Global Monetary System

In order to fully understand the current monetary system you have to wind the clock back to WW2.  As we all know, Japan rolled the dice on attacking America and lost.  Of course the full truth is always a bit more complicated.   Japanese leaders didn’t just wake up one day and decide that they needed a bigger war.  We pushed them into doing it by steadily interfering in their joint war effort with Germany (which Germany kicked off on Sept 1st, 1939 by invading Poland).  In 1940 we had just started the mass production ramp of what were later to be called Liberty Ships under a lend-lease agreement with Great Britain.  In other words, we were supplying Japan's enemy with ships and supplies even though we were not officially at war.  Furthermore, we were doing it at essentially no up-front cost; we were essentially loaning Great Britain the means to fight Germany and JapanJapan could see our ship production ramping up.  They could calculate the value of the military and food supplies we were sending to England.  The Japanese knew that the economic tie between Great Britain and the US was tantamount to a military tie.  The USA was out of the war in name only.

This is what drove Japan to attack our naval forces on Dec 7, 1941 in Pearl Harbor.  They wanted to limit our ability to protect the Liberty Ships so that German U-boats would have an easier go of stopping the flow of goods from US to the war theaters of the world.  If we couldn’t protect those ships, Great Britain would soon collapse.   Of course back door support of Great Britain and others was the right thing for the US leadership to do.  The Japanese attack played right into the hands of America’s leaders by pushing Americans out of their comfort zones so that they would approve war spending and send their children off to get turned into hamburger on foreign shores.  The alternative was to let Japan and Germany unify the whole Eurasian continent under a violent military dictatorship and if that happened then chances were near zero that they would stop there.  So it was important that the Axis powers not be allowed to succeed and our leaders did what they had to do in order to get pulled into the fray in a way that would be backed by the American people.

Fast forward to 1944.  The Allied forces were clearly winning the war.  Because of the imminent victory, the US decided to call a series of meetings to take place during the first 3 weeks of July, 1944 in Bretton Woods, New Hampshire, USA.  The meetings were basically discussions between Allied powers on how to divide up the spoils of war once it ended.  By the age old rule of “to the victor go the spoils”, each of the Allied nations had their eye on something they wanted.  In Roman times, the losers of a conflict would end up with all their men killed, their women raped and their children taken into slavery.  The villages were plundered of all wealth and then burned to the ground.  This is how the victors would ensure that old enemies could not eventually regroup and extract revenge in a decade or two.

The problem with all that killing and burning was that it was wasteful.  Given that human labor is the source of all future value creation, more illuminated minds of the era reasoned that it made best sense to leave the men of the vanquished nations mentally and physically able to work.  Still, Japan and Germany had to be made to pay war reparations, right?  The only problem with this thinking was that it was tried during WW1 and it led to such hardships in the Weimar Republic of Germany that the German leadership attempted to hyperinflate its way out of the debt.  This caused great internal suffering of the German people leading to the rise of Hitler and the Nazis.  All in all, it was a badly conceived and executed affair by the victors of WW1.

The solution?  Instead of wiping out the productive capacity of the battered nations any further, let them stand and work to improve it over time.  This would give the losers the basic productive capacity to make war reparations.  And instead of demanding the money immediately as occurred during WW1, set up a system whereby the payments were made over time. 

There was one other issue to consider which was that not all Allied efforts contributed equally to winning the war.  In fact, Russia sided with the Axis powers until Hitler turned on her and Great Britain had been receiving US aid for a long time before the US entered the war.  France of course itself had to be liberated.  Stepping back to look at the big picture it seemed that everyone in the world really owed the US big time, no exceptions.  The whole world owed the USA some form of compensation for its part in the war, even those who fought in the same trenches with America against the Axis powers.  The trick was how to collect on these various unspoken but unforgotten debts.

