defined by its inviolable right of convertibility. There are not many peopled or politicians leading those peopled today who would select that. Certainly, it was not an appealing choice in 1971.
Ed Coyne: It seems like we're learning nothing from history, unfortunately. I won't use just Bitcoin, but cryptocurrencies, in general, continue to grab the headlines along with Modern Monetary Theory, effectively, as I like to say, is the Frankenstein of Econ 101. We really don't know what all these different policies are going to do to our overall economy, whether it's from an inflation standpoint, from a k-shaped recovery of squeezing out, as you talk about in your most recent letter, the middle class. I think I read there that the middle class has gone from 61% down to 51%, and effectively, the middle class is our economy. Those are some problems that are byproducts of whether what we did 50 years ago or what we're doing today. How do you, and this is self-serving for us being a precious metals firm, but how do you see gold's role in the modern world with cryptocurrencies and with quantitative easing and zero rates for longer? Where do you see gold's role in this environment?
Jim Grant: Gold's role is to go up, damn it!
Ed Coyne: I'd agree!
Jim Grant: It's immensely frustrating, right? Because where you see heterodoxy posing as the gospel truth, we see heresy wrapped up as sound policy. And you keep on saying, "Hello, Mr. Gold Bullion, have you noticed what they're saying and doing? Have you noticed that the Fed's balance sheet doubled during the pandemic? Have you noticed that the Fed is talking about nurturing a rate of inflation higher than its target in the midst of evidence accelerating inflation? Have you noticed any of this?” We address this new thing called gold bullion and gold bullion keeps on slumbering.
You have a self-interest in this. I have a self-interest. I'm a great advocate of gold and own some for myself. Gold's role is to serve the office it has served from time immemorial, which is money. It is by no means a perfect and unvarying store of value. The great American economist Irving Fisher who was heralded by Keynesians and monetarists alike as a singular American economic genius came out with a scheme in the late 1910s-20s to help us stabilize gold. There had been inflation since about 1900 or a few years earlier until about 1921, and Irving Fisher wanted something better than gold to deliver price stability. Well, we have tried all other things than gold and we have not achieved price stability. Gold, as my friend Lewis Lehrman says, is the least imperfect monetary medium, but it is now out of the limelight, having been shoved aside by cryptocurrencies.
Ed Coyne: Could you address inflation a little bit and how are you're seeing it right now in the current environment? Clearly, in the 1970s, the act of decoupling gold and dollars could certainly be pointed the finger at for causing inflation. Maybe we're finding that to be the case now with all this quantitative easing and suppressing interest rates and free cash and so forth. Could you dive into that and help our listeners think about how inflation really can impact an overall portfolio over time?
Jim Grant: I guess one ought to try to define it first. I think inflation is a growth of money in excess of a compensating rise in the demand for money.
Inflation is not the manifestation of inflation. Inflation is too much money and the redundant portion of the money is expressed in different stuff. You can have inflation that's suppressed by packaging through the willful averting of eyes. People choose not to see it. It's not there. Practically speaking, Wall Street chooses not to see it. Hence, bonds have proven the best inflation hedge of the year 2021, which is not something you would expect, perhaps in the year 2020. You can see inflation in asset prices. You can see inflation at the checkout counter and you can see inflation in the foreign exchange markets. There are all sorts of ways that it manifests itself. The thing itself is a monetary phenomenon, I think, it seems to me that it is present. It is here and unusually, today, it is present in all the aforementioned forms.
We have it in the reflation of asset values. Interest rates are the lowest worldwide since interest rates were invented. We have some of the highest equity valuations since capital markets began. We have house prices rising 15-20%, depending on what houses you're measuring. The evidence of asset inflation is not disputable. And then we have the humbler kind at the checkout counter and at rates between 2, 3, 4 or 5%, when using year-over-year or sequential, whether you're projecting over the course year or not annualizing (trimmed to mean) all manner of ways of looking at it.
It's also possible to overthink this and overanalyze it. Money is gushing. The Federal Reserve is laying it on with a trowel. One question is, how do you want to be wrong? We're always guessing about the future, and mostly wrong about the future. That's why the future was invented, right, to make us humble. The question is, how do you want to be wrong? Do you want to be wrong by denying the possibility of inflation when the money supply is growing at double digits? Is that the way you want to make a mistake?
