Explosions in the cost of living used to take decades – even centuries – not mere years...
WHAT TO DO when you fear that a rising cost of living is about to destroy your savings and income?
"People rightly buy gold when they see inflation ahead," said William Rees-Mogg at a private seminar held in the City of London last Thursday evening.
Former editor-in-chief of The Times of London...a member of the House of Lords...and an advisor to Margaret Thatcher's administration in the early '80s...he also warned that "I believe today inflation should cause us to be very anxious once again."
Roll back for a moment...back to the last time inflation gave the world's home-owning democracies their No.1 cause for concern. William Rees-Mogg's point is well made. By 1979, in fact, inflation was hurting every last country for which we have data.
In the United States, growth in the cost of living hit 12.8% annually; in Israel it hit 132%; globally, said the International Monetary Fund, the cost of living increased by 15.6% inside 12 months.
Put that statistic another way, and you can see how the value of money worldwide dropped one-sixth of its spending power in the last year of the '70s – an unprecedented attack upon private wealth and savings.
"In the price-revolution of the twentieth century," writes David Hackett Fischer in his sweeping study of historic inflations, The Great Wave, "more than half of the total increase in prices from 1896 to 1996 happened after 1970. Nine-tenths of it came after 1945."
Previous explosions in the cost of living had taken decades...even centuries...to unfold. But the '70s bubble in guns and butter put the pedal to the metal. Inflation kicked through the gears and raced ahead as never before in history.
The economic response, however, was more familiar.
"Wages, which had at first kept up with prices, now lagged behind," says Hackett Fischer. "Returns to labor declined while returns to land and capital increased...[and] interest rates were driven up."
This same pattern – of rising returns to capital vs. falling returns to labor – was seen in the great medieval inflation of 13th century Europe; again in the global price revolution of the 16th century; and also in the 18th century inflation that preceded the revolutions in North America and France.
You might just happen to think we've witnessed similar trends during the last 5 years, too. For despite living through what central bankers laughingly call 'The Great Moderation', all the evidence points to a surge in the cost of living. All the evidence except the inflation data, that is.
Real wages have failed to keep pace with energy and food costs. Wealth inequality has yawned ever wider, creating billionaire speculators in Manhattan and London even as middle-income families have been priced out of buying modest properties by a bubble in real estate from Florida to Bulgaria...Thailand to Spain.
But the 20th century inflation that may – or may not – have peaked out at the close of the 1970s also saw one big difference; for while interest rates rose in response to higher inflation, they didn't rise fast enough. Holding cash regularly destroyed wealth during the '70s; real interest rates paid less than zero in 41 of the 48 months between 1974 and 1978.
What had changed? In two words, central banking.
Before World War II, gold was a key part of the global monetary system. It put a cap on money-supply growth, by limiting fresh credit creation to government stores of bullion. After the Bretton Woods agreement of 1946, however, the world's currency system was tied to the value of the US Dollar instead.
Yes, the Dollar continued to be backed by gold, in principle at least – and by extension, that kept a cap on global credit creation. But by 1971, the United States government was printing so many paper Dollars to fund its policy of "guns and butter", Richard Nixon felt compelled to severe this final link too. Gold floated free of the Dollar, Washington's debts shrank in real terms, and governments everywhere were set loose to print as much money as they chose.
Now there was no gold backing each Dollar, Peso or Pound. The metal was no longer related to money, let alone being money itself. De-monetized, gold became an irrelevance – or so the world's financial leaders hoped.
Is this why the 20th century Price Revolution also displayed another big difference compared to its precedents? Over the six decades to 1980, the real value of gold actually rose. This hadn't happened in three centuries of British data, according to Professor Roy Jastram of the University of California at Berkeley. Previously, it had always failed to keep up.
In the United States, said Jastram's research, the purchasing power of gold fell by more than one-fifth on average during the inflations he studied from 1808 onwards. Only the final period in Jastram's study – beginning in 1951 – saw the metal gain value. It continued to gain purchasing power right up to that famous top above $850 at the start of 1980.
Meantime, those negative rates of real interest paid on the US Dollar might have been saving Washington a few bucks on its interest repayments. But they were slowly destroying confidence in the world's primary unit of account, too.
What to do, wondered the Feds. The International Monetary Fund (IMF) – effectively controlled by Washington's casting vote – had tried but failed to speed gold on its way into the dustbin of history. Between 1976 and 1980, the IMF sold one-third of its bullion holdings, some 1,555 tonnes of gold, following an agreement to reduce gold's role in the global monetary system still further.
But the price of gold rose regardless. It rose nearly six-fold. And all this time, the value of money – freed from all gold backing and all golden constraints – evaporated in the heat of the fastest global inflation in history.
What if people caught onto the link? What if gold was rising because government-approved money was being destroyed? What if the Dollar, now the world's primary unit of account, was about to lose out to gold...the "barbarous relic" it was supposed to have replaced back in 1946...?
The United States had suffered a similar crisis of confidence in 1933. Washington then opted to force US citizens to accept paper Dollars with the threat of $10,000 fines or imprisonment if they were found hoarding or trading gold. Now, once again, gold threatened the dominance of the almighty US Dollar. In late 1979, at one of the policy meetings led by Paul Volcker, the Federal Reserve committee noted the threat of "speculative activity" in the gold market. It was spilling over into other commodity prices. One official at the US Treasury called the gold rush "a symptom of growing concern about world-wide inflation."
"We had to deal with inflation," as Volcker said in a PBS interview of Sept. 2000. "There was a kind of great speculative pressure.
"It was the years when everybody wanted to buy collectibles from New York. The market was booming, and other markets of real things were booming – because people had got the feeling that things were inflating and there was no way you could stop it."
Besides waving a gun at anxious gold owners, there seemed only one other route to stopping speculators profiting from – or rather, defending themselves against – the demise of the Dollar.
Fix it up with higher interest rates.
Volcker chose this path. He took US rates to 19%. Real US interest rates shot above 9% per year. That stopped the great gold speculation dead in its tracks. It also destroyed long-dated bond prices, but no one wanted long-dated bonds anyway. US Treasury bills were mocked as "certificates of confiscation"! Raising the yield paid by new bond issues meant the US government could at last go the bond market for fresh finance once again.
The Fed kept US interest rates at double-digits until Sept. 1982. Inflation began to sink. Gold stabilized around $400 per ounce. As Volcker's medicine worked its way through the economy – and inflation continued to slow – gold tipped lower again. During Volcker's reign at the Fed, real US interest rates averaged 4.40%. Gold just couldn't compete. It pays you nothing, remember.
But now today, the US Federal Reserve, the Bank of England, ECB in Frankfurt and the Bank of Japan are only too willing to pay you less than zero on your cash savings yet again. Shoring up the Dollar with higher interest rates would put it way out of step with Sterling, Euros, Swiss Francs and – most especially – the Japanese Yen. To stay competitive in today's world of thoroughly globalized trading markets, the Chinese and south-east Asian governments are also racing to devalue their currencies, too. The prize is export dominance; the cost, for now at least, is to push fresh "safe haven" investors into gold once more.
There's nothing to celebrate here, of course. The grinding destruction of global monetary values can only end badly.
Gold may simply allow a handful of anxious investors their chance to preserve a little wealth through the turmoil, ready to buy productive assets at rock-bottom prices in the aftermath.