The Poet of Finance

Lessons from the past: Chris Mayer examines the ideas of Jacques Rueff, the eminent French economist and former minister of finance to Charles de Gaulle.

The Poet of Finance

Jacques Rueff was accused of being a perennial prophet of doom – a doom that never seemed to arrive.

Rueff first began to voice his concerns in 1961, alerting the world to the dangers inherent in the world’s monetary system, then operating under the Bretton Woods agreement. It would take ten years before Rueff’s view was fully vindicated.

The international community must have shivered as Reuff evoked the haunting memories of the Great Depression. He compared the years 1958-61 to the years 1926-29, which many could still chillingly recall as the prelude to an economic disaster none wished to see again. As Rueff notes, “there was the same accumulation of Anglo-Saxon currencies in the monetary reserves of European countries, in particular France, and the same inflation in creditor countries.”

In the 1920s we had the gold-exchange standard; in the 1960s we had Bretton Woods. Both systems were monetary jalopies, jerry-rigged Rube Goldberg-like contraptions that could not hold together for long. The two convertible currencies, dollars and pounds, became reserve currencies, effectively held by European banks as reserves instead of gold.

Rueff uses the example of the years after WWI, when a large influx of U.S. and British capital flowed to Germany and France. The new liquid funds entered these recipient countries and were held as reserves, since they could theoretically be converted to gold. In the older gold standard days, these dollars and pounds would find their way back to the banks of issue and be redeemed for gold. In this way the debt was settled. Gold was the world’s money accepted as final payment; not dollars or pounds, which were essentially notes – promises to pay the holder in gold, which was real, as opposed to printed paper, which was not.

In the booming twenties this was not the case. So, France and Germany held dollars and pounds and issued more of their currency and credit against these dollars and pounds. In the gold-exchange standard of the twenties, only dollars and pounds were redeemable in gold – all other currencies were redeemable in pounds, which were in turn redeemable in dollars. Very confusing, I know. Why the Genoa experts recommended this is another sorry episode of political expediency, compromise and historical accident, which we will skip here or I may never get to my conclusion.

Such a system, only loosely tethered to gold, allowed considerable inflation. As Rueff noted, it was “probably one cause for the long duration of the substantial credit inflation that preceded the 1929 crisis in the United States.”

The ensuing collapse of this pyramid scheme was to figure prominently, in Rueff’s estimation, in explaining the birth of the Great Depression.

Anyway, the point of the comparison with the 1920s was that Rueff thought that, mutatis mutandis, the same thing was happening again in 1960. He noted how the international community held tremendous reserves of dollars against an ever-smaller base of gold reserves. As in the 1920s, the U.S. was able to expand its supply of dollars skirting the old discipline that would have shackled it under a gold standard. No final payment was required; dollars – lots and lots of printed dollars – were accepted as final payment. Again, this allowed considerable inflation of dollars.

Here Rueff gives us one of his most famous sayings, when he called this situation circa 1960 and the situation in the 1920s as creating a “deficit without tears.” He wrote that, “it allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing, and to acquire without paying.” Rueff does not lay all this at the feet of the U.S. After all, these other creditor countries willingly accepted U.S. notes in lieu of gold. Rather, Rueff calls it an “unbelievable collective mistake.”

The holding of vast dollar reserves by foreign creditors puts the credit structure of the U.S. on notice. In the days of the gold standard, and even in the gold-exchange and Bretton Woods eras, this was more acutely felt because the gold stock of a country was visible, could be counted and was routinely reported. In the sixties, Rueff noted that an uncomfortable gap was growing between the dollars outstanding and gold in stock that backed it.

Writing in 1960, Rueff felt that if foreigners “requested payment in gold for a substantial part of their dollar holdings, they could really bring about a collapse of the credit structure in the U.S.” Rueff called for a return to the old gold standard.

The Le Monde article caused a stir, and a rash of criticism followed, in which Rueff was chided as an old-timer, applying a quaint antique analysis to a modern problem. The gold standard was a thing of the past, one author noted at the time, like sailing ships and oil lamps.

The new iterations of money, though, did not represent an advance in man’s understanding of money. On the contrary, each new monetary wrinkle, each new invention, each creative expedient only cheapened it.

