The Daily Reckoning
Baltimore, Maryland
Wednesday, July 21, 2004
The Daily Reckoning PRESENTS: Lessons from the past: Chris
Mayer examines the ideas of Jacques Rueff, the eminent
French economist and former minister of finance to Charles
de Gaulle.
The Poet of Finance
by Chris Mayer
Jacques Rueff was accused of being a perennial prophet of
doom - a doom that never seemed to arrive.
Rueff first began to voice his concerns in 1961, alerting
the world to the dangers inherent in the worlds monetary
system, then operating under the Bretton Woods agreement.
It would take ten years before Rueffs view was fully
vindicated.
The international community must have shivered as Reuff
evoked the haunting memories of the Great Depression. He
compared the years 1958-61 to the years 1926-29, which many
could still chillingly recall as the prelude to an economic
disaster none wished to see again. As Rueff notes, there
was the same accumulation of Anglo-Saxon currencies in the
monetary reserves of European countries, in particular
France, and the same inflation in creditor countries.
In the 1920s we had the gold-exchange standard; in the
1960s we had Bretton Woods. Both systems were monetary
jalopies, jerry-rigged Rube Goldberg-like contraptions that
could not hold together for long. The two convertible
currencies, dollars and pounds, became reserve currencies,
effectively held by European banks as reserves instead of
gold.
Rueff uses the example of the years after WWI, when a large
influx of U.S. and British capital flowed to Germany and
France. The new liquid funds entered these recipient
countries and were held as reserves, since they could
theoretically be converted to gold. In the older gold
standard days, these dollars and pounds would find their
way back to the banks of issue and be redeemed for gold. In
this way the debt was settled. Gold was the worlds money
accepted as final payment; not dollars or pounds, which
were essentially notes - promises to pay the holder in
gold, which was real, as opposed to printed paper, which
was not.
In the booming twenties this was not the case. So, France
and Germany held dollars and pounds and issued more of
their currency and credit against these dollars and pounds.
In the gold-exchange standard of the twenties, only dollars
and pounds were redeemable in gold - all other currencies
were redeemable in pounds, which were in turn redeemable in
dollars. Very confusing, I know. Why the Genoa experts
recommended this is another sorry episode of political
expediency, compromise and historical accident, which we
will skip here or I may never get to my conclusion.
Such a system, only loosely tethered to gold, allowed
considerable inflation. As Rueff noted, it was probably
one cause for the long duration of the substantial credit
inflation that preceded the 1929 crisis in the United
States.
The ensuing collapse of this pyramid scheme was to figure
prominently, in Rueffs estimation, in explaining the birth
of the Great Depression.
Anyway, the point of the comparison with the 1920s was that
Rueff thought that, mutatis mutandis, the same thing was
happening again in 1960. He noted how the international
community held tremendous reserves of dollars against an
ever-smaller base of gold reserves. As in the 1920s, the
U.S. was able to expand its supply of dollars skirting the
old discipline that would have shackled it under a gold
standard. No final payment was required; dollars - lots and
lots of printed dollars - were accepted as final payment.
Again, this allowed considerable inflation of dollars.
Here Rueff gives us one of his most famous sayings, when he
called this situation circa 1960 and the situation in the
1920s as creating a deficit without tears. He wrote that,
it allowed the countries in possession of a currency
benefiting from international prestige to give without
taking, to lend without borrowing, and to acquire without
paying. Rueff does not lay all this at the feet of the
U.S. After all, these other creditor countries willingly
accepted U.S. notes in lieu of gold. Rather, Rueff calls it
an unbelievable collective mistake.
The holding of vast dollar reserves by foreign creditors
puts the credit structure of the U.S. on notice. In the
days of the gold standard, and even in the gold-exchange
and Bretton Woods eras, this was more acutely felt because
the gold stock of a country was visible, could be counted
and was routinely reported. In the sixties, Rueff noted
that an uncomfortable gap was growing between the dollars
outstanding and gold in stock that backed it.
Writing in 1960, Rueff felt that if foreigners requested
payment in gold for a substantial part of their dollar
holdings, they could really bring about a collapse of the
credit structure in the U.S. Rueff called for a return to
the old gold standard.
The Le Monde article caused a stir, and a rash of criticism
followed, in which Rueff was chided as an old-timer,
applying a quaint antique analysis to a modern problem. The
gold standard was a thing of the past, one author noted at
the time, like sailing ships and oil lamps.
The new iterations of money, though, did not represent an
advance in mans understanding of money. On the contrary,
each new monetary wrinkle, each new invention, each
creative expedient only cheapened it.
We will skip ahead a bit in Rueffs chronology to 1965.
By this time, Rueff had continued his attempts to persuade
the monetary authorities to alter their course. On February
4, 1965, Rueff would gain something of a public victory
when General de Gaulle made his now famous speech on the
need for gold as a basis for international monetary
cooperation. Rueff finally had the ear of an important head
of state; he had the ear of de Gaulle, who would eventually
refer to Rueff as the "poet of finance."
After giving a brief history of the international monetary
scene beginning with the Genoa Conference, de Gaulle noted
how the acceptance of dollars to offset balance of payments
deficits with the U.S. lead to a situation where the U.S.
was heavily in debt without having to pay. He correctly
observed how the dollar was a credit instrument and
recommended that the system be changed.
We consider that international exchanges must be
established," proclaimed de Gaulle, "as was the case before
the great worldwide disasters, on an unquestionable
monetary basis that does not bear the mark of any
individual country."
"What basis?" continued the French head of state,
"Actually, it is difficult to envision, in this regard, any
other criterion or any other standard than gold. Yes, gold,
which does not change in nature, which can be made either
into bars, ingots, or coins, which has no nationality,
which is considered, in all places and at all times, the
immutable and fiduciary value par excellence.
Rueff pressed on with renewed vigor and the U.S. monetary
situation continued to deteriorate with accelerating gold
losses. Yet, negotiations continued, as Rueff says, at a
snails pace on a volcano, which may erupt all of the
sudden. While the experts dallied, the volcano belched and
smoked all around them. That a crisis was brewing was now
obvious even to the skeptics.
European nations that had been accumulating dollars at a
pace of $1-2 billion per year began liquidating them - more
than $2 billion were liquidated inside the twelve months of
1965 alone. By 1970, there was $45 billion in dollars held
by foreigners against only $11 billion in gold stock.
At this point, the ending was inevitable. Though there were
some changes made to the monetary structure in the waning
days of dollar convertibility, it would finally expire in
the summer of 1971 when Nixon brought the Bretton Woods
agreement to an end by taking the U.S. entirely off the
gold standard.
I think there are many ways in which Rueffs criticisms to
the monetary systems of the 20s and the 60s apply to the
monetary world of today. There are many observations that
we can take from this tale and apply to our current
situation.
For one thing, note that the inflation of money and credit
was able to continue for a long time after Rueffs initial
diagnosis that a crisis was brewing. Like any bubble, the
pin is hard to find. Though he could not point to when the
crisis would break, he thought that any number of events
could trigger it - a continued weakening of the balance of
payments deficit, some banking or financial incident, some
political event, a mere shift in opinion.
Any of these could effect the subservience of dollar
holders and induce them to request conversion of their
dollar holdings in whole or in part, even at the risk of
antagonizing the Washington authorities.
In the end, the math simply became too stark to ignore.
Regards,
Chris Mayer
for The Daily Reckoning