I quoted this article several days ago, but there were parts of it I didn’t really understand then:
Summary: The massive growth of hedge funds has sparked warnings of instability and demands that the industry be regulated. But the fear of hedge funds is overblown, based on a misunderstanding of their role in the international financial system. In reality, hedge funds do not increase risk; they manage it — and policymakers, rather than clamping down, should make sure hedge funds have the tools to perform this function well…
In the end, the critics of hedge funds would do well to remember why this sector has emerged as such a force. Until the late 1960s, the financial world was quaintly stable: exchange rates were inflexible, interest rates were regulated, and the whole system was anchored by a fixed gold price. But that world collapsed when inflation drove the dollar off the gold standard and currencies and interest rates began to float; from then on, it became impossible to amass savings without facing financial uncertainty. Tools for coping with that uncertainty — deep markets in futures, options, and other derivative instruments — sprang up in response to the newly volatile environment. And hedge funds emerged as the masters of these tools, providing quasi insurance to investors and firms and introducing a healthy dose of contrariness into financial markets. For this, they are accused of generating risk. But their real systemic function is to manage it – and it is their very success in doing so that has generated both their profits and their phenomenal growth.
That part in red is the piece I want to return to because I think what he says is not true, or, at the least, not accurate.
Post-war international gold standard (1946–1971)
After the Second World War, a system similar to the Gold Standard was established by the Bretton Woods Agreements. Under this system, many countries fixed their exchange rates relative to the US dollar. The US promised to fix the price of gold at $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of gold. However, under the fiscal strain of the Vietnam War, President Richard Nixon eliminated the fixed gold price in 1971, causing the system to break down.
I specifically remember this because it happened on the exact day I got off of a plane at an Air Force Base in England where I was to spend three years as a soldier. The floating of the dollar was a big deal for us. Before I got there, £1 = $2.40. After I arrived, it floated all over the place, mostly down. And it wasn’t that "inflation drove the dollar off the gold standard and currencies and interest rates began to float." It was because of the "fiscal strain of the Vietnam War." I think this is an important point. Sebastian Mallaby implies that the Hedge Funds heroically filled a need caused by factors that had to do with international economics. Not true. And there’s more. By floating the dollar and going off the gold standard, Nixon opened a doorway – if we need more money, just print it. The doorway, once cracked, sat there for a few years, then Ronnie Reagan drove a Mac Truck through it:
In Hedge Fund parlance, Reagan "went short" on our economy. He "leveraged" our government and military. And the Bush father/son team continued his lead. Under the same guise as the Hedge Fund Managers, these Republican Administrations told us they were making us safe, but what they did was put us at risk. The Hedge Fund mentality wasn’t because of something, it was part of something – something sometimes called Reaganomics, sometimes called Compassionate Conservatism, but rarely what it really is, Deficit Spending. Sebastian Mallaby goes on, "from then on, it became impossible to amass savings without facing financial uncertainty." Again, he is implying that financial uncertainty became a problem because of some world economic thing, "inflation." Wrong again, the uncertainty came from floating the dollar to pay for the Viet Nam War. Whatever the case, Mallaby justifies Hedge Funds as a way to amass savings without facing financial uncertainty failing to mention that they are only available to the already very wealthy.
When it’s all said and done, all Hedge Funds do is selectively give the wealthy a way to deal with the financial uncertainty introduced into our economy by Richard Nixon, Ronald Reagan, George Bush I, and George Bush II. Cut their taxes; leave holes for their Hedge Funds and other Market Raiders; Bail-out their Banks; profiteer on their "bubbles," and sell the rest of America very Short.
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