We will skip ahead a bit in Rueff’s chronology to 1965.

By this time, Rueff had continued his attempts to persuade the monetary authorities to alter their course. On February 4, 1965, Rueff would gain something of a public victory when General de Gaulle made his now famous speech on the need for gold as a basis for international monetary cooperation. Rueff finally had the ear of an important head of state; he had the ear of de Gaulle, who would eventually refer to Rueff as the “poet of finance.”

After giving a brief history of the international monetary scene beginning with the Genoa Conference, de Gaulle noted how the acceptance of dollars to offset balance of payments deficits with the U.S. lead to a situation where the U.S. was heavily in debt without having to pay. He correctly observed how the dollar was a credit instrument and recommended that the system be changed.

“We consider that international exchanges must be established,” proclaimed de Gaulle, “as was the case before the great worldwide disasters, on an unquestionable monetary basis that does not bear the mark of any individual country.”

“What basis?” continued the French head of state, “Actually, it is difficult to envision, in this regard, any other criterion or any other standard than gold. Yes, gold, which does not change in nature, which can be made either into bars, ingots, or coins, which has no nationality, which is considered, in all places and at all times, the immutable and fiduciary value par excellence.”

Rueff pressed on with renewed vigor and the U.S. monetary situation continued to deteriorate with accelerating gold losses. Yet, negotiations continued, as Rueff says, “at a snail’s pace on a volcano, which may erupt all of the sudden.” While the experts dallied, the volcano belched and smoked all around them. That a crisis was brewing was now obvious even to the skeptics.

European nations that had been accumulating dollars at a pace of $1-2 billion per year began liquidating them – more than $2 billion were liquidated inside the twelve months of 1965 alone. By 1970, there was $45 billion in dollars held by foreigners against only $11 billion in gold stock.

At this point, the ending was inevitable. Though there were some changes made to the monetary structure in the waning days of dollar convertibility, it would finally expire in the summer of 1971 when Nixon brought the Bretton Woods agreement to an end by taking the U.S. entirely off the gold standard.

I think there are many ways in which Rueff’s criticisms to the monetary systems of the 20s and the 60s apply to the monetary world of today. There are many observations that we can take from this tale and apply to our current situation.

For one thing, note that the inflation of money and credit was able to continue for a long time after Rueff’s initial diagnosis that a crisis was brewing. Like any bubble, the pin is hard to find. Though he could not point to when the crisis would break, he thought that any number of events could trigger it – a continued weakening of the balance of payments deficit, some banking or financial incident, some political event, a mere shift in opinion.

Any of these could effect the “subservience of dollar holders and induce them to request conversion of their dollar holdings in whole or in part, even at the risk of antagonizing the Washington authorities.”

In the end, the math simply became too stark to ignore.


Chris Mayer
for The Daily Reckoning
July 21, 2004

God is in his heaven. Bush is on his throne. Gold is over $400. And the economy is recovering; everybody says so. So why worry?

But what’s this…?

“The fact that at this point our economy is delivering a satisfactory level of growth is, I believe, the temporary result of an overlong Federal Reserve policy of ‘free money’ and a falling dollar, coupled with unsustainable deficits.”

Felix Rohatyn, the man who once rescued New York City from eminent bankruptcy, was explaining to Wall Street Journal readers why he was fed up with the Bush administration. Despite the war on terror, he said, Americans were no safer. And financially, they were headed for trouble.

Of course, this is the trouble we’ve been writing about for years. People do not get rich by spending money they don’t have. As long as America’s ‘recovery’ is led by consumer borrowing…it is no recovery at all – it is a hoax, a fraud, a flim-flam.

We have looked at the figures. They tell us that Americans are getting poorer, by going deeper and deeper into debt. But we are, what is known in the profession, derisively, as ‘literary economists.’ We believe more in words, ideas, metaphors – and what we see with our own eyes – than in the numbers themselves. Below, we continue looking around…

First, here’s Tom with the news:


Tom Dyson, from the wrong side of Blackfriars Bridge…

– “It’s always the little guy who gets robbed,” said a friend over a pint or three last night. “It really gets my goat.”

