Global markets put in a mild week. The news of the week was gas prices. If you have not filled up lately, you’re in for a shocker. This week also saw the beginning of our fearless leaders already blaming those darn speculators for driving up the cost of black gold.
I am constantly reading commentary from other advisors throughout the world. The following commentary is from a colleague/friend of mine who is a Certified Financial Planner practitioner in Washington DC, and also received a college degree in History. In light of the recent oil price spike and election year politics, I thought it would be good to look at this from a historical perspective:
“Every time I hear a government official blame the speculators, I think of former President Nixon. Nixon had the unenviable task of going on television to inform Americans that we would be defaulting on our obligations. Yes, you read those words correctly. In 1971, Nixon closed what was known as the gold window. The gold window, very simply, was where foreign countries that held US dollars could trade those dollars for gold. The trade was $35 for an ounce of gold. The short history here was that after World War II, the global monetary system got a reboot. That reboot was called the Bretton Woods agreement, and Nixon had to tell the world we broke the agreement in spectacular fashion.
The Bretton Woods agreement backed the US dollar with gold at a rate of $35 for an ounce of gold. Then, all other currencies would peg or relate their value to the US dollar. This established the US dollar as the world’s reserve currency and as good as gold. Consider that to maintain a gold peg, the ratio of gold held by the US had to line up with the money supply. As an example, if there is 100 ounces of gold backing $3,500 US dollars (35:1 ratio), what should happen if the money supply grows to $7,000? The answer is that the price of gold should rise to $70 an ounce to be able to back the $7,000 in the money supply. History shows that starting in the 1960s the US expanded the money supply to pay for wars and deficits, but did not let the price of gold adjust up. The government held gold’s price down by leasing and outright selling gold into the global market place. At the outset of the Bretton Woods agreement, the US had about 22,000 tons of gold. Today, it is estimated that the US has about 8,000 tons of gold (if that). Where did the rest go? Much of it was sold to suppress the price of gold from rising until 1971. Keep in mind if gold would have been left to rise as the money supply grew, the public would have caught on to the declining value of the dollar.
In the mid to late 1960s, foreign governments realized that we had printed too much money. They also realized that the purchasing power of the dollars they held was being destroyed through over creation. Then, it hit that foreign governments could take the loads of US dollars they had and convert it into gold at a deep discount through the US gold window. Gold started to flood out of the US. This flood of gold leaving the US ended when Nixon closed the gold convertibility window. By closing the gold window, the US effectively defaulted (or reneged) on the agreement to back the dollar with gold. As well, foreign governments were now stuck with dollars that were being debased through excessive dollar creation.
Here is what Nixon told the nation:
“In the past seven years, there has been an average of one international monetary crisis every year. Now who gains from these crises? Not the working man; not the investor; not the real producers of wealth. The gainers are the international money speculators. Because they thrive on crises, they help to create them. In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the American dollar… Now, what is this action – which is very technical – what does it mean for you? Let me lay to rest the bugaboo of what is called devaluation. If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today. The effect of this action, in other words, will be to stabilize the dollar.”
Were evil speculators to blame for the loss of purchasing power of the dollar, or was it creating too much money and not holding up to the agreement made? Same question today – are the evil speculators driving up oil prices (and other commodity prices), or could it be that the massive surge in dollars, Euro, Yen and Francs around the world at work?”
Caution is still the name of the game.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.402.6099.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.