Businessweek on Nixon's dollar shock.

At Bloomberg Businessweek, Roger Lowenstein provides an excellent – and surprising, coming from the mainstream media – report on the breakdown of the Bretton-Woods gold-linked dollar, including laying blame on monetarists Milton Friedman and George Shultz, and linking today's economic problems to the floating dollar.

From his 1999 Nobel Prize lecture, Robert Mundell explains the circumstances that led to the demise of Bretton-Woods and the Great Inflation of the 1970s:

The adoption of my policy mix [by JFK after 1962] helped the United States to achieve rapid growth with stability. It was not intended to and could not solve the basic problem of the international monetary system, which stemmed from the undervaluation of gold. Nevertheless the problem of the U.S. balance- of- payments was intricately tied up with the problem of the system. With very little excess gold coming into the stocks of central banks from the private market, and the US dollar the only alternative component of reserves, the U.S. deficit was the principal means by which the rest of the world was supplied with additional reserves. If the United States failed to correct its balance of payments deficit, it would no longer be able to maintain gold convertibility; on the other hand, if it corrected its deficit, the rest of the world would run short of reserves and bring on slower growth or, worse, deflation. The last scenario hinted at a repetition of the problem of the interwar period.

Two basic solutions were consistent with preserving the system. One solution was to raise the price of gold. The founding fathers of the IMF had put a provision in the IMF Articles of Agreement for dealing with a gold scarcity or surplus: a change in the par values of all currencies, which would have changed the price of gold in terms of all currencies and left exchange rates unchanged. In the 1968 election campaign, candidate Richard M. Nixon chose Arthur Burns as his emissary on a secret mission to sound out European opinion on an increase in the price of gold. It turned out to be favorable and Burns recommended prompt action immediately after the election. Nothing, however, came of it.

The other option was to create a substitute for gold. This course was in fact adopted. In the late summer of 1967, international agreement was reached on an amendment to the IMF articles to allow the creation of Special Drawing Rights (SDRs), gold-guaranteed bookkeeping reserves made available through the IMF, with a unit value equal to one gold dollar, or 1/35 of an ounce. Somewhat less than SDR 10 billion were allocated to member countries in 1970, 1971 and 1972, but they proved to be inadequate—too little and too late--to meet the main problems of the system.

On August 15, 1971, confronted by requests for conversion of dollars into gold by the United Kingdom and other countries, President Nixon took the dollar off gold, closing the "gold window" at which dollars were exchanged for gold with foreign central banks. The other countries now took their currencies off the dollar and a period of floating began.

But floating made the embryonic plans just forming for European monetary integration more difficult, and in December 1971, at a meeting at the Smithsonian Institution in Washington, D. C., finance ministers agreed on a restoration of the fixed exchange rate system without gold convertibility. A few exchange rates were changed and the official dollar price of gold was raised but the act was almost purely nominal since the United States was no longer committed to buying or selling gold.

The world thus moved onto a pure dollar standard, in which the major countries fixed their currencies to the dollar without a reciprocal obligation with respect to gold convertibility on the part of the United States. But U.S. monetary policy was too expansionary in the following years and, after another ineffective devaluation of the dollar, the system was allowed to break up into generalized floating in the spring of 1973. Thus ended the dollar standard….

With the breakdown of the system, money supplies became more elastic, accommodating not only inflationary wage developments but also the monopolistic pricing of internationally traded commodities. Each time the price of oil was raised in the 1970's, the Eurodollar market expanded to finance the deficits of oil-importing countries; from deposits of $223 billion 1971 they would explode to $2,351 billion in 1982(International Monetary Fund, IMF International Statistic Yearbook, 1988 p. 68).

Inflation in the United States had now become a major problem. It had taken twenty years, from 1952 to 1971, for U.S. wholesale prices to rise by less than 30 percent. But after 1971, it took only eleven years for U.S. prices to rise by 157 percent! This mainly peacetime inflation was greater than the war-related inflations from World War II (108 percent over 1939-48), World War I (121 percent over 1913-1920), the Civil War (118 percent over 1861-1864) or the War of 1812 (44 percent over 1811-1814). The greatest inflation in U.S. history since the War of Independence took place after the United States left gold in the decade after 1971.

Monday round up.

On The Daily Reckoning, Nathan Lewis notes that wheat is cheap in real terms but expensive due to the low dollar.

At New World Economics, Lewis explains the British gold standard from 1778-1844.

On the Kudlow Report, Stephen Moore debates the President’s plan for big new spending:



In Forbes, John Tamny relieves Nixon Fed Chairman Arthur Burns of responsibility for that era’s dollar devaluation.

On Bloomberg, Kevin Hassett suggests a shift to a consumption-based tax system.

The NY Sun editorializes that if President Obama wants to imitate JFK, he should eschew targeted tax breaks in favor of lower tax rates:



In The Houston Chronicle, Houston branch Federal Reserve Bank Paul Hobby opposes efforts to investigate the Fed saying, “No one who studies the global economic issues today would forfeit this nation's ability to conduct monetary policy through a central bank.”

At The Washington Examiner, Robert Patterson (a friend) cites former Kemp-staffer John Mueller’s argument that lower birth rates have damaged the economy.

Tuesday summary.

On NRO, Larry Kudlow explains that continued volatility between the dollar and euro is damaging the world economy.

At Forbes, Brian Domitrovic recounts how Sen. George Mitchell derailed George H.W. Bush’s drive for a capital gains tax cut in favor of higher taxes, dooming Bush’s presidency.

On The Kudlow Report, Heritage’s Curtis Dubay debates tax rates:




In The WSJ, Seth Lipsky reviews Nixon Fed chairman Arthur Burns’ diary.

At Alhambra Investments, Joseph Calhoun expresses cautious optimism on the economy.

Also on Kudlow, Brian Wesbury discusses the stock market’s weakness:




In Forbes, Wesbury and Robert Stein see the economy improving.

On NRO, Reihan Salam explains the negative budget impact of raising upper income tax rates.

NRO’s editors cite Art Laffer in opposing Sen. McCaskill’s (MO) millionaire tax rate increase.

The economic facts are a good deal more complicated. As the always-sensible Reihan Salam reports in the current edition of National Review, economists expect that raising taxes at the top end would reduce economic growth significantly. Democrats will call that a Republican talking point, but it is consistent with the findings of the nonpartisan Congressional Budget Office, currently under the management of Douglas Elmendorf, a Democratic appointee. The CBO numbers suggest that a partial preservation of the Bush tax rates — meaning a compromise that raises taxes on “the rich,” in this instance defined as those earning $250,000 or more — would reduce real GNP by 1.2 percent, as lower revenue necessitates more government borrowing, slowing down long-term economic growth. But an across-the-board extension would reduce real GNP by only 0.6 percent, cutting the economic losses in half. Another way of saying that is that the growth effects of extending the tax cuts at the affluent end of the scale would make up half of the forgone real GNP associated with the tax cuts. That isn’t Arthur Laffer’s analysis, it’s the Democratic-led CBO’s.

From the Mises Institute, Frank Shostak rebuts Nouriel Roubini on the gold standard. (Hat tip: Ralph Benko.)

At Capital Gains and Games, Bruce Bartlett continues to drift from classical economics by endorsing floating currencies.