– “Last night,” explained our friend, “I was listening to the Money Program on the radio. An elderly consumer was complaining about being ripped off, again, by the insurance industry. They had refused to honor a claim. Then the host said: ‘Sir, what you need to realize is that it’s all-out war. It’s them against us. They will do whatever they can to earn a buck at your expense. Underhand tactics, false marketing, biased small-print…I’m not just talking about one insurance company, I’m talking about all big business in general.'”

– “I couldn’t believe the host of the radio show had said it, but he was absolutely right. We always knew that it was like that in the States, but here in Britain, this is a new corporate ethos…perhaps only twenty years old. In the old days, pensions, banks, insurance, brokers, all those type of people, they provided a service. And it was provided at fair cost. And the consumer trusted them to provide this service at fair cost.” Now, everyone’s out to screw money from the hard-put middle-class, he added – and particularly those older folk stupid enough to try and save a little for their retirement.

– “I know this one guy…he is an idiot,” said our friend. “No education and no depth of character, but he is a good and ready liar and he always does well in job interviews. Last I heard, he’d been hired by a commodity futures broker which targets retail investors. They encourage ordinary people to give them control of their nest eggs, and then trade with the capital. Often they lose the lot. Well, this guy’s job, I mean, his specific job and sole function in the company, is to phone up the old ladies after they have lost their life’s savings, and apologize, and smooze and charm them, and convince them to deposit some more cash. ‘We’ll win it all back for you,’ says the shyster.” [Ed. Note: Readers should have a look at this fascinating article by Richard Russell on how things used to be in America, 100 years ago – and some incredible facts that illustrate just how much life has changed.

– News of another shyster – this time playing double or quits with the whole worldundefineds credit rating. Alan Greenspan testified before the U.S. Senate yesterday. Care to guess what the Maestro had to say? Hereundefineds a clue: bonds went down, stocks went up…

– “Economic developments have generally been quite favorable in 2004, lending increasing support to the view that the expansion is self-sustaining,” said the Grease Pan. He said that June’s slow down in consumer spending was nothing but a blip and July’s numbers were already shaping up to be much stronger.

– Moreover, growth was likely to regain its momentum over the remainder of the year, he said, while inflation would remain subdued. “The little bulge in inflationary pressures seems to have created a soft patch here,” Greenspan said. “And, it is something, obviously, we are watching very closely.”

– Stock market gains have been scarcer than a Microsoft dividend of late, but thanks to Greenspan and Gates, yesterday, we got both. The Nasdaq leapt 33 points or 1.76% to 1,917, while both the Dow and the S&P, though more subdued, did some leaping of their own. The Dow gained 55 points, half a percent, to 10,149 and the S&P ended the session at 1,109, up 8 points on the day.

– Meanwhile, Microsoft finally announced that it would pay out $75 billion to shareholders, over the next four years in dividends and share buy-backs. The stock rallied 5%…while U.S. bonds were sold off hard. By the New York close, the 10-year T-bond yielded 8 basis points higher at 4.44%.

– But were the lumpen really listening to Greenspan, we wonder, or was this just an overdue bounce following three weeks of one-way traffic? We get the distinct feeling that Easy Al’s speeches are designed to appease Mr. Market. But Mr. Market’s not stupid. He’s heard this rhetoric before. If July was going to be so strong, how come the Dow is on course to record its worst monthly performance since Jan 2003?

– The market is giving the distinct impression that it is quietly rolling over. The Nasdaq shed over 8% in the first two weeks of July. While this stealth plunge hasn’t escaped your editors’ attention, here at the Daily Reckoning, it may have escaped the mainstream press…they’ve barely mentioned the fact. And volatility remains glued to 97-month lows. Yesterday the VIX closed at 14.17. It’s not a new 8-year low; it hit 13.34 five days ago, but it’s not far off.

– We get the feeling that the little guy is about to get squashed again…

– And this just in…a big guy getting crushed…by an even bigger government: Russian Bailiffs said, last night, that they would sell off the main operating arm of Yukos, the Russian oil giant, in order to recoup back taxes. “It’s the worst-case scenario,” said one analyst. “Frankly, it’s similar to performing a heart transplant on a man with a cough.”

