The October 1987 New York stock market crisis and the 2008 financial meltdown were controlled as fast as they came. That was in sharp contrast to the 1929-30 depressions that threw the world markets first into convulsions and then into a prolonged state of agony. The keyword separating the two sets of — pre and post World War II — financial crises was “liquidity.” The abolition of fractional reserve system in 1971 facilitated the US central bank to expand money supply at will to manage the 1987 and 2008 crises. This was not the situation when the Great Depression unfolded in 1929. The limited money supply limited the role of the central bank which was widely criticized later for its failure to manage the crisis.
The debate regarding a gold-backed dollar vis-a-vis a totally free dollar is still on and the arguments for and against a free dollar keep on baffling the audience. A free dollar is as much prone to economic bubbles as it is capable of managing their aftereffects. After the abolition of dollar convertibility, the incidence of economic crises has become high. Every new economic bubble gives rise to newly printed money under such economic pretexts as “quantitative easing.” This new money in turn gets quadrupled or so with the help of the banking credit system. That is not the end of the story. The mounting foreign reserves of exporting countries and the expansion in privately-owned wealth create such formidable monsters as hedge and sovereign funds. These funds enter and leave the global financial markets to create economic volatility. Prices of goods and services keep rising interminably. The masses and the middle classes are the ultimate sufferers as the new money makes it way into the tills of the already rich. This keeps persistently reducing the purchasing power of the dollar of those at the lower rungs of the income ladder.
The unprecedented money expansion has suddenly changed the 20th century “billions, world” into a 21st century “trillions, world”. We now talk less of billions and more of trillions. The systemic risk has gone up by three zeros within the short period of a few decades. An excerpt from the Robert Jenkins, May 2014 speech is reproduced: Let us take a step back. Our global financial system is big, complex and accident prone. That it is big is beyond doubt. You will know the numbers. China’s reserves exceed $3.6 trillion; the Fed’s balance sheet $4 trillion; daily FX turnover $5 trillion; Federal debt outstanding $17 trillion; globally managed assets $80 trillion; and the downturn notwithstanding, the notional value of global derivatives has risen to $700 trillion. The interesting thing about big numbers is that even a small percentage of a big number is still a big number. Thus a 10% change in China’s holdings generates $360 billion of sales and another $360 billion of purchases. A 5% rise in US interest rates will add (over time) $850 billion to the US budget deficit annually. A 3% shift in global asset preferences triggers more than $4 trillion in securities transactions. And a mere 1% of derivative contracts gone wrong could cause some $7 trillion in losses. Yes the numbers are big.
How violently the prices have gone up after the abolition of fractional reserve system by the US in 1971, can be seen in the price movement of gold itself. Gold spiked from $35 an ounce in 1971 to $1900 an ounce before dropping to the current level of less than $1200 an ounce. Such an erratic pattern of market behavior in a short period of 43 years spells more disaster for the already disrupted world, in the years to follow. The US has been the epicenter of the global financial tornadoes. Both, financial crises and new money are created there. The industrial-turned-consumer economy sends the shock waves to other parts of the world by grabbing a chunk of global consumer goods in exchange for its zero-cost dollars. China, holding as little as $100 billion in reserves in 1996, now finds itself seized with the responsibility of having to manage a mountain of reserves valued at $4 trillion. With the oversized stock of reserves, Chinese often falter into the wrong zones of investment. Recently, they have been found guilty of making unsound investments to the tune of dollar six to seven trillion.
How to handle the prospects of a bigger, impending crisis? By going back to the pre-World War I, gold standard when the price stability used to be the norm, or to a more complex, US-dictated New Gold Order? James Rickards, while drawing a parallel to the 1971 Nixon shock, writes in the preface to his book Currency Wars: The new crisis will begin in the currency markets and spread quickly to stocks, bonds and commodities. When the dollar collapses, the dollar-denominated markets will collapse too. Panic will quickly spread throughout the world.
As a result, another US president, possibly president Obama, will take to the airwaves and cyberspace to announce a radical plan of intervention to save the dollar from complete collapse, invoking legal authority already in place today. The new plan may even involve a return to the gold standard. If gold is used, it will be at a dramatically high price in order to support the bloated money supply with the fixed quantity of gold available. Americans who had invested in gold earlier will be confronted with a 90 percent “windfall profits” tax on their newfound wealth, imposed in the name of fairness. European and Japanese gold presently stored in New York will be confiscated and converted to use in the service of the New Dollar Policy. No doubt the Europeans and Japanese will be given receipts for their former gold, convertible into New Dollars at a new, higher price. James Rickard, in the New Dollar scenario, has endeavored to calculate new gold prices that will range from $2,590 an ounce in case of 40% gold backing of US M1 money supply, to $44,552 an ounce in case of 100% gold backing of the US, China, ECB M2 money supply.
It is worth trying to calculate the value of a unit of ordinary bread in the backdrop of gold selling at $44,552 an ounce.