Now, the US had some of the finest financial thinkers in the world.  They understood money and they understood math.   To them it didn’t matter who else got what concession during the Bretton Woods meetings as long as the USA ended up with control over the global money supply.  These guys had it all worked out.  Once in control of the money supply the US could extract an annual tax from the entire world in the form of inflation.  Inflation based taxation is really the best kind if you are a sneaky con man. 

There are several reasons why inflation is such a sneaky form of taxation.  For example, people don’t readily sense it because it only happens at 2-3% annually.  When commodity prices rise they can always be explained away as the fault of "greedy Arabs" or "greedy farmers".  Additionally, the common people of the taxed nations don’t really know that they are paying it because no bill is ever presented to them.  The tax just shows up as higher prices for everything. 

However, probably the most important reason that sneaky con men love inflation is that it is an exponential function.  For example, the graph of the simple 3 percent inflation formula given by Price[Thisyear]=Price[Lastyear] *.03 looks like this:
The graph starts off with a value of $1000 and increases by 3 percent per year.  The result is a clearly exponential graph. The first red line is the price level after just 10 years of this compound inflation.  It shows that 30% of the system (in this case, the portion of the global GDP controlled by US-inflated dollars), was simply an inflation tax.  By the time 25 years goes by (second red line), the prices of goods and services have doubled.  The buying power associated with these price increases does not go into the pockets of those who worked to produce those goods but rather into the pockets of those who control the dishonest money. 

If this were not bad enough, look at what the graph looks like at 7.5% inflation (.075).  The graph again starts off at $1000 and goes for 65 years:  If you have been wondering how in the heck the gold price could
possibly have gone from $35/oz in 1971 to ~$1700 per oz today, now you know.  Gold is known as "the money of kings" and kings are educated elitists who understand what a scam inflation is.  Inflation is a taxation game that they play upon the uneducated populace, not a game that they themselves will easily fall for.  Thus, gold tends to keep up with inflation in any society which regards gold as money.  In fact, have a look at this next figure which is a compound interest calculator.  It shows the value of gold was $35/oz in 1971 which was 41 years ago.  Gold is between $1650 and $1700/oz today.  The calculator shows that it takes an annual increase of nearly 10% in order to go from $35/oz to $1678/oz in that time frame.  Gold's price rise tells us that this was the likely rate of inflation that occurred in
aggregate during that time period.  It is clearly an exponential function.  The elite certainly understand this math and it was this knowledge that led the French Prime Minister of Finance (Valery  Giscard ‘d Estaing) to refer to US control of the global money supply as “Exorbitant Privilege” in the 1960s.

Inflation is also a great way to quietly tax someone because the person who is being taxed is not relied upon to submit payment and thus there is no possibility of tax evasion (and thus no cost associated with collection).  The imposition of the inflation tax is automatic and it is collected each time the taxed person buys something from the store.  Finally, war reparations during WW1 were a set value (even though it was an astronomical value, un-payable by anyone at the time).  Still, it was a fixed value that people could conceivably work toward paying off.  Conversely the inflation tax was and is perpetual.  There was never any set payoff amount or end payoff date.  In fact, the USA never even acknowledged that it was collecting this tax – quite the opposite.  The US maintained up until late 1971 that it had gold to back any new dollars it printed even though history now clearly shows that was untrue - a bold faced lie if you will. 

Pretty slick, huh?

The mechanics of the Bretton Woods repayment plan (although it was never called such) were that the US, having a bunch of gold in its vaults and having a manufacturing infrastructure that had not been touched by enemy bombs, was clearly the strongest (militarily and economically) and most trusted country in the world.  The logic was that the rest of the world should have confidence in US ownership of the global money supply given all this earned trust.  It's the same technique used by con men today on a daily basis to fleece their victims.  Some of this trust was earned though self-control during the war.  It is to the credit of the US military that it never gained the reputation of committing systematic or massive atrocities upon their conquered foes.  The same could not be said of, for example, the treatment of German or Japanese POWs.  The fate of the Jews under Hitler is self evident.  However, the Chinese were also especially trodden under the heel of the Japanese war machine and it has created social wounds that have not healed between the two countries to this day.

