An Anniversary to Forget

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Published on Wednesday, 15 August 2012 15:20

Written by Bill Bonner, Founder and President, Agora Inc.

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Yesterday, some French rowdies set fire to cars, burned down a schoolhouse and sent police officers to the hospital. What's their beef?

Who knows?

These are the "dog days" of summer. They're called the dog days because the Dog Star, Sirius, the brightest star in Canis Major (the "big dog" constellation), is prominent in the sky in the Northern Hemisphere this time of year.

We went up to Paris yesterday morning. The city is practically empty. Only the tourist spots were crowed; the Parisians are away on summer holidays.

In the markets, the dog days are marked by low trading volumes, because traders have better things to do during these August weeks -- such as go to the beach.

Yesterday, for example, the Dow moved only two lousy points.

Gold had a bigger day, down $10 per ounce, for reasons unexplained.

Yet in the middle of these dog days, at least two remarkable things happened. One of them is the reason the church bells from our nearby village are ringing this morning. The other rang a bell too... but of an entirely different sort.

This is the day reserved to mark the assumption of the Virgin into heaven. How exactly this happened, we don't know. We weren't there. But it's a big day on the church calendar, at least on the Roman Catholic calendar, and there's a mass this morning to celebrate it.

It is also the day that old hound Richard Nixon chose to interrupt the T.V. show Bonanza to tell the nation he was doing something very stupid. He said that after much sober reflection, he had decided give up on a market economy. Henceforth, a group of bureaucrats would decide who could raise prices, how much and when. And by the way, he added, from now, on those dollar bills you have in your wallet... well... they're worthless.

He didn't exactly say it like that. But that was the gist of it.

We still live in the world Nixon created. It is a world in which dollars... pounds... euros... and zlotys have no real fixed value. They float, one on top of the other, like windblown leaves. How far they go depends entirely on how fast the breeze is blowing.

What's a dollar worth? Intrinsically, nothing.

All paper currencies sooner or later revert to their intrinsic value: zero. There are no counterexamples in history... except... the present one. So we have to wonder. Did Richard Milhous Nixon begin a really "new era" on this day 41 years ago? Or are today's paper currencies doomed, just like all those that came before them?

One thing to keep in mind is that -- whatever the value of the dollar -- there are a heck of a lot more of them in circulation than there were in 1971. The quality may have slipped. But the feds more than compensated in quantity.

How much value has the dollar lost since it was cut loose from gold? Just look at the gold price. In round numbers, a dollar was worth one-fortieth of an ounce of gold in 1970. Now it's worth one-sixteen hundredth. So the dollar was worth 40 times more back then, measured against gold.

Or take gasoline. You could have bought a gallon of "high test" gasoline in 1970 for 25 cents. That's about one-fifteenth of today's price.

What about stocks? From about 800 to 13,000 on the Dow is an increase of 16 times, too. So investors have made nothing... zero... for the last 40 years in terms of purchasing power. All of those gains they think they made are nothing more than a money illusion -- the tendency, much relied upon by politicians and central bankers everywhere, for people to think of currency nominally, instead of in real terms.

However you choose to measure it, the value of the piece of paper known as a "dollar" has gone down.

But that doesn't mean dollars aren't popular. In some ways, they're more popular than ever. People need them to pay their rents... their auto payments... their bar tabs... and their cocaine habits. Mostly, they need dollars to pay their debts.

Whence cometh these debts?

Ah... glad you asked. Since Nixon broke the bond with gold, the financial system was free to create as much dollar credit as it wanted. It never had to settle up.

That's the main difference between a paper system and a gold-backed system. In a gold-backed system, you settle accounts by transferring gold from debtor to creditor... from deficit country to surplus country. When the debtor country runs out: game over.

Usually, the gold-backed system is self-correcting. As soon as gold begins to flow out of the country, interest rates rise... credit becomes expensive... and savings increase. This boosts exports relative to imports, stopping the growth of credit and the outflow of gold.

But without this feedback loop, the Fed -- in collusion with the financial industry -- could create dollars by the boatload. It could lend them out. And so it did! Trillions of them.

The amount of credit in the system exploded 50 times. (At least, that is the number given to us by our old friend Jim Davidson. It is a round number, easy to remember.) Debts of all sorts -- mortgage, student, financial, credit card -- grew larger and larger... so large that in 2007, the underlying economy could no longer support them.

You know what happened next...

Which is how we came to be where we are on these Ides of August, 2012. We're paying down... renouncing... and reneging on bad debt. This debt deleveraging is in its fifth year... with about $15 trillion worth of debt still to be squeezed out of the U.S. economy alone.

The debtor is dogged by his debt. The creditor is dogged by worry that he won't be repaid. The Fed is dogged by concern that its cheap money policy isn't working. The investor is dogged by doubt as to when the Fed will give the market more printing-press money. The saver is dogged by wondering what this new printing-press money is worth. The spender is dogged by not having enough of it. And we are dogged by the suspicion that the whole system has become so infernally cut off from financial reality that we will never be able to figure out what is actually going on.

Dog gone!