When the Dollar Nearly Died

  • Paul Volcker and the crisis of 1979: Worse than his obits say
  • Dark side of Volcker legacy — “too big to fail”
  • Are the big banks holding the repo market hostage on purpose?
  • An artwork that retains value even after another artist eats it
  • Awaiting a market storm… facial scans and global travel… how to prepare for a windfall profits tax on gold… and more!

“The man who broke the back of inflation” 40 years ago is gone.

Paul Volcker Obit

To be sure, Paul Volcker was not your typical Fed chairman. “He was not an academic like his successors Ben Bernanke and Janet Yellen,” recalled Agora founder Bill Bonner a few weeks ago. “And he was not a status-seeking hustler like his immediate successor in the Eccles Building, Alan Greenspan.”

Volcker was also the last Fed chairman who wasn’t held captive by the stock market. No sooner did he leave the post in August 1987 than the Black Monday crash occurred in October. Ever since, Fed chairs have viewed “rising stock prices” as part of their mandate along with “stable prices” and “maximum sustainable employment.”

The media’s prewritten obituaries tell a very incomplete story. We intervene to fill in some critical blanks.

Depending on your age, you remember the near-runaway inflation of the late Jimmy Carter years — about 1% a month. This was before the government started monkeying around with the inflation numbers.

That was the backdrop for when Volcker took the post in August 1979. Here’s the New York Times account: “He prevailed by delivering shock therapy, driving the economy into a deep recession to persuade Americans to abandon their entrenched expectation that prices would keep rising rapidly.

“The cost was steep. As consumers stopped buying homes and cars, millions of workers lost their jobs. Angry homebuilders mailed chunks of two-by-fours to the Fed’s marble headquarters in Washington. But Mr. Volcker managed to wring most inflation from the economy.”

The Times understates the case. The dollar very nearly collapsed during Volcker’s first months as chairman.

The obit from Reuters makes passing mention that Volcker “was only a few months into the job when on Oct. 6, 1979, he announced a 1-point rise in the discount interest rate to an all-time high of 12%.”

But that wasn’t the turning point. Not by a long shot.

November brought the Iran hostage crisis. The Carter administration froze Iranian assets in the United States. Not that that mattered to the students who took the hostages in the U.S. embassy; it wasn’t their money, after all.

“As the world watched and waited, other foreign investors began to wonder about the safety of their money,” writes Richard Maybury, one of the graybeards of the newsletter biz, in his book The Money Mystery. “What might happen to my money, they asked, if my government does something to anger the American government? Will my money be frozen, too?

“A run on the dollar began,” Maybury continues, “first among wealthy Arabs whose governments were not on good terms with U.S. officials, then among wealthy persons worldwide.”

They dumped their dollars in favor of gold, Swiss francs and West German marks.

Then came the Soviet invasion of Afghanistan in December. The Carter administration responded with a grain embargo. “Around the world, people began to fear that U.S. officials would pressure their allies into freezing all Soviet bloc assets.”

At the time, Soviet-bloc debt to Western banks totaled $80 billion. “With financial markets already in turmoil, an $80 billion default hitting dozens of large banks worldwide could set off a global bank run and financial crash every bit as bad as 1929.”

As the dollar neared collapse, gold soared.

The gold price was about $300 an ounce when Volcker took his post in August 1979. By the time of his shock interest-rate increase in October, it had leaped to $390. But the panic out of dollars was so extreme that gold skyrocketed past $800 by Jan. 21, 1980.

The only way to prevent a collapse of the dollar was to jack up interest rates and dial back Fed money-printing far more than Volcker probably intended in October. Mortgages of 16% couldn’t have been the plan from the beginning!

The pain from his actions was enormous, but the pain of not acting would have been far worse. (Hollywood took a stab at the worst-case scenario in the 1981 movie Rollover with Kris Kristofferson and Jane Fonda.)

The good news was that the global economy was brought back from the brink. The bad news was that Volcker restored the credibility of both the Fed and a paper dollar with no gold backing.

At least Volcker deserves the credit he gets for his actions in a moment of crisis — which is more than you can say for Ben Bernanke in 2008.

One postscript: There’s a darker side to Volcker’s legacy too. Modern bailout culture began on his watch.

In May 1984, Continental Illinois — the nation's seventh-largest bank, with $42 billion in assets — went bust. It became insolvent for the usual reasons — too many foolish loans to imprudent customers who didn't have the means to pay them back.

Continental Illinois gave us the first widespread use of the term "too big to fail," as used by Connecticut Congressman Stewart McKinney.

Indeed, the Federal Reserve and the FDIC would not allow the bank to go under. Of course, the bank's depositors were made whole — that's the point of FDIC deposit insurance…

But something brand-new happened in 1984: The bank's bondholders were also made whole.

"Basically," G. Edward Griffin wrote in his Federal Reserve history The Creature From Jekyll Island, "the government took over Continental Illinois and assumed all of its losses. Specifically, the FDIC took $4.5 billion in bad loans and paid Continental $3.5 billion for them. The difference was then made up by the infusion of $1 billion in fresh capital in the form of stock purchase.

"The bank, therefore, now had the federal government as a stockholder controlling 80% of its shares, and its bad loans had been dumped onto the taxpayer."

Which was just how Fed chief Paul Volcker wanted it. Days after the deal was done, he defended it before Congress…

Volcker Bailout Illinois Snippet

Ten years later, Continental Illinois was folded into an even more notorious too-big-to-fail — Bank of America.

