Paying For War

Ending the Gold Standard

Ending the Gold Standard: Paying for War
by Bill Bonner
The Daily Reckoning
London, England
Wednesday, November 30, 2005

Bill Bonner discusses the effects of World War I on the world economy, specifically what it did towards Ending the Gold Standard in Europe.

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Sure, Wall Street offers a service: separating people from their money…such an attractive bamboozle!
Uncle Sam…from modest meat packer…to symbol of an empire in the throes of a decline?
This half-told story of the U.S. economy…Goldman’s peak…George Romero’s new movie…and more!

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If you like The Daily Reckoning, you'll love Empire of Debt. Same sardonic wit...same critical insight...same great authors...all wrapped up in an entertaining read that only a full-length book can bring you. Now at a bookstore near you!

Empire of Debt - In stores today!

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We continue to read the story of the U.S. economy as a tale that is only half told. We see it as if a man had put a bullet in the firing chamber without pulling the trigger. It is like a sunrise without a sunset…a yin without a yang...a shilly without a shally...a drunk without a hangover…a boom without a bust.

In short, it is either unnatural…or incomplete. We lean towards “incomplete” as an explanation.

Bonuses at Goldman are said to total $40 million this year.

“In every war the victors get the spoils,” writes Paul Farrell. “Same here, as Wall Street doles out more than $20 billion in bonus money to its army. Huge bonuses: $105,000 to first-year associates right out of business school. Imagine some 25-year-old with an MBA gets a bonus three times bigger than the average American's income.”

“Worse yet, Wall Street's top generals get one-time bonuses bigger than most Americans make in their lifetime, $6 million or more from the Wall Street Greed Machine. How do they justify those huge bonuses? By being greedy all year long, playing with your money while secretly siphoning big bucks off the top.

“Look at Wall Street's rotten performance since the 2000 crash. Wall Street's a big loser. Seriously, have you checked the Wilshire 5000 or the S&P 500 indexes lately? Both are in negative territory, below where they were five years ago.”

Farrell is indignant. He needs to step back, take a deep breath and smile. Wall Street is a business, just like any other. It offers a service: separating people from their money. This year it has done a good job of it. Why shouldn’t it celebrate?

Wall Street offers to help people make money without working. It is such an attractive bamboozle, few people can resist. Google at $400? Gimme some right away…before it goes to $500!

We take the bonuses on Wall Street, and high salaries throughout corporate America (G.M. may have cut 30,000 employees, but it still spreads good cheer through the ranks of top management), as more evidence that we have reached a late, degenerate stage of our imperial economy. The sun has not set yet, but the decaying serenity of late afternoon hangs in the air, like the perfume of an old woman. The companies that make the most money are those that shuffle money - not those that make things people want to buy. And throughout the entire society, everyone participates in what has become an orgy of swindle and delusion. Consumers earn less and less each year (for the last two years), but they spend more anyway. We read estimates this morning that next year will be no different. Average wages are expected to rise 3.5%. But after increases in energy and health care, the typical wage earner is likely to have less money in his pocket in 2006 than he did in 2005, or 2004, or 2003.

In the third quarter of ’05 alone, Paul Kasriel of Northern Trust reports, U.S. households spent $531 billion more than their after-tax earnings. About half of that money came from “equity extraction.” Consumer spending has risen to 76% of the economy; before 2000, it was only two-thirds.

Bankers are eager to lend the money. They get a friendly appraiser to over-value their houses, and then slip the loans into a package to be sold off to investors (let them take the losses!). And foreigners continue to lend to America; the country may be a mess - they figure - but not as big a mess as their own countries.

The U.S. government jiggles and jives the figures so no one knows what is really going on. The last 12 months have seen a spike up in residential real estate prices - a 17% increase, the biggest increase in many, many years. That, combined with soaring costs for energy, property taxes, insurance and upkeep, has greatly increased the cost of shelter to the average family. Still, the government’s statistical hacks conveniently figure that the cost of housing rose only 2.3%. Likewise, they come up with a cost of living figure only 3% higher than the year before, despite the fact that the typical family is spending far more than that just to stay even.

