The Next Financial Crisis Began Long Ago

01. TLDR: 

Economic history can help you understand the next global currency crisis. Unfortunately, most people are not interested in economic history. And that includes economists. So here are the crucial events – as I see them – distilled into 33 factoids you can consume on the go. 


02. THE BEGINNING.

Our global monetary system was born on August 15th, 1971. US President Nixon went on television and ended gold’s official role in international finance. Nixon said he was protecting the dollar from foreign ‘money speculators’. This was not true. The real reason was that France and other nations wanted the gold owed to them after years of imbalanced trade.

03. Before 1971, western currencies operated under Bretton Woods rules. The US dollar was (and still is) the world’s reserve currency. This meant the US allowed foreign central banks to exchange their dollars for gold. At the time, the US imported more stuff from the rest of the world than it exported. To settle the difference, they sent gold abroad – mostly to Europe. This caused a decline in US gold reserves: from over 20,000 tonnes, to 8,133 tonnes.

04. Shrinking US gold reserves threatened the US standard of living. It also put the Bretton Woods currency system under pressure. The US wanted to keep their gold, and the exorbitant privilege of issuing the world’s reserve currency. So Nixon announced a ‘temporary’ end to gold convertibility. 47 years later, this temporary measure is still in place.

05. The Nixon shock created a new problem: why would foreigners want US dollars, if they couldn’t swap dollars for gold? To solve this problem Paul Volcker and Henry Kissinger devised the petrodollar system

06. Since the early 1970s, this system has created international demand for dollars by linking it to oil. Most nations buy large volumes of oil. The petrodollar means they must pay with dollars. To get dollars, foreigners must collectively send real goods and services to the US, and accept US paper in return . 


07. VOLCKER’S MONSTER.

Although ‘born’ in 1971, the US dollar Superbubble was conceived in 1969 by Paul Volcker – a young US Treasury employee at the time. Yanis Varoufakis calls this system the ‘Global Minotaur’. Here, he explains how Volcker designed a debt-fuelled global empire:

08. The petrodollar caused economic problems for Europe and Japan. First, they had to work to earn US IOUs that could be printed out of thin air. Second, they were forced to overpay for oil when the US raised the price by 400%. This price rise was intended to boost the US oil industry, reducing dependence on Middle Eastern supplies.

09. Wanting more balanced trade, European central bankers asked the US authorities to bring gold back into the system (at a much higher price). Henry Kissinger said no: gold had to be kept out of the way for the US dollar to dominate. 

10. Behind closed doors, some European central bank governors began work on the euro: a currency designed to help Europe to escape the dollar. They made their plans in private at the Bank for International Settlements (BIS). The BIS might be the most powerful institution you have never heard of. 

11. Although European central banks wanted out of the dollar system, there was no other currency big enough for international trade. The euro took decades to create, so the dollar system had to be supported. The world continued to stockpile US paper, and the Superbubble grew to absurd levels.

12. Karl Blessing was president of the Deutsche Bundesbank from 1958 to 1969. In 1967 he wrote to the US Treasury. This letter indicates that Germany ‘bought’ US military protection through the Cold War, by supporting the dollar system.


13. SOLE SUPERPOWER.

In 1989 the Soviet Union collapsed and the US became the world’s only superpower. Without an obvious enemy, new storylines and unifying threats were needed. Zbigniew Brzezinski had previously been a US National Security Adviser. In 1997, he told of new strategies and imperatives for US adventures across Eurasia.

14. Globalization accelerated through the 1990s, giving millions of workers capital, technology and access to new markets. Mexico, China, and other emerging nations could now compete for US dollars.

15. Outsourcing US manufacturing created huge profits at home and abroad. Foreign profits were recycled back to the US financial system. This tsunami of credit hid the destruction of manufacturing in the US, UK, and other deficit economies. Few noticed that the America Dream was dying.

16. In 1999 the euro was launched. The ECB balance sheet quietly signaled that gold – not US paper – was their preferred reserve asset. Europe had stopped funding US deficits. 

17. After Europe discontinued dollar support, China was quickly brought into the WTO. Globalization accelerated again, as their manufacturers sent vast amounts of stuff to US consumers. The profits were loaned back to the US, when their central banks spent trillions on US Treasury securities. This funded US deficits and bought the dollar system a few more years.


18. THE WAR ON CHEAP OIL.

(This section is speculative. The aim is not to persuade you of anything, but to clarify an explanation for the waves of violence that killed millions across the Middle East in recent years. You decide if it is useful or relevant.)