The US used its newfound central importance to suggest during Bretton Woods that, after the war was over, countries of the world should no longer back their currencies with their own local gold reserves.  Instead, it would facilitate trade (blah, blah, blah) if these countries instead were to “peg” their currencies to the US dollar at some agreed upon and publicly known fixed rate.  In turn, the dollar would be backed by gold held in reserve by the US at the exchange rate of $35/oz.  In this way all countries of the world would have gold backed currencies even if only indirectly.  The dollar would become the currency standard - the standard by which all other global currencies would be measured going forward (AKA the world's reserve currency).  As part of the deal, if anyone ever suspected the US of printing more dollars than it had gold to back them, they were free to bring their dollars to the US’ “gold window” and demand that the paper money (or accounting equivalents) be exchanged for physical metal.  Fair enough, right?

For the next quarter century the world labored under the sneaky inflation based taxation system of Bretton Woods.  Japan was allowed to rebuild – sans military – and they served as a low cost source of goods and technologies to the US for many years.  They were basically economic slaves paying for their sins of WW2 long after the war had ended.  The US prospered by effectively skimming 2-3% of everyone else’s production right off the top through inflation. 

The inflation tax was imposed by printing 2-3% more money each year than we had gold to back it.  Because it takes time for market equilibrium to occur, those with first access to this new money got to spend it into the economy at the valuation that existed before the debasement occurred.  But the additional flood of new money did not go unnoticed for long because it chased up the prices of everything it touched.  The market's response to this inflation was to increase prices on everything in the US: salaries, commodities, you name it.  While the con men at the top perceived this as prosperity because they had first access to the money, the middle and lower classes were always the last to get access to the cash.  By the time they got their raises, they had already been paying higher prices for food and clothing.  In other words, the cost of living raises did not benefit the net purchasing power of the lower echelons, it merely pushed them back up toward their pre-debasement purchasing power.

Those additional dollars would eventually be used to purchase foreign imports whose prices were also chased up by the weaker dollar.  Higher import prices reduced American desire to purchase foreign made goods.    In response, the foreign countries would have to print more of their money so that prices of their exports would not rise relative to the US dollar.  In other words, since we printed they would also be required to print in order to maintain a currency peg which would enable the exports upon which their recovering economies survived.  

We are seeing increasingly visible evidence of this today: a strong currency is the enemy of any country that desires to be a net exporter.  Because of slightly delayed debasement of the exporter's currencies in order to maintain their dollar peg(s), the debased American dollars from last year would again buy the same amount of stuff that could be purchased before the new dollars were added.  But that meant Americans got a whole year of enhanced and unearned buying power.   In essence, the foreign exporters were working part of the time simply to make up for inflation.  When you are forced to work for someone without getting actually paid, its called slavery.  So you can see that the methods might have changed from the Roman enslavement of conquered foes but the goal is unchanged: getting something for nothing as a result of forcing or fooling someone else into working for free.

The above cycle would repeat time and again.  As soon as foreign countries would debase their own currencies in order to cure the imbalances brought on by last year's USD printing by the US, the US would print more money again (of course this is a gross oversimplification in the name of brevity).  In this way the US basically got average cheaper prices on foreign imports than it should have, year after year.  It is essentially the modern version of the butcher covertly pressing on the scale with his thumb when selling meat by the pound to customers.  It was and is a cheat.

The inflation tax was an effective scam because it was slow and measured, or so it seemed at least for a while.  But the temptation of getting something for nothing like that is just too great.  If a little inflation was good, then a little more was better.  Also, since the function is inherently exponential it started becoming very noticeable to the patsies (a technical term meant to describe the victims of a confidence game or so called "con job").  As I explain in the Insight.Money section of this blog, we eventually began inflating so badly that others caught on, pushed back, and caused the Bretton Woods agreement of 1945 to collapse on November 15th of 1971 with the de-linking of the US dollar from gold.