The poor householders don’t have a clue. They think they really can get rich by buying and selling each other’s houses, or by putting their money with Wall Street. They really believe you can have a yin without a yang, and that after the sun rises, it stays up forever.

We shall see…

More news from our team at The Rude Awakening…

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Dan Ferris, reporting from Wall Street:

“‘Every 7 seconds another boomer turns 50,’ BullMarket.com reports. As the largest consumer-spending group - $900 billion a year - boomers will control the vast majority of the nation's wealth within the next 20 years.”

To learn more about the boomers, check out today’s Rude Awakening:

Golden Nematodes and "Active Adults"

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Bill Bonner, back in London with more reflections and cogitations…

*** Talk about the Great Moderation! Stocks barely moved yesterday. The dollar, too. Gold stuck at nearly $500.

*** And what’s this? Goldman’s peak must be coming soon. Today’s news tells us that the money shufflers are building a new headquarters in Manhattan, at a cost of $2.4 billion. One of two things usually marks the top for major companies: either they get onto the cover of a magazine, or they build a flashy new headquarters.

*** George Romero’s new movie, Land of the Dead, is a masterpiece of social and political satire. He has the audience rooting for the zombies!

Corpses get no respect in America, unless they are in uniform. In Romero’s film, the walking dead are used for target practice. Plus, they provide vulgar entertainment for the proletarian masses in staged “ultimate combat” fights to the death. Bourgeois ladies have their photos taken next to chained up zombies...as if they were prison guards at Abu Ghraib. But then, a spark of political consciousness strikes. The zombies become in a whole new underclass of victims. All of a sudden, the dead become aware of their own exploitation. Revolution is in the air!

Meanwhile back in Fiddler’s Green, a gated community that looks out for all the world like modern America, a member of the ruling classes explains how they keep “the people” happy: “I kept the people off the streets by giving them games and vices.”

Bread and circuses. It worked for Rome. It works for America.

But you just can’t keep a dead man down. In modern America, it is the wisdom of the dead that menaces the consumer society. In “The Land of the Dead,” the zombies revolt; they march on Fiddler’s Green and eat the consumers themselves.

*** And, this from Addison:

We discovered yesterday that there is no copyright on the image of Uncle Sam used by Army recruiters in World War I (which can be seen here: Uncle Sam Wants YOU! )

Since that time, Uncle Sam has, “become the most widely recognizable symbol of the United States,” according to the Library of Congress Web site. It goes on to say:

“Originally published as the cover for the July 6, 1916, issue of Leslie's Weekly with the title ‘What Are You Doing for Preparedness?’ this portrait of ‘Uncle Sam’ went on to become--according to its creator, James Montgomery Flagg – ‘the most famous poster in the world.’ Over four million copies were printed between 1917 and 1918, as the United States entered World War I and began sending troops and matériel into war zones.

“Flagg (1877-1960) contributed forty-six works to support the war effort. He was a member of the first Civilian Preparedness Committee organized in New York in 1917 and chaired by Grosvenor Clarkson. He also served as a member of Charles Dana Gibson's Committee of Pictorial Publicity, which was organized under the federal government's Committee on Public Information, headed by George Creel.

“Because of its overwhelming popularity, the image was later adapted for use in World War II. Upon presenting President Franklin Delano Roosevelt a copy of the poster, Flagg remarked that he had been his own model for Uncle Sam to save the modeling fee.

“Uncle Sam is one of the most popular personifications of the United States. However, the term ‘Uncle Sam’ is of somewhat obscure derivation. Historical sources attribute the name to a meat packer who supplied meat to the army during the War of 1812 - Samuel (Uncle Sam) Wilson (1766-1854). ‘Uncle Sam’ Wilson was a man of great fairness, reliability, and honesty, who was devoted to his country - qualities now associated with "our" Uncle Sam. James Montgomery Flagg (1877-1960).

