Wednesday, January 25, 2012

August 15, 1971 and the "pendulum swing away from an economy based on hard currency to one based on virtual money, or credit"

Clonal recommends this interview with David Graeber, author of “Debt: The First 5,000 years”. In the intro to the interview (and in the related text) the speaker says that President Nixon, by taking us off gold,

began what anthropologist and author David Graeber says is the latest pendulum swing away from an economy based on hard currency to one based on virtual money, or credit, which can lead to debt spinning out of control...

Sounds reasonable, right?  Well, I disagree. No surprise there, I guess.

If going off gold in 1971 is the reason debt went "spinning out of control," then I think we should see a noticeable increase in debt after 1971. We should see that increase soon after 1971. And we should that increase get bigger over time, as debt gets more and more "out of control". Yeah, sort of like this:

Graph #1: Total Credit Market Debt Owed

But the thing of it is, until the crisis, the blue line on Graph #1 was increasing all the time. So of course it is higher at the end than at the start. And of course it looks worse after 1971 than before. Glancing at a line that "goes up" does not provide the strength of evidence we need if we are to accept the interview statement. Not for me.

On Graph #1 I highlight what looks like a temporary increase in the general pattern of increase. This distortion of the general pattern, like the swelling from a bug bite, begins in the mid-1980s and tapers off to nothing by the mid-1990s. What I'm looking for is a change that begins the same way, but never tapers off. If debt "spins out of control" because we went off gold in 1971, there is no reason for the increase to be temporary, and every reason to expect the increase to be permanent and to grow larger.

Furthermore, the timing of the temporary increase on Graph #1 is wrong. It does not come shortly after President Nixon took us off gold. It comes shortly after President Reagan started making changes to economic policy.

Still, Graph #1, overall, does show increase that looks like an "out of control" increase in debt. Yes, I agree that it does. But again, there is the timing problem, the absence of any change associated with the Nixon policy action. I am therefore forced to reject the view presented in the Graeber interview, that the growth of debt in our lifetime is in any way a consequence of "going off gold".

To finish that thought: I think "going off gold" was a policy response to conditions that demanded action; and I think the particular "condition" demanding action was the increase in total debt that had happened before 1971. But that's just me.

Did "going off gold" create the debt problem? No.

Did going off gold make the problem worse? Yes and no. Going off gold allowed debt to continue growing and therefore allowed the debt problem to grow worse. But going off gold did not cause debt to grow worse.

As I have it, the mindset that thinks going off gold -- or any policy -- is "a good idea because it allows debt to continue growing" is the cause of the problem. That mindset has been the cause of the problem since the end of the second World War, and remains the problem today.

FRED provides TCMDO (Total Credit Market Debt Owed) numbers for every year from 1950 to 2010. Conveniently, the Nixon gold action occurred 21 years after the start-of-data. I broke up the FRED data into three periods of equal length: 1950 to 1970, 1970 to 1990, and 1990 to 2010. If going off gold was the turning point that allowed debt to "spin out of control" then we will be able to see this in the difference between debt growth before 1971, and after.

I used an old trick from Milton Friedman, and figured the debt numbers for each period relative to the period average. I think of this as making three separate graphs, for each graph finding the "center" of debt, and then stacking the graphs one on top of the other with the centers lined up. This way I can compare three 20-year increases in debt, and I am not befuddled by the fact that each subsequent increase starts where the previous increase left off.

I am looking for evidence that the Nixon gold policy of 1971 allowed debt growth to go "out of control", or that it did not. On the horizontal axis of the graph below, years are represented by the numbers "0" through "20". To figure out what those years are, add the year-number to the start date in the legend. For example, year "0" for the blue line represents 1950, for the red line 1970, and for the gold line 1990. Year "6" for the blue line represents 1956, for the red line 1976, and for the gold line 1996.

Graph #2: Comparing Three Periods of Debt Increase

The blue line on Graph #2 shows the growth of debt for the first period, 1950 to 1970. This line starts out higher than any other, and ends up lower (except for the crisis effect in year "20", when the gold (2010) falls below the blue. The blue line shows the slowest rate of increase.

The red line shows the growth of debt for the second period, 1970 to 1990. This line starts out lower than any other, and ends up higher. It shows the fastest rate of increase. So far, Graph #2 seems to support the view that the Nixon action of 1971 did result in "out of control" debt growth. But we're not done evaluating the graph!

The gold line shows the growth of debt for the third period, 1990 to 2010. This line starts out extremely close to the blue (1950-1970) line. And it stays close to the blue line for the whole period: extremely close from the "0" year (1950, 1990) to the "14" year (1964, 2004) before rising briefly and then collapsing in crisis.

The 1950-1970 period shows the slowest rate of increase. 1970-1990 shows the fastest. But then 1990-2010 shows an increase that is nearly as slow as 1950-1970. In other words, if Nixon's 1971 decision to separate money from gold had any effect at all, that effect dissipated by 1990. Given the profound significance of the Nixon decision, the effect of such an act would never dissipate, in my view. Therefore I must conclude that despite the significance of the Nixon decision, it had little consequence for the growth of debt.

