Lessons for President Trump (and Investors), Part 4
Shocking Unexpected Consequences

When new presidents first walk into the White House, they expect to grab the helm of government and sail along smoothly. But it’s mostly an illusion, and Trump’s first month in office is a classic example.

He’s running into severe headwinds from career staffers at the State Department, the FBI and other major agencies — a growing resistance movement in his own executive branch of government.

His ship of state is being rocked by rebellions in Congress, courts and states.

Most important, any major policy shifts for the global economy could set off a chain reaction of shocking unexpected consequences that ricochet through time.

Many years ago, after Elisabeth and I returned from our trek through Latin America, we soon found ourselves in a similar cycle under another American president. He deliberately disrupted the established order. He created waves that shook the world. And while some investors profited handsomely, others lost fortunes.

When I name that president, you will probably say Trump is different. True.

Or you might say times have changed. Also true.

Nevertheless, if you’re around my age or older, you’ll remember that earlier episode very well. You’ll see how it provides some of the most illuminating lessons of history for world leaders today. And you’ll take away equally valuable lessons for your investment strategies.

The Nixon Shock

Richard Nixon shocks the nation on August 15, 1971. Click here to view the entire 18-minute speech and judge for yourself how similar or different it was from Trump’s proposals today.

On August 15, 1971, President Richard Nixon appeared on TV before a national audience and, without prior warning, announced a series of drastic actions that forever changed our financial future.

With the aim of creating more U.S. jobs and resetting global trade relations, he issued several directives:

He abandoned the Bretton Woods agreement that fixed the dollar’s exchange rate with other major currencies.

He unilaterally canceled the direct convertibility of the U.S dollar into gold.

And in a feeble attempt to contain the inflationary impact of his first two actions, he simultaneously imposed a 90-day wage-and-price freeze on a broad range of goods.

It was, in effect, a massive devaluation of the dollar.

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At first, Wall Street reacted with glee. The Dow enjoyed one of its biggest one-day surges ever. The editors of The New York Times wrote that they “unhesitatingly applaud the [President’s] boldness.” And for a while, the U.S. economy continued to grow nicely. At the same time, however, the Nixon Shock also set off a long series of unexpected consequences.

The first was both quick and dramatic. Minutes after Nixon gave his landmark speech to devalue the dollar, foreign-exchange traders in Tokyo began dumping U.S. dollars in massive quantities. The dollar began to plunge, and the value of the Japanese yen began to soar, a trend which could make Japanese products very expensive and undermine, or even destroy, Japan’s ability to export those products to the United States.

To prevent a wholesale collapse in the dollar against the yen, and to save its export economy from near-certain death, Japan’s central bank had no choice. It was forced to launch its greatest currency intervention of all time, and within just 48 hours, it bought a record $1.3 billion in U.S. dollars.

At the time, virtually no one on Wall Street was paying much attention to Japan, but my father and I were.

Martin’s father, Irving Weiss, extracting U.S. dollar data from monthly Federal Reserve Bulletin.

“This thing that happened in Tokyo last night is just the first warning sign,” he said to me at the kitchen table as he pored over a Federal Reserve Bulletin and munched on unshelled sunflower seeds. “We have lost the Weiss family’s hard-fought war against inflation. The bombshell Nixon just dropped last night is going to change everything. The U.S. dollar is going to sink in fits and starts. To compensate for the weaker dollar, foreign exporters are going to demand much higher prices for their goods. Ultimately, inflation in the United States is going to take off like a rocket. Gold will explode. Interest rates will go through the roof. The U.S. Treasury bond market will collapse so bad, it will be tough to finance the federal deficit. And God only knows what other crazy things the future will bring!”

Oil Shock

Sure enough, Nixon’s devaluation of the dollar led straight to the next crisis: On October 16, 1973, two years and three months after Nixon delivered his bombshell, the Organization of the Petroleum Exporting Countries (OPEC) delivered theirs. They hiked the price of oil by a whopping 70% from $3 to $5.11 per barrel, the biggest single-day price hike of any major commodity in modern history. And as if that wasn’t enough, the next day, they dropped another economic weapon of mass destruction — an oil embargo.

The immediate reason that OPEC spokesmen cited was entirely political; they said they were punishing the United States and its allies for aid given to Israel during the Yom Kippur War, a conflict that had just begun days earlier. But the real reason was entirely financial — the decline in the U.S. dollar precipitated by the Nixon Shock.

Indeed, after Nixon unilaterally pulled out of the Bretton Woods agreement and abandoned the Gold Exchange Standard, Britain soon followed, floating the pound sterling. As a result, not only did the U.S. dollar go down against other major currencies, but all major currencies went down in terms of the commodities they could buy. Meanwhile, crude oil was universally priced in the one major currency that was falling the fastest — the U.S. dollar.

The oil ministers of Saudi Arabia, the world’s largest producer, were livid. Other major Persian Gulf producers, like Iran, Kuwait, Qatar, and the United Arab Emirates added their voices of anger. Every member of OPEC tacitly agreed with a comment made by one minister on the sidelines of the conference: “Thanks to Nixon, we’re getting screwed.”

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Soon the price of crude oil doubled again, reaching $12 per barrel, for a total rise of approximately 300%. And suddenly, the world’s most important commodity was in desperately short supply, gutting the economies of countries dependent on imported energy, driving inflation through the roof.