“With the storm of war brewing behind her, a personification of America sleeps. She wears a Phrygian cap, a symbol of liberty since Roman times. This poster tells all of America to wake up and do their part for the war effort.”

As you may have noticed, we thought it fitting that the image coincided roughly with America’s “Will to Empire” and brazenly applied it to our own promotional campaign for Empire of Debt.

No Really, Uncle Sam WANTS Your Money! (heh, heh)

For more on the lasting influence of the Uncle Sam “War Bond” poster on the American character, see Bill’s essay below.

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The Daily Reckoning PRESENTS: There was a time when “conservative” meant you were a stodgy old curmudgeon; an isolationist, closed to new ideas. Now, the conservatives are leading the charge – promising to make the entire world “safe for democracy”! Never has such a bold plan been put into action – that is, not since the “liberal” populist Woodrow Wilson coined the phrase nearly a century ago. How could such a shift in the politics and economy of the United States have come about? Read on…

PAYING FOR WAR
by Bill Bonner

Nothing softens money up as fast as war. The shells pound it. The bullets puncture it. Armies march on it. And politicians and central bankers stretch it out to the point that it inevitably breaks.

In July 1914, all the major belligerents were on the gold standard - along with 44 other countries. The system was simple and effective. It had fostered an international financial climate so conducive to the growth of capital and trade that most of the West had never been more prosperous.

Central banks of the various nations held gold in their coffers. The gold was used to back up the paper currencies. If a nation spent too much on external products, its currency flowed to foreign countries. It came back in payment for either goods or services supplied by the home country. In the event of an imbalance, that is to say when a foreign nation found itself with more of the nation’s currency than it could spend on goods and services from that nation, the resulting surplus currency was presented to the central bank to be replaced by gold. Every nation’s imbalances were settled in the one thing that none of them could print or counterfeit: gold. If a nation ran a persistent trade deficit, it would find its gold pulled away.

This would encourage the central bank to do something to protect it. Usually, interest rates rose, which had the effect of rewarding savings and discouraging the outflow of funds.

Ending the Gold Standard: Ill-Suited to the Needs of War

The system was neat. It was honest. Which made it ill-suited to the needs of war and empire-builders. War, particularly, was distressingly expensive. Politicians noticed—as monarchs had long ago - that people might be enthralled by the cannon f ire, but they hated to pay for it. Typically, according to R. S. Hamilton-Grace, who studied English war financing, about a third of the cost of war had to be covered by borrowing. Gold was famously uncooperative. It yielded neither to flattery nor to technology. You couldn’t pretend it was worth more than it was. And you couldn’t create more “out of thin air.”

Each ounce needed to be dug up out of the earth - at considerable expense. Increasing the money supply - no matter how glorious or worthwhile the cause - was a difficult thing to do. Central banks had only so much gold. If they wanted more, it had to come from somewhere. It had to be saved, put away, stored. The old expression, “you can’t get something for nothing,” seemed to have been coined to describe the yellow metal. Every ounce of it represented an ounce of thrift, a pound of self-discipline, and a ton of forbearance. It represented money that had not been spent on new clothes, or guns, or food, or entertainment, lodging, tools, roads, or a million other potential uses. Gold was so hard to get that central banks were reluctant to let it go.

Kings used to castrate the keepers of their royal mints if they let the gold slip away, either through chicanery or lack of attention. Central bankers were naturally careful with the stuff; caution was in their blood. They knew that if they issued too much paper—that is, if they allowed too many claims against their horde of gold - they risked having it taken from them.

On the other hand, war also was a serious matter. And central banks were asked to help finance the war. This difficult position was made even worse in 1914 when the threat of war caused a drop in stock prices—wiping out much of the liquidity that might be sopped up for wartime finance. The European nations needed to borrow vast amounts to cover the war expenses. But each additional unit of currency further reduced the gold cover, or the ability of the borrowing nation to pay its debts with real money.