The stock market begins a new week on a “meh” note. The major indexes are in the red, but not much. The Dow is off less than a quarter percent as we write at 27,953.

Gold languishes at $1,460. Crude hovers around $59.

In general, it’s shaping up to be a quiet week. The Fed holds one of its every-six-week meetings, but there’s no drama; the fed funds rate will hold steady after three straight cuts. At his press conference, Fed Chairman Jerome Powell will sidestep difficult questions — assuming any are asked — about the ongoing rescue of the “repo” market.

It’s next week when things could get interesting, with U.S. tariffs on Chinese goods set to rise at the very moment impeachment will collide with a partial government shutdown.

As long as we brought up the repo market, here’s something we can file under “Now they tell us.”

From the Reuters newswire: “The unwillingness of the top four U.S. banks to lend cash combined with a burst of demand from hedge funds for secured funding could explain a recent spike in U.S. money market rates, the Bank for International Settlements said.”

The BIS is sometimes known as “the central bank for central banks.” Its report did not pin down a precise reason that overnight lending rates shot up in September, but as Reuters puts it, “BIS analysts said the growing reliance on the biggest U.S. banks to keep the repo market functioning may have been a big factor.” The report also did not identify the four banks by name.

Hmmm… So far during the repo rescue, we’ve assumed those biggest banks are simply too frightened to lend — that there’s a someone or someones out there whose financial position is so shaky that the banks want nothing to do with them.

But lately we’ve been hearing an alternative explanation within certain financial circles: The biggest banks are refusing to lend because they want looser regulations. In other words, they’re holding the repo market hostage until the Fed and other regulators ease up on their lending rules.

No, there’s no smoking-gun document out there. That’s just the buzz. Plausible enough, as far as it goes…

Up until now, the saga of the duct-taped banana hadn’t impressed us and so we didn’t see fit to mention it. But then someone ate it.

The essential background: Fed money printing has juiced financial assets to such crazy heights that someone paid $120,000 for an “artwork” consisting of an overripe banana duct-taped to the wall of the Art Basel gallery in Miami.

Maurizio Cattelan Art

The work is called Comedian and it’s the brainchild of the Italian artist and sculptor Maurizio Cattelan.

[Curious aside: It turns out Cattelan is the guy behind another famous artwork, one of undisputedly high value — the solid gold toilet we mentioned first in 2016 when it went on display in a public restroom at the Guggenheim in New York, and again this fall when it was stolen from a British museum. It’s still missing.]

On Saturday, a performance artist named David Datuna took the banana off the wall, peeled it and ate it.

Ah, but gallery director Lucien Terras says the integrity of the work is still intact: “He did not destroy the art work,” Terras tells the Miami Herald. “The banana is the idea.”


Or as the newspaper tries to explain, “The work comes with a Certificate of Authenticity, and owners are told that they can replace the banana as needed. Instructions on how to replace the banana are not included.”

We throw up our hands and move on to the mailbag…

After we noted the feds had ditched their plans to collect face scans of U.S. citizens entering and leaving the country, we got this note…

“Last time I entered the U.K., I had to have a picture taken by a machine (on thermal paper, no less!) and had to hand it in to the customs officer before clearing.

“This is not new stuff — however, it is deplorable!”

The 5: We’re sure this isn’t the last we’ll hear of such a scheme. Just one more high-profile incident and they’ll trot it out again.

On the topic of a windfall profits tax on gold, broached here on Friday: “The feds did it with oil in the ’70s, and you know damn well they'll do it again with gold.

“So if the feds take away any opportunity to profit from a gold fly-up, can Jim Rickards please let us know what's the use of owning it?”

The 5: Your editor asked him about that during one of our very first conversations in 2013. We share his answer at length.

“The world of $4,000 gold is the world of $400 oil, $100 silver, higher prices for copper, corn, wheat and everything else. In other words, it’s a world of very high inflation in which the value of your retirement funds and your annuities, etc., have been wiped out. Well, who are the winners? The winners are going to be the people who were prepared and had an allocation to gold. That’s going to be a very small minority. It’s a small minority today. It might get a little bit larger, but that’s not most of the population.

“So you’re going to have this resentment, this political resentment, where the vast majority of the people who just sort of took it on the chin are going to be looking at a small number of people who protected themselves, and they’re going to say that’s not fair. And we’ve seen this before. Congress has a way of dealing with it, which is a windfall profits tax.

“Now, as a practical matter, I think it’s important for readers to understand that laws like that don’t happen overnight. They have to go through Congress, there have to be bills, there have to be hearings, there have to be votes. So first of all, it might not happen at all — maybe somebody would try to do it, but it wouldn’t get through Congress, depending on who’s in Congress at the time. Secondly, you should be able to see it coming and maybe pivot out.

“What I suggest is to buy your gold at current levels… and ride the wave up to these much higher levels, $4,0005,000 an ounce, and then assess the situation. Be nimble. I don’t think you can just write a game plan today and say here’s the plan and just follow it step by step. That’s nonsense. You have to be nimble, you have to be following developments, you have to be prepared to change your mind based on new news.”

As we said on Friday, Congress would have to act because it’s a tax we’re talking about; the president can’t just up and issue an executive order.

Well, unless any semblance of Constitutional governance has been stripped away. In which case there will be much more to worry about than a windfall profits tax on gold…

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

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Dave Gonigam

Dave Gonigam

Dave Gonigam has been managing editor of The 5 Min. Forecast since September 2010. Before joining the research and writing team at Agora Financial in 2007, he worked for 20 years as an Emmy award-winning television news producer.

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