At service stations in the United States, drivers waited hours in long gas lines for a few gallons to fill their empty tanks. In major financial capitals, investors scrambled to dump the dollar, buy commodities, load up on gold. And in every nation that depended on imported oil, leaders pulled their hair out in a panic to find solutions. But the unintended consequences of Nixon’s rash actions weren’t limited to oil markets.

Stagflation

Beginning in 1974, the entire world economy sank into the deepest recession since World War II, with one unique feature that no one had witnessed before: Not only were the economies of advanced nations suffering absolute declines in GDP, but they also continued to suffer from inflation at the same time.

In Latin America, this was a common phenomenon, and the formula was simple: Economic stagnation + inflation = “stagflation.”

In advanced countries, however, it had rarely happened before. Either the economy expanded with inflation, or it contracted without inflation.

Now, however, stagflation was spreading from Latin America to North America, Western Europe and Japan, a harbinger of more serious troubles yet to come.

More Violent Dollar Collapse

Between early 1977 and late 1978 — within a matter of 24 short months — the greenback plunged from nearly 300 to 175 against the Japanese yen, from 2.4 to 1.8 against the German mark, and from 2.5 to 1.5 vis-à-vis the Swiss franc. It was the sharpest drop in an American currency since the collapse of the Continental during the Revolutionary War against England.

One sunny spring day, walking to class from Columbia University’s Butler Library, I heard the din of a student demonstration that was louder than virtually any protests I had ever heard before. So I stopped to talk to a young foreign student on the fringe of the crowd. “What’s going on?” I shouted to make myself heard.

“We’re from Iran,” came his shout in response. “We are followers of the Imam, Ayatollah Khomeini. We will depose the Shah.”

I walked away, but they didn’t. On January 16, 1979, similar protests around the world and in Iran forced Shah Pahlavi to flee into exile. Their oil exports came to a sudden halt. Global oil traders panicked. And the price of oil zoomed like a ballistic missile to $39.50 per barrel.

All told, within just six years from the day OPEC announced its first big price hike in 1973, the world’s most important commodity had risen by over 13 times. That was like the price of prime beef going from $10 per pound to $130 per pound; a $20,000 VW going to $360,000; or the tuition bill for an Ivy League MBA surging from $160,000 to over $2 million. But it was really much worse — because it was happening with a commodity that was a direct or indirect cost factor for almost every major industry, product, or service in the world.

14.8% Inflation; 1,876% Rise in Gold

The surging cost of energy merely set off the first sparks, and before the end of the decade, global inflation was raging like a house on fire. Some historians blamed it on the Arab Oil Embargo, the Iranian Revolution, and other extraneous events. However, the consensus of economists now agrees with the analysis that my father had spit out with sunflower seed shells on the morning of August 16, 1971: The true source of surging inflation in the late 1970s was the Nixon Shock of August 15, 1971.

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In the months before Nixon’s speech, year-over-year consumer price inflation in the United States was under 5%. By January of 1980 it hit 14.8%, the worst-ever in America that was unrelated to a major war.

Meanwhile, the price of gold rose from $43 per ounce in August of 1971 to a peak of $850 per ounce in early 1980, an increase of 1,876%.

More Shocking Consequences

In the same period, the Federal Funds rate jumped from 5.75% to nearly 20%.

The U.S. bond market suffered its worst price collapse in history. Government security dealers shut down operations. It became virtually impossible to sell even small lots of U.S. Treasury notes and bonds to finance the gaping federal deficit.

Then, due primarily to these massive interest-rate swings, we witnessed the worst wave of bank failures since the 1930s, followed by the worst insurance company failures ever. Next in line came Global deflation … the Tech Wreck of 2000-2003 … the Great Housing Bust of 2007 … the Debt Crisis of 2008-2009 … the Fed’s Money Printing Binge of 2010-2016 … and to this very day, some of the distant shock waves from Nixon’s Big Bang can still be felt.

Important Lessons for Trump and Investors

Lesson #1. Trade disruptions. Global trade and currency markets are heart muscles of the world economy with connecting tissues that extend to interest rates, bond markets, banking, insurance and more. If, for example, Trump initiatives reset trade patterns and exchange rates, you could see a cycle of global actions and reactions that includes some key features of the 1970s and 1980s.

Lesson #2. Powerful forces. Once that kind of megacycle is set into motion, it can continue for decades, and no one can stop it. Our colleague Larry Edelson says it’s the cycle itself that drives government policy, not the other way around. But disruptive policy changes from Washington can certainly play an important role in precipitating a major turn of events.

Lesson #3. Rising prices. One of those major turns could bring back inflation. It may start slowly and may take time to hit with full force. But any major changes that make foreign imports more expensive or weaken the U.S. dollar could be catalysts.

Lesson #4. Gold. Even without much inflation, gold is bound to be among the leading beneficiaries. I repeat: After the Nixon Shock, it surged from $43 to $850 per ounce. An equivalent rise from today’s gold price would take one ounce of the yellow metal to over $24,000. Certainly, no one is predicting anything that extreme. But it just goes to show the power behind the cycle that fueled — and was fueled by — the Nixon Shock.

These things don’t happen overnight. They can take years to incubate and hatch. Just bear in mind that all of the examples I’ve told you about here today may still exclude other dramatic changes, both good and bad, that history alone cannot prepare us for. For some sneak previews of what’s possible, be sure not to miss:

Lessons for President Trump (and Investors), Part 1: The Worst Ways to Fight Corruption and Other Ills

Lessons for President Trump (and Investors), Part 2: Our Lost War Against Inflation

Lessons for President Trump (and Investors), Part 3: Inflation, Corruption and Terror

Good luck and God bless!

Martin