Readers will be quick to notice the parallels to the global financial system of 2005. The Europeans wanted to increase the consumption of war materiel. Now, Americans consume other things as if they were fighting for their lives. Cannons and bullets were not much different from big-screen TVs and automobiles; they were quickly used up with no economic progress to show for it.

Ending the Gold Standard: War Beyond Their Means

From 1914 to 1918, France and Britain needed U.S. financing to conduct war beyond their means. Now, America turns to its principal suppliers in Asia and asks for credit. Without it, the United States cannot continue consuming at its present rate. In 1914, the world’s most important supplier was the United States. France, Britain, and Russia (and to a much lesser extent, Germany, early in the war) had to turn to the United States for supplies. But since they consumed more than they earned, they put their gold reserves at risk. France dealt with this problem early on by simply going off the gold standard. Britain remained on the gold standard throughout the war, barely, but only by the grace of U.S. creditors.

Fortunately for Britain, the United States did not force the issue. (Fortunately for America, 90 years later, its major creditors in Asia do not seem to want to force the issue either - at least, not yet. Even without a gold standard, China and Japan could wreak havoc with the dollar any time they chose. For the moment, like America in 1914 to 1916, they are happy to take the orders and increase market share, knowing that their major customer cannot really afford to pay for all that they send her.)

As the war grew more and more grim, not only was the honest money of the gold standard abandoned by most belligerents, the export of gold to settle accounts was expressly forbidden (under cover of fear that the gold would fall into enemy hands). Each nation began increasing its supply of money, issuing more paper currency, borrowing more and more money from foreign (mostly American) and domestic sources, and spending far beyond its means.

France was already heavily in debt when the war began, with a consolidated debt in July 1914 of 27,000 million francs, in arrears already by 967 million. Normally, the French assembly resisted - however weakly - plans to spend more money. But with war cries in their ears and the Huns at the Somme, the peoples’ representatives got in the habit of merely rubberstamping any request that came their way. They voted for credits of 22,804.5 million francs in 1915 - an amount that rose every year, reaching 54,537.1 million in 1918. In practice, the government spent far more than the credits that had been voted, using special accounts that we might call “off budget” accounts similar to those used by the Bush administration to pay for the war in Iraq. In 1920, 30,000 million francs - an amount nearly equal to the nation’s entire prewar debt- passed through the special accounts.

When America entered the war, its expenditures outdid the other combatants, averaging $42.8 million per day from July 1917 until June 1919. Total federal expenditure rose 2,454 percent in the three years 1916 to 1919. The Federal Reserve issued more and more paper notes; the supply rose by 754 percent between March 1917 and December 1919. The overall money supply increased 60 percent between 1913 and 1918, while GDP increased only 13 percent. The government raised money partly by taxing people much more heavily and partly by borrowing from them. Four “Liberty Loans” were floated during the war years. At the war’s end, a “Victory Loan” was offered.

Ending the Gold Standard: Not a Single Major Government Survived

All of this borrowing, spending, and taxing left the world’s major economies - especially those in Europe - very fragile. After the war was over, they all attempted to return to the prewar, gold standard that had worked so well for so long. But they were like the farmers going out to plow their fields in northeastern France; they kept hitting unexploded bombs and blowing themselves up.

Wilson’s meddling was disastrous from practically every point of view - except one. The war continued for another 18 months. Not a single major government in Europe survived in its prewar form. “In 1914, Europe was a single civilized community,” wrote A. J. P. Taylor, “A man could travel across the length and breadth of the Continent without a passport until he reached…Russia and the Ottoman Empire. He could settle in a foreign country for work or leisure without legal formalities…every currency was as good as gold.”

In 1919, European civilization was a wreck, out of which tough new menaces would be hammered - first in Russia, then in Italy and Germany. Nor did any currency buy as much at the end of the war as it did at the beginning. All the principal belligerents, with the exception of the United States, were forced off the gold standard. The one and only respect in which the war paid off was that it turned America into an empire.

Bill Bonner
The Daily Reckoning

Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner’s and Wiggin's follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount - just click on the link below:

Empire of Debt: The Rise of An Epic Financial Crisis

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