– Yesterday we published an essay by Dr. Steve Sjuggerud in which he recommended Yukos as a risky, but potentially profitable, speculation. Today, Dr. Sjuggerud has recommended to his subscribers that they sell their stake, immediately, after his recommended stop-loss was breached.


Bill Bonner, back in Baltimore…

*** “My daughter is only 25, but she just bought a house in Northern Virginia. Of course, she mortgaged most of it. But can you believe that they lent her $275,000? Is that crazy, or what? She works as a bartender, part time. She’s very responsible and is good for the money, I’m sure. But I can’t believe they would lend her that much money. How do they think she will pay it back?”

Are Americans really the heavily indebted spendthrifts the world’s press makes them out to be? On the evidence, yes!

The Bureau of Labor Statistics figures that the average hourly worker earned $521.73 per week in 2003, (the 12 months ending in June). During the same period a year later, he earned an average of $524.37. Immediately, we notice that there is not a lot of difference between the two numbers. In fact, BLS tells us that the latter is only 0.5% greater than the former. Which is too bad for the poor schlep who works by the hour. Because the cost of living – the CPI – rose by more than 3% during the same period; he actually has less spendable income this year than he did the last.

How then, is a consumer-led recovery possible? How can he spend more in 2004 than he did in 2003?

The answer, dear friend, is blowing in the wispy wind of America’s housing bubble.

“How much do places like these go for?”

We posed the question to our lawyer as we drove through a section of Baltimore known as Federal Hill – near where the British lobbed cannon balls in the War of 1812…and Francis Scott Key, looking on, composed the national anthem.

The houses are hardly fancy. Instead, they are neat, modest places…which would be more familiar in Britain as ‘mews’ houses. They were meant for factory workers in the 19th century – tiny, cheap, and simple.

Twenty-five years ago, so many of these houses had been abandoned that the mayor started giving them away for $1 each.

But the area has changed…and so has the nation. Twenty-five years ago, America was at the bottom of a confidence cycle. Nothing seemed to go right. Interest rates were high and stocks were low – selling for 6 to 8 times earnings. Gold was twice as high – even in nominal terms – as it is today. And Federal Hill was a derelict, abandoned, forgotten, trashy slum.

Today, America has never been more sure of herself. Everything seems to go her way. The Dow is more than 10 times higher than it was at the end of the ’70s; many sectors sell for 50 times earnings – and more. Interest rates, by contrast, are low – the Fed’s key lending rate is barely a tenth of what it was back then. Gold sells at a humble $400 per ounce. And Federal Hill is booming. There are bars, cafes, restaurants, even restaurants good enough to entertain a group of expensive Washington lawyers.

And the houses?

“Well, I just sold one,” said our own consignee, “so I know what the market is doing. You can buy them for about $300,000. Two-fifty to three-fifty, I’d say.”

We have pointed out on more than one occasion – often enough so you must be getting tired of hearing us say so – that rising house prices do not make people rich. A house can sell for $1 or for $300,000; it provides exactly the same yield either way: you can live in it.

But rising house prices are not neutral. A man buys a house for $1 and then sells it for $300,000. He then buys another house for $500,000 – with a $200,000 mortgage. He feels much richer. He is now consuming a house worth half a million dollars. But while he was previously debt-free…now he is $200,000 in debt.

And what about the first-time house buyer, like our colleague’s daughter? She puts down $25,000…and borrows $275,000 to buy the $300,000 house. The same place she could have gotten for a buck in the year she was born.

Are they richer? Not really. Instead, without realizing it, they have become speculators – leveraged ones – betting heavily that interest rates don’t rise and house prices don’t fall. Woe to them if they’re wrong.

*** Pittsburgh correspondent, Byron King, with more thoughts about prosperity in America, 2004:

I think that you could have written the paragraphs on “prosperity” from Volume II of “Democracy In America”, or something close to them, but Mr. de Tocqueville beat you to it by about 165 years.

When Mr. de Tocqueville discusses “prosperity,” he does not define the term. He is discussing a conclusion, and only describing the foundations of the premise in a roundabout way. Perhaps the foundations and constructs of the term “prosperity” in the 1830s were so obvious and self-evident, that they needed no description to readers in that age.

Everyone knew, back then, that prosperity came from work and saving, from transforming one’s local resources into saleable capital.

The Daily Reckoning