It seems to me that you have to present a somewhat academic and perhaps somewhat contrived argument to contend that inflation in these circumstances is impossible. You have, in addition to the monetary stuff, you have a fiscal blowout. Consider that the Fed, in its insistence that these manifestations of inflation are transitory, is laying down an immense bet. The entire financial world, the world in which people are preening and counting their winnings in their 401(k)s or counting their capital gains in the cryptos — all this hangs by the thread of the lowest interest rates in history, which are predicated upon the contention that there is no inflation. So you really want to not hedge that?
Gold has a way of disappointing its most devoted adherents. In 2008-09 it broke people's hearts and went down. "This is a crisis!" Gold is an ancient medium that appears in the periodic table. I didn't invent it. Some people think I invented it! It appears in the periodic table, it's an old thing and it takes its sweet time, right. It has a kind of a geological time set, that's its clock: geological. Over the sweep of a reasonable investment horizon, it protects against the depredations of the stewards of our currencies. That's what its purpose is. And that's what it mainly does. Over the course of fiscal quarters and even some years, it will disappoint, but over the course of a reasonable investment, long-term horizon, it will spare you the punishment that our central bankers so willfully are meting out.
Ed Coyne: We've certainly seen that in the numbers over the last two plus decades. Most of the investors we talk to are always surprised to see the overall total return of gold relative to bonds of course, cash and even the S&P 500. It has been one of the better-performing assets out there, period.
Jim Grant: It all depends on the time period. I mean, you go back to the highs of 1980 and you look forward a couple of decades and The Wall Street Journal is writing stories about the idiots who are still holding these coins. And this was about the time that gold had gone from about $850 in 1980 and then at the end of the 1990s was about $250 when Chancellor Brown sold Britain’s gold. That was a period of the deepest anguish on the part of the gold faithful. And then you've got several decades in which gold miraculously seemed to outperform equities, for Pete's sake. And you really have to take these things in with a great grain of salt and just say, all right, what I have here in gold, and very cheap gold equities, by the way, what I have here is an investment in monetary disorder, not a protection against it. We have it (monetary disorder) already. Monetary disorder is in fact the monetary system. It is an inherently disorderly system. In gold, you have an investment in that you do well, the more disorderly it becomes and especially well when the world recognizes the essential chaos of our monetary institutions.
Ed Coyne: What would you say to an investor today who's maybe putting, you know, $10,000 to work in the market for the first time? Of course, they have to buy dividend-paying stocks, but to your point about gold, what would you say to that investor? It's getting harder and harder to put your capital to work in the market because the market is getting so expensive. How should someone think about that today?
Jim Grant: The higher the market, the lower the prospective returns for anyone who invests at that high price. And we have the second richest valued market in modern annals. The outlook for prospective returns is not great. And the risk of substantial capital loss is high. Income-bearing securities bear little income and you get nothing at the bank.
How is that so far? How does that sound?
The trouble is that you don't know when it stops. Okay, if the question really is, should that person consider a few Krugerrands? I would say yes. I'd say that would be a helpful thing to have in one's portfolio with the knowledge that gold is non-regenerative. The idea of a common stock is you've got people out there every day working to increase dividends, working to build better products. Gold sits there looking good, like someone you know. And it's not meant to be one's entire portfolio, but it can play a part in stabilizing a portfolio, especially at times when gold is among, I suppose, in relative terms, the cheaper things.
$1,800 an ounce; I would say that it's relatively cheap compared to the monetary risk that our central bankers are presenting to us with suppressed interest rates and with the unending spinning of money through this thing we call quantitative easing.
Ed Coyne: I think stabilizing the portfolio is a key element. And I think also helping investors stay invested in their portfolio is key. You so often hear it's not timing, it's time, you have to stay invested in the market. I like to think gold helps you stay invested in other assets over multiple market cycles. That's the way we like to think about it over at Sprott.
Jim Grant: Yes, I think that's true.
Ed Coyne: Jim, we could do this for probably three or four hours, but I think we'd have one listener!
Jim Grant: No!
Ed Coyne: It's been great to have you on Sprott Gold Talk Radio, and we really appreciate your time. And what I would tell all the listeners is that if you'd like to learn more about Jim Grant, and Grant's Interest Rate Observer, we encourage you to visit their website and learn more about what's going on in the economy, learn more about your environment and learn more about how you can make gold work for you and help you stay invested in the market. Jim, do you have any last bits of wisdom you'd like to leave our listeners?
Jim Grant: I think I spilled my entire bits of wisdom here on the counter! But thank you for the opportunity.
Ed Coyne: Wonderful. Well, thank you so much, Jim.
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