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.
Rueff first began to voice his concerns in 1961, alerting the world to the dangers inherent in the world's monetary system, then operating under the Bretton Woods agreement. It would take ten years before Rueff's 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 world's 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 Rueff's 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 man's 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 Rueff's 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 snail's 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 Rueff's 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 Rueff's 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.
for The Daily Reckoning
27 July 2004
Editor's Note: Christopher W. Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Christopher's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is also the author of "Capital and Crisis," a recently launched investment advisory for contrarian-minded financial observers. For details, see:
Capital and Crisis