The Daily Reckoning Presents: A Bonnerian Final Reckoning of the 'Great Dollar Standard System'...

Nixon's The One!

August 31, 2003

This morning, we sat down in the Paradis for a cup of coffee. We had in front of us two books and two whores.

The Paradis is a local hangout, not only for your Daily Reckoning team, but also for a team of prostitutes who work the rue des Lombards. Looking at them, and looking at us, it is hard to tell which team is more broken down. Of course, it all depends on the context. In any other line of work, the whores would be delightful and attractive. In a crowd of grandmothers, they could be as fetching as the average. They seem like cheerful women...and ready to please; what more could you want?

In the running for the governor's office in California are two whores, too...that is, two women who perform indecent acts in front of the camera. One promised 'a date' to any contributor to her campaign fund who gave $5,000. Pressed for details, she maintained that the date didn't include anything dirty - which must make her the first and maybe only candidate in American history to publicly refuse to prostitute herself for the sake of public office.

We mention this only because it opens today's discussion; it allows readers to think we are writing about something interesting.

We are still talking about dirty deeds and family resemblances. Resemblances between the trade deficit and the mortgage refinancing boom...betwixt worldwide deflation and the rise of gold...between...between...well, the harder we look, the more resemblances we see. In today's world economy, we see brothers and sisters and cousins everywhere!

So far, we seem to have been the only ones to notice. But when we look at almost any chart, it is like looking at a family tree, with the same common ancestor. There he is...circa August 1971: Richard Nixon. Remember his campaign slogan: "Nixon's the one!"

In the 1968 election campaign, Nixon's opponents - or maybe it was Rolling Stone magazine - came out with a spoof, showing a pregnant welfare mother accusing: Nixon's the one!

History will show that Nixon was the one who cut the dollar loose from gold. A paternity test would show that he was also the one who loosed upon the financial world almost all its current discontents. Hardly a discontent appears anywhere in the world's financial press that can't be traced to Nixon's dirty deed.

But we have made this point before. We think we see Nixon's nose on every newborn crisis. We dust every crime scene for his fingerprints. We imagine we spot his jowly face in every line-up in the financial pages.

And so, we bore our friends and trouble our dear readers with ennui. "You're repeating yourself," they say. "You're becoming obsessed," they warn.

"So what?" they want to know.

But today, we elaborate anyway. For we think we have stumbled upon a dirty deed that explains nearly everything...and gives a hint of what comes next.

A chart of imports compared to exports, for example, shows steady progress in the '60s...but there, in 1972, comes an inflection point. All of a sudden, world trade explodes upward...with a growing gap between what America imports and what it exports.

A chart of the world's central bank reserves shows little growth before 1971. Then, in 1972 it lifts upward, slowly at first, but climbing steadily...and then really takes off in the mid-'90s.

Just look what happened in Japan. Gold had prevented trade balances from getting too far out of whack...because the gaps had to be filled with gold. But under Nixon's new system, the trade chasms could widen to grotesque proportions, for the limits had been removed. Japan was the first nation to take advantage of this opportunity. Lights went on in factories all over the nation. Around the clock they worked...producing for the American market. The money flowed into Japan's companies...and was then deposited in its central bank. And there it is on the chart...on page 123. Dollar reserves rose steadily in the '70s...and then exploded upward in the '80s. We know what else happened: the gush of new money sent Japanese stocks and real estate spurting to preposterous levels. Of course, then the bubble burst...and Japan has been trying to recover ever since.

I refer to the charts in Richard Duncan's book, The Dollar Crisis. There, on page 145, is his chart showing "the infamous twin deficits," the U.S. budget deficit and U.S. trade deficit. Again, both begin to lift off after Nixon unloads the gold ballast. The rise slowly at first...but then, in the early '80s, they begin to soar. The budget deficit shifts dramatically in the mid-'90s -- thanks to the tax revenue generated by the bubble economy. For a few years, the federal budget went into a surplus of sorts (ignoring the fact that federal debt actually increased in those years) and then, when the bubble burst, took flight again, reaching the highest levels in history.

