Erich Utrie

WTF happened in 1971? Nixon closed the gold window on August 15, 1971, and every piece of the 1970s crisis flows from that single act of political cowardice. The standard story blames OPEC. The 1973 oil embargo, the 1979 Iranian Revolution, Arab sheikhs holding the West hostage. How convenient. It shifts blame onto foreigners and obscures the damage Washington had already done to its citizens' purchasing power years before any tanker changed course. The Federal Reserve, running the printing press aggressively through the 1960s to fund Vietnam and Lyndon Johnson's Great Society simultaneously, had already created far more dollars than the gold at Fort Knox could back. Foreign central banks, particularly France under de Gaulle, noticed. They started demanding gold for their surplus dollars at the legally fixed rate of $35 per ounce. The vault was draining. Nixon's choice, then, was discipline or default. He chose default, selling it as patriotism. Once the dollar floated, the inflation already baked into the system became visible. A dollar purchased dramatically less real value than it had twelve months earlier. Oil producers, receiving payment in depreciating paper, rationally raised nominal prices to protect their real revenue. You would have done the same thing. Arthur Burns, Federal Reserve chairman from 1970 to 1978, compounded the damage by keeping interest rates below the inflation rate, producing persistently negative real rates. Cheap credit flooded the economy, misallocating capital into projects that only penciled out because borrowing felt free. When reality reasserted itself, those investments collapsed. The stagflation you lived through (or read about) resulted from the central bank destroying the price signals businesses need to make rational decisions. Nixon's price controls in 1971 and 1973 then guaranteed shortages. Suppress prices, and producers stop producing. Gas lines stretched around blocks in New Jersey and California not because the earth ran short of oil, but because Washington made it illegal to charge what oil was actually worth.

In 1965 Malaysia kicked Singapore out of the Malaysian federation, and Tunku Abdul Rahman thought he had won. He had dumped a port city with no oil, no farmland, no fresh water, and two and a half million people crammed onto an island smaller than Lake Tahoe. Sixty years later Singapore's GDP per capita runs past $84,000 while Malaysia limps along under $12,000. The man who got expelled built the richest patch of dirt in Asia. The man who did the expelling built the New Economic Policy. Let's study what happened. Start with what Singapore lacked. No resources. No hinterland. No domestic market worth the name. By every theory that says a nation needs raw materials to prosper, Singapore should have starved. Instead Lee Kuan Yew made his country a place where capital felt safe. Low tariffs. Easy entry for foreign firms. Courts that enforced contracts instead of shaking down the parties. Corporate tax dropped to 17 percent, personal rates capped at 22, no tax on most capital gains. Money flowed in because money is not stupid. Malaysia chose the opposite. The New Economic Policy was racial central planning dressed up as fairness. Bumiputera quotas demanded that ethnic Malays hold 30 percent of corporate equity, that government contracts favor Malay-owned firms, that universities admit by race rather than ability. The state picked winners by bloodline. Predictably, the productive Chinese and Indian minorities took their capital and brains elsewhere, much of it to (where else) Singapore. You distort prices and incentives long enough, the talented people leave. They always leave. Lee Kuan Yew was not perfect. The man jailed opponents, sued journalists into poverty, and ran a soft authoritarian state with a fondness for caning. He banned chewing gum, which is the kind of thing a control freak does when he runs out of real problems. Singapore is no libertarian paradise. The government owns Temasek and GIC, sovereign wealth funds sitting on close to a trillion dollars combined, and public housing covers 80 percent of the population. Plenty there for a free market thinker to dislike. But here is the lesson Malaysia missed. Lee understood the difference between an interventionist government and a parasitic one. Singapore's state stayed mostly out of the price system. It kept inflation low, the currency credible, the bureaucracy clean, and trade open. Transparency International ranks it the fifth least corrupt country on earth. Malaysia sits at 57th, with a former prime minister, Najib Razak, currently serving time for looting 1MDB to the tune of billions. One country treated public office as a trust. The other treated it as a buffet. Capital responds to incentives, not slogans. When Singapore guaranteed property rights and kept the rules predictable, Exxon and Shell built refineries, banks set up regional headquarters, and the port became the busiest transshipment hub in the world. When Malaysia told investors that race would override merit and that the rules could change whenever a minister felt like it, the smart money discounted everything by a risk premium. Over fifty years that premium compounds into a $70,000 gap in living standards.

If creating new money doesn't cause inflation, why is counterfeiting illegal? If new money doesn't affect the economy, why can't anyone just print as much as they want? Banks conjure money from nothing, and you pay the interest on that conjuring. This is fractional reserve banking: your deposit of $1,000 becomes the legal basis for the bank to lend out $9,000 it doesn't possess, collecting interest on the full sum while you earn 0.4% on your savings account. This mechanism is elegant fraud, if you're generous. The bank holds reserves, say 10%, and lends the remainder. That lent money gets deposited elsewhere, becoming reserves for another round of lending. One dollar of base money fans outward into a pyramid of credit. Murray Rothbard calculated that a 10% reserve ratio allows a single $1,000 deposit to support $10,000 in total deposits across the system. This expansion creates purchasing power that competes with your existing dollars. Your savings are diluted as surely as a counterfeiter working in your neighborhood. Prices rise. You feel poorer because you are poorer. The Federal Reserve, established in 1913, backstops the entire structure. Banks lend recklessly because the Fed stands ready to bail out the system with freshly printed reserves. Privatized profits, socialized losses. The 2008 crisis saw the Fed expand its balance sheet from $900 billion to over $2 trillion within months, and you bore the inflationary consequences.