At that point the entire world’s money supply became just as un-backed and essentially worthless as the US Dollar.  Close on the heels of the collapse of Bretton Woods we saw the gas shortage of the 1970s show up in the US because the Middle East oil exporters (who did not feel any need to make WW2 war reparations to us) were now fully aware that they were working hard and shipping their precious oil to the US and they were taking worthless green paper in return.  In response, prices at the pumps skyrocketed while the talking heads blamed the shortages on the Yom Kippur war.

Japan also found its legs during that time and they planted the seeds of a massive industrial boom that would eventually spell the downfall of the US automotive industry and the US electronics manufacturing industry as well.  Of course we got the benefit of cheap cars and stereos so most of America was pretty happy about it.  The massive redemptions of paper money for gold leading to the collapse of the original Bretton Woods agreement was the world's way of telling the US that compensation for its part in WW2 had been paid in full.  The world was going to be much less inclined to accept US exported inflationary pressures going forward.

However, the master con men of the US were not to be thwarted from their global taxation scheme so easily.  For many decades the US had nearly zero political or economic relationships with communist China.  After all “those people” were just so culturally different than us…  We saw the Bretton Woods agreement headed towards collapse because we could see the growing line of people asking to trade in their dollars for gold metal.  So in July of 1971 Nixon sent his (extremely money and people savvy) advisor, Henry Kissinger, on a secret mission to China to arrange a visit by the president and the first lady.  In February of 1972 Nixon shocked the world by visiting Communist China and opening up the path for a new economic and political relationship between the two countries.

Let me say that again: Kissinger to China in July 1971, gold standard dropped in November 1971, Nixon in China in Feb 1972.  Bada Bing Bada Bang! Coincidence?  Hardly.  The US needed some way to prove to the world that its currency wasn’t simply worthless green paper.  Kissinger et al. knew that, in absence of direct commodity backing of money, the value of it could still be maintained if people needed to use it for trading purposes and for the settlement of international debts.  Knowing that all future value comes from the labor of man and seeing that China had an incredible and untapped labor force, the logical solution for people that know how money works was to help China develop in the same way we helped Japan develop post war.  When China got strong enough it could then send us all of its cheaply made, high quality goods which we would pay for with money printed out of thin air.  In exchange for our help getting them up and running, China could price its goods in dollars which meant people needed to hang onto their dollars outside of the US in order to trade with them.  We also made political deals with Saudi Arabia so that they would continue sending us oil, albeit it higher prices, but they too would be required to price their oil sales in dollars.  Thus was born the petrodollar.

Once the world saw that the US was going to develop China as a new entrant into the global economy it decided to put up with our worthless money being the world’s reserve currency even though we had abused the privilege time and time again in years past.  Still, Europe and others were benefiting from the rise of China and that included the middle east which began selling oil into the region to power all of the Chinese industry.  Because of this, Bretton Woods I morphed into the so called Bretton Woods II system which is really just elite speak for “the US found a new source of slave labor to be its pasty and others got benefit too so they didn’t seriously challenge the hegemony of the US dollar”.  In other words, as long as they were getting something interesting in the deal they put up with the abuse.

While history has not closed the book on this chapter yet, Bretton Woods II is very long in the tooth.  The Chinese, like the Japanese before them, have grown up economically and politically.  They are now making more demands on the US and they are becoming resentful of the fact that they have been forced to buy up nearly 3 trillion worth of US dollars into their foreign reserves.  This was required due to the long standing trade deficit (AKA vendor finance scam) that we hold with them in addition to Ben Bernanke’s wild money printing operations known as “Quantitative Easing” rounds 1 and 2.  In other words, China is tiring of being our economic slave.  Yes, the relationship has been good for China for the last 30+ years but now they perceive, perhaps rightfully so, that America is taking a lot more than it is giving in trade between the two nations. The near global economic collapse of November 2008 which the Federal Reserve called “an electronic run on the dollar” was the biggest evidence of that to date.  It was the world telling the US to either show some new leadership or it would be dragged down from its pedestal and stripped of the exorbitant privilege.  Bernanke responded by driving a global can kicking exercise on the debt but it can only be viewed as a temporary solution at best.