Going off gold opened no floodgate. Going off gold, by itself, did not lead to debt spinning out of control.

As a point of interest, the red line starts out low because it ends up high, and because we are "centering" each 20-year period on the others. So again, this confirms that the red line -- 1970 to 1990 -- shows more of an increase than either of the other two lines.

Looking at that red line, I see a kink (an increase) around year "7" and another around year "13". These are changes in the pattern of debt increase. Year "7" on the red line is 1977, six years after the Nixon move. Year "13" is 1983, three years after the election of Ronald Reagan.

In the years before 1977, the red and blue lines appear to run parallel, red perhaps increasing slightly faster than blue, but this is not definitive. I conclude that red and blue in these years (1970-1976 and 1950-1956) show essentially the same pattern of increase. So there was no "spinning out of control" after 1971. At least, not for several years after 1971.

Did the Nixon move contribute? Did it facilitate the growth of debt? Of course. It was part of a policy dedicated to the increase of credit use and the accumulation of debt. Evidently there were other parts to that policy as well, one around 1977, and one around 1983.

Evidently it was always thought wise to use credit and to let debt accumulate:

Graph #1 repeated: Total Credit Market Debt Owed

I think the apparent strength of Graeber's argument arises from the precision of the date he chooses as a turning point: A well-defined moment. How could he be wrong?

But he *is* wrong. He is wrong because he picks one moment and says that moment defines the start of the problem. He is wrong because the moment he picks is only one of many moments, moments of policy, moments when the idea was this policy will allow debt to continue increasing, and that's good -- moments that could only lead to a very bad ending.

If there was any single turning point that opened the floodgates of debt, we would see a flood happen after that point, and no flood before. There is no such point. Debt was always increasing, as the graphs all show. It was always policy to encourage credit use and the accumulation of debt.

It is our policy -- always encouraging debt -- that is the problem. And if you bristle at the thought, let me suggest that your reaction is typical. It is this view, your view, that leads again and again and again throughout history to the crises David Graeber describes, crises that must result from a policy of perpetual debt accumulation.


jim said...

Hi Art

You are arguing against a misrepresentation of Graeber made by an interviewer who is making a introduction that is supposed to grab the viewer's attention. It apparently grabbed your attention, but it doesn't have much to do with Graeber's view.

Graeber's position is that credit is the oldest medium of exchange. It preceded money and barter. In primal societies when an individual had a surplus the best strategy was to give it away. This created an implied obligation to return the favor. Everyone benefitted as everyone was following this same strategy. The value of things was always on a floating exchange rate and since disputes on the value of things were fatal to the entire societal existence, Darwinian logic dictated such disputes never occurred.

The issue of money or barter (where the value of things needed to be quantified) arrived when the primitive society encountered foreigners and trade needed to involve sales that were finalized.

In regard to Graeber and modern debt. He does say there is an increase in the western world debt starting in the 80's. But that has nothing to do with the gold standard. He attributes that to Thatcher and Reagan policies. We all can agree that the federal debt/GDP ratio changed from declining to growing in the early 70's, but I don't think anybody other than this PBS interviewer has ever tied the general public debt to the gold standard change in 1971.

Here is another Graeber interview:

Clonal said...

US went off the gold standard in in 1933. FDR issued Executive Order 6102 followed by the Gold Reserve Act in 1934

These effectively took the US off the gold standard in 1934. However, the gold standard remained for international trade. These actions allowed FDR to increase the money supply - and that allowed for the spending that enabled the FDR policies.

By 1971, the international trade had increased to a level, which made the international gold standard untenable, and when Frnace threatened to cash in its dollar IOUs for gold, is when Nixon took the action, and floating exchange rates were born.

The Arthurian said...

Jim: "Graeber's position is that credit is the oldest medium of exchange. It preceded money and barter."

From chapter Two of Graeber's interminable and dreary book:
"Not only is it money that makes debt possible: money and debt appear on the scene at exactly the same time... A history of debt, then, is thus necessarily a history of money."

But do you think it really matters which came first? I don't. What's important is economic forces and the resulting monetary imbalances.

Clo: "By 1971, the international trade had increased to a level, which made the international gold standard untenable"

I think "going off gold" was a policy response to conditions that demanded action; and I think the particular "condition" demanding action was the increase in total debt that had happened before 1971.

jim said...

Hi Art

Sorry I wasn't being clear. I meant debt used as a medium of exchange preceded commodities such as gold as a medium of exchange.

And no, the ancient history of debt and money doesn't matter much. But, you went to considerable length to argue against the claim that the US economy moved from hard currency to credit money in 1971.

I thought your insinuation that Graeber had made such a claim was not a fair representation of anything he had said.

Clonal said...


You have to look at the money pyramid of John Exter

John Exter (September 17, 1910 – February 28, 2006) was an American economist, member of the Board of Governors of the United States Federal Reserve System, and founder of the Central Bank of Sri Lanka. He is also known for creating Exter's Pyramid.

Gold used to be at the Apex of the pyramid. However, once gold stopped being the anchor, I would contend that the US National Debt took its place. In other words, The accumulation of US budget deficits formed the base of high powered money that is essential to keep the world economy running.