National Debts, Debt Monetization and Inflation

This last week marked the 40th anniversary of Nixon's move to break up the international gold standard, set by the Bretton Woods Agreement among 44 nations in 1944. The move represented a post WWII culmination of a U.S. balance of payments crisis, including a run on U.S. gold reserves that would trigger an insolvency event:

"Recently the markets had panicked. Great Britain had tried to redeem $3 billion for American gold. So large were the official dollar debts in the hands of foreign authorities that America's gold stock would be insufficient to meet the swelling official demand for American gold at the convertibility price of $35 per ounce." [1]

This insolvency event was chiefly driven by the unbalanced fiscal spending of the Johnson administration (e.g. the "Great Society" welfare state and other profligate spending), Nixon's inability to deal with rising deficits, and the growing shift of the U.S. from a creditor to a debtor nation, with a trade deficit that would likewise increase in coming years.

While Bretton Woods was a flawed international monetary system in many respects - imposing currency pegs and encouraging intervention by monetary "authorities" such as the IMF - the decision to make the dollar the reserve currency backed by gold was among the positive aspects that supported the growth of the U.S. as a net creditor nation.

It is worthwhile to review what has happened since Nixon declared a fiat end to the gold standard, allowing the dollar to float. By removing the restrictions of a dollar-to-gold conversion, debt monetization by monetary authorities (in particular the Federal Reserve) could ensue without check, under pretense of the "full faith and credit" of the sovereign.

The figure at the top depicts the geometric growth of the U.S. national debt, the broad M3 money supply metric, and price inflation as represented by the original Consumer Price Index (CPI) calculated before 1984 [2,3], resulting in an 82% decline in the purchasing power of the dollar. Such national debt growth does not take into account the 'unfunded' liabilities faced by the U.S. government through Medicare, Medicaid and Social Security programs, which exceed $100T.

Keynesians and Post-Keynesians have misguidedly supported deficit financing and debt monetization to stimulate aggregate demand and to prevent deflationary or disinflationary relief during debt deleveraging cycles. When will they wake up to the damage caused by such fiscal and monetary policies, chief among them financial instabilities that occur due to the unsustainability of perilously high debt loads, the understated risks due to artificially low interest rates, and the growing lack of confidence in the dollar?

[1] "The Nixon Shock Heard 'Round the World," Lewis E. Lehrman, WSJ, August 15, 2011.
[2] Graph is taken from "Modern Monetary Madness and King George III," May 8, 2011. 
[3] The pre-1984 CPI is tracked by ShadowStats.com HERE.