Abolish The FOMC Now! (Part 3)

The old story about the boy who killed both parents and then threw himself upon the mercy of the court on the grounds that he was an orphan tells you all you need to know about the pivotal monetary policy events circa 1970 and after. The inflation break-out of that period, which led Nixon to the foolish act of severing the dollar’s link to gold, was actually caused by the Fed money-pumping surge in the latter part of LBJ’s “guns and butter” escapade and most especially owing to the full-on money printing spree by Arthur Burns in the run-up to the 1972 election.

As we pointed out in Part 2, prior to this turn of events the Fed had no inflation-fighting mission per se—let alone a 2.00% target for the PCE deflator—because the gold-based anchor to the Breton Woods system theoretically precluded a sustained rise in the general price level. Indeed, under an old-fashioned gold standard (i.e. pre-1914) the Fed’s reckless money-printing after 1966 would have resulted in a massive outflow of gold, a sharp curtailment of domestic bank credit growth and an eventual recessionary contraction of the US economy.

Accordingly, the Fed would have had no choice except to shutdown the printing presses to staunch the gold outflow, restore balance to the nation’s trade and external accounts and, at length, return to the path of noninflationary growth on the free market.

Unfortunately, by the late 1960s the politicians had already fatally impaired the gold standard under the guidance of J.M Keynes and US Treasury economist and closet communist, Dexter White, at Breton Woods two decades earlier. That is, they had gutted the very essence of the gold standard’s disciplinary magic, which was the ability of private holders to redeem currency for a fixed weight of gold, and also to move the latter at will out of markets imperiled by inflationary government policies.

Instead, the Keynesian and statist operatives who designed the Breton Woods system provided that convertibility would be exclusively a state-controlled operation conducted through gold movements between central banks. Accordingly, financial discipline would only happen if government officials were willing to take the medicine of banking system curtailment and economic austerity, which was the automatic result of gold outflows.

As it happened, the central banks of the lesser economic powers and nations still recovering from the carnage of WWII—Germany and Japan—had no choice except to stick to the straight and narrow of non-inflationary monetary policies. They and their governments understood well that massive, sustained outflows of gold or dollar reserves would led to economic ruin.

No so much for the world’s sole post-war superpower domiciled on the banks of the Potomac, however. The Breton Woods system amounted to a gold exchange standard, which invited the rest of the world to hold purportedly “convertible” dollars in their foreign exchange reserves rather than gold bullion. After all, Washington’s dollars were averred to be good as gold and the rest of the world initially had no reason to doubt that promise.

Indeed, during much of the first decade or so after 1945 there was claimed to be a dollar shortage. As the world economy and global trade recovered from WWII, demand for dollars for purposes of trade finance, capital flows and FX reserves rose apace.