Friday, March 30, 2012

Hey Nonny No

Woke up thinking about Nixon closing the gold window, and the first oil spike three years later, and how near those events were in time. And the recent Anonymous comment:

You could say that Reaganomics started with Nixon , when he dismantled Bretton Woods , a keystone in the post-war economic foundation. Monetary policy was bad prior to Volcker , but maybe this was to be somewhat expected , given the new exchange rate regime and the oil shock. Burns was a total hack though , driven by political pressures to a scandalous degree.

The quadrupling of oil prices had a huge effect...

I'm wondering why Nixon dismantled Bretton Woods. Why he took the dollar off gold. What happened in the years before 1971 that forced his hand?

Obviously it has to do with the value of the dollar, and gold, and the quantity of money. I would argue that the expansion of private credit even then was the source of the troubles.

Graph #1: Percent Change in Base Money, Inflation, and Private Debt (before 1975)
Blue is the growth of base money. Red is the rate of inflation. Green is the growth of private debt. Debt growth -- and spending, and velocity -- are substantially higher than base money growth throughout the period, except briefly after the 1970 recession.

I would argue that the growth of debt increased the economy's need for money. You can see the blue line respond to that need after both the 1958 and 1960 recessions: Just a little bit after '58, but hugely after '60. There was already an imbalance in the money, in the 1960s. There was already excessive reliance on credit, then.

I would argue that the problem began long before 1971, and that policy finally acknowledged the problem in 1971 when Nixon dismantled Bretton Woods.

But it was the wrong solution. Nixon's solution allowed base money to increase without limiting the increase of credit use. Thus his solution failed to correct the monetary imbalance, failed to reduce the reliance on credit, and invited even more inflation.

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