The last time the world began to move away from US money based hegemony our response was to find some new source of value for us to exploit.  Finding new economic slaves has been the mechanism of choice, first Japan and the rest of the world and more recently China.  But the US must again seek some new value source to exploit going forward or face a precipitous if not well deserved drop in our average standard of living.  You might recognize this threat as the disappearing middle class. 

Perhaps Obama’s recent mission to India will turn out to be analogous to Nixon’s visit to China.  Perhaps we will help India become disciplined and broadly organized the way we have helped Japan and China to become.  If this is the case then we will be able to continue living a better than earned lifestyle for some time to come.   

On the other hand, the India benefit may not have as much runway as the China benefit did.  Not long ago Bernanke was addressing Congress on the matter of where we need to go next and he mumbled something vague about inventing cool new stuff that would pull us out of this mess.  It appeared that he was searching for a miracle outside of a new relationship with India that would again shine the light of leadership on the US without which others will likely dump our currency in order to shed the parasitic effects of our exported inflation.

Then again, perhaps the next step is a return to the ways of old Rome where growth of the empire was achieved by militarily conquering other people and taking their stuff by force.  This is not as far-fetched as it might seem.  The fact that, as of 2010, the US continues to spend 4-5x as much as the next highest military spending nation and more than all other military spending nations combined might be taken as evidence that the “Roman Option” is certainly not off the table with US leadership.  The fact that we are doing all this massive military spending in deficit mode and at a time when no clear enemy exists to attack us says even more about the option.  Finally, the so called "Bush Doctrine" created precedent in the U.S. for the use of preemptive military strikes.  This is something that would come in handy for a future president should he decide to "Go Roman".

I want to end this section by saying I am not anti-American as one might be led to believe in reading some of my non-sugar coated commentary.  I’m simply calling it the way I see it.  I am sure that others would have played the same games on us as we did on them had the tables been turned.  At the same time, the benefit of the con game is not shared equally by all in the US.  It has enriched our elite but it has quenched the fires of our young, threatening to steal their futures.  Not only are we piling on a mountain of debt for our children, we are also setting a poor example which they are, in many cases, following dutifully.  When people don’t have to work hard in order to eat and have clothing and shelter then the children tend to discount the value of a good education and of working hard.  Unfortunately, if these bad lessons are learned while young then they are hard to overturn later in life.

I also freely admit that we did give something to Japan and to China during the early years of our inflation tax extraction agenda.  We gave them modern leadership and we taught them discipline and we shared our technology with them.  Japan has never been such a global economic force as it became under the teachings of Deming et al. and China was an economic backwater before Nixon offered to bring it into the 21st century even if only so we could exploit its cheap labor.  The Chinese have had unprecedented access to US technology since then and they are now to the point where they can actually think and invent on par with the best that the west has to offer.  It is entirely uncertain that this would ever have happened had no relationship been forged. 

So we did give something of value in perhaps the same way that a ridiculously overcompensated CEO gives something to his company.  CEOs are of significant value in providing vision and setting direction but after the system is headed in the right direction the CEO does not add 500x the economic value of an engineer even though in US corporations he oftentimes gets paid 500x.  We must continue to keep this concept in mind going forward because the way of the world is to ask on a regular basis, “what have you done for me lately”. 

If I understand the collective mind of American politicians, they will either do something for the world so that it chooses to leave us in control of the money supply or we will do something to the world in an attempt to demand that they leave us in control.  It is entirely uncertain which of these will occur and no clear 3rd choice seems to be presenting itself.
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