Since 2003, US military action across the Middle East has looked increasingly incomprehensible and disorganized. $6 trillion was spent fighting for abstract concepts and unclear aims. You can remember WMDs. And nation building. And revenge for 9/11. And getting rid of the evil dictator. And the other evil dictator. And the other one et cetera. 

19. Now, the most common explanation we hear is that ‘mistakes were made’. More plausibly, Luke Gromen has defined the ‘State Dept Oil Market‘: military action to control the flow and pricing of oil. 

20. Previous US administrations maintained a ‘strong dollar policy’. Cheap oil undermines that policy. A strong dollar requires higher oil prices to:
• maintain international demand for US dollars, and;
• to keep US shale competitive against lower cost producers.

21. In the late 1990s, a threat to the petrodollar system was noticed: the realization that much more oil lay under the Middle East than previously thought. That meant oil was about to become cheap.

22. Geopolitical risk premiums are oil-price rises due to unplanned outages. Terrorism, sabotage, and war often halt production. These events increased exponentially after 1999 and correlate with a pretty dodgy War on Terror.

23. Successive US administrations had reasons to stop Iraqi oil getting to market. Victor points out that whenever Iraq’s oil production reached certain levels, war or sanctions swiftly took them offline. Saddam created more problems for himself when he tried to bypass the dollar, to sell oil for euros

24. 9/11 and WMDs were pretexts for the 2003 invasion of Iraq. Whatever the true aims of the war, Iraq’s oil infrastructure was destroyed. This ensured their oil stayed in the ground. 

25. Other nations with large oil reserves also had problems. US-sponsored sanctions disrupted supplies of Russian, Venezuelan and Iranian oil. After Iraq was flattened. Libya, Syria, Nigeria, and others were beset by lunatics (some religious). These terrorists almost always destroyed local oil infrastructure.

26. Whatever the truth, lets hope radical Islamic terror vanishes as suddenly as it appeared.


27. THE SUPERBUBBLE EXPANDS.

With the dollar/oil link intact, the US dollar Superbubble could expand and expand. In the early 2000s, the glut of money meant it was very easy to borrow. Many Americans took mortgages they couldn’t afford and bought overpriced houses.

28. Wall Street bundled these mortgages into incomprehensible financial products and sold them to the world. This triggered the 2008 financial crisis. In response to the crisis the US government created trillions of dollars to save financial institutions. Many of these institutions had commited massive fraud. 

29. The US authorities’ failure to properly manage the world’s reserve currency was becoming obvious. This put pressure on foriegn central banks to find ways out of the Superbubble.

30. Previous US administrations used their enormous political, military and financial power to support dollar overvaluation. However, this destructive currency system began to affect the US in ways that were hard to ignore. Americans were angry at the decline in their living standards, real wages and life-expectancy. So they ‘shook the box’ and made the King of Debt their President.


31. DE-DOLLARIZATION ACCELERATES.

Team Trump has hinted it is ready to devalue the US dollar, and give up world reserve currency status. A sudden devaluation would cut US debt, and make their industry more competitive. Trump has also given contradictory signs about wanting to strengthen his ‘cherished dollar’. Whatever he says, it looks like we are approaching a breakdown in the global currency system – a crisis bigger than 2008.

32. The world looks particularly chaotic right now. At the core of the conflict and turmoil is an escalating fight over the world’s monetary future. The actions of major central banks suggest a choice has been made: we are deep into the process of replacing the US dollar with something yellow, shiny and useless.

33. The transition to a new global currency system could be a very rough ride. However, I am optimistic that a more peaceful world will emerge, if, and when physical gold replaces US-issued IOUs as the world’s reserve asset. This blog will test the truth of that idea as events unfold.

Have I omitted something crucial? Comments welcome.

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Jackie Stack

Very interesting discussion. As a relative novice to these subjects I am struck by how little they are aired in the media. When reading some fairly recent literature on Bretton Woods, was equally struck by how little was generally known about these pivotal discussions against the background of world War11 and the Cold War; Probably not much aired in the Press then either.

Simon Vrantsis

Hi. Great concise breakdown of the chronology. The only point I would make is with regard to point 10- you give the impression that the euro and BIS are somehow in opposition to the US dollar and the FED. The project for the euro and a ‘United States of Europe’ was in fact first funded by the US in the aftermath of WW2, and many of the key individuals were working on the payroll of the CIA. Also, the BIS is not only the institution that sits above the central banks of European nations, but also the FED reserve banks… Read more »