And there's the surge in U.S. stock prices. It took a while to get underway; yet the Dow went over 1,000 in 1972...dropped back...and then began its rise to glory 3 years later.

On page 101, we find out what the Dollar Standard did to total credit-market debt in the U.S.. There again, we see the same pattern: gently rising indebtedness throughout the '70s and '80s, on a steeper and steeper slope. From 150% of GDP in 1971, the figure is now near 300%.

Of course, for every debit there is a credit. Who owns all this debt? To whom is it owed, in other words? We find the answer on page 96. It shows that the amount of U.S. credit market assets owned outside the U.S. has risen from about $300 billion in 1980 to more than $3.5 trillion in 2002.

Believe it or not, the U.S. was a net creditor until about the time Alan Greenspan became chairman of the Fed. But in the mid-'80s, it crossed the line that separates the slave from his master...and then sank to such a level of servility that it now faces net indebtedness of more than $2.5 trillion.

While the lines were all rising, central bankers, investors and consumers felt like rats that had fallen into a dumpster in a good neighbourhood. They gorged themselves on the leftovers. But now, they struggle to get out.

The whole world economy is stuck in a system that no longer works. It depends on the U.S. economy as its 'engine of growth'...and upon the U.S. consumer to push the pedal to the metal. If Americans do not continue to buy, the whole thing comes to a halt. But something is going wrong. American consumers still buy...but they are running out of money. Americans have begun to ache and strain under the burden of the $2.5 trillion net that they owe to foreigners. And if the 'engine of growth' is to keep running, Americans must add another $500 billion to its borrowings each year.

At the present rate, estimates the Levy Institute, the amount owed to foreigners will rise to $8 trillion by 2008, or 60% of GDP. Which shows why Nixon's Dollar Standard system is about to go bad. Every dollar the U.S. borrows from abroad adds to the amount it must borrow to service its borrowings. Even at 5% interest, the carrying cost of $8 trillion in debt is $400 billion per year. That is in addition to the $500 billion of trade deficit...and in addition to the anticipated federal deficit of $500 billion or so. The U.S. would soon be in the position of needing to import more capital than the entire world saves.

Something that cannot continue in the same direction must go in a different one. We're not sure how the Dollar Standard will end...nor what direction the new world financial system will take. But we know it won't be the same one.

Exactly where we are going, we don't know. But Richard Duncan describes what getting there is likely to be like:

"The U.S. economy has only just begun to enter the vicious downward spiral stage of this credit bubble cycle....It is only a matter of time before [consumers] are forced to rein in their consumption, pay down their debts and rebuild their savings. That...will drive the U.S. - and the world - much deeper into recession. Aggregate demand will contract, but industrial capacity will remain in place. Capacity utilization will fall further, providing a graphic illustration of the excess capacity, and corporation profitability will suffer as a result. One bad thing will lead to another in a negative mirror image of the virtuous upward spiral the economy enjoyed during the bubble years. Poor corporate profitability will result in higher unemployment, which in turn will cause a further reduction in consumption, still worse profitability, rising corporate bankruptcies, financial-sector distress, and credit contraction. Housing prices will deflate again once the aggressive credit expansion that fuelled their rise is cut off."

We sign off and pledge to change the subject.

P.P.S. If you would like to peruse Richard Duncan's excellent book, you can purchase it at Amazon.com... we cannot recommend it enough.

The Dollar Crisis
www.amazon.com/exec/obidos/ASIN/0470821027/dailyreckonin-20

Editor's Note: Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies, and the author of the free daily e-mail The Daily Reckoning (www.dailyreckoning.com). He is also the author, with Addison Wiggin, of "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons) due out in September.

China has only 2% of its Total Foreign Reserves in gold.