The 50 year-old shock
Fifty years ago today, on 13 August 1971, US President Richard Nixon delivered a shock to the US and the world. He effectively brought to an end the Bretton Woods agreement, established in 1944 and designed to provide a new international monetary system for the post-war world. Some of Bretton Woods’ legacies are still with us, such as the International Monetary Fund (IMF) and the World Bank. But the international financial stability promised by Bretton Woods, through fixed exchange rates, is today in tatters.
Bretton Woods was to prevent problems arising from protectionism, beggar-thy-neighbour devaluations, hot money flows and unstable exchange rates. The core feature was the mandatory convertibility of any currency to another; central banks were required to intervene in currency markets to maintain their exchange rate within 1% of a set “par” value. Those par values were held in place by the guaranteed convertibility of the Dollar to gold at a set price. Because the US held the majority of the world’s monetary gold, the US became the centre of the international monetary system. The Bretton Woods system therefore came to function as a de facto Dollar standard.
Two days later Nixon addressed the nation via television, in which he promised in an 18-minute speech “prosperity with full employment during peacetime” and to stifle inflation, which he correctly said “robs every one of you… in the four war years between 1965 and 1969 your wage increases were completely eaten up by price increases. Your pay checks were higher, but you were no better off”.
He continued: “We must protect the position of the American Dollar as a pillar of monetary stability around the world… the strength of a nation’s currency is based on the strength of that nation’s economy… I have directed the Secretary of the Treasury to take the action necessary to defend the Dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the Dollar into gold or other reserve assets… the effect of this action will be to stabilise the Dollar… Our best days lie ahead”.
What “best days”?
That “temporarily” turned into “permanently”. The so-called ‘gold window’ wasn’t just shut; later administrations have painted over it.
President F. D. Roosevelt started the process in June 1933. In April that year he decreed that all gold coins and gold certificates in denominations of more than $100 were turned in to the Federal Reserve by 1 May for the set price of $20.67 per ounce. By 10 May 1933 the government had taken in $300 million of gold coin and $470 million of gold certificates. In 1934, the government price of gold was increased to $35 per ounce, effectively increasing the gold on the Federal Reserve’s balance sheets by 69%. This increase in assets allowed the Federal Reserve to further inflate the money supply.
President Nixon in 1971 was facing a serious threat to his re-election. Unemployment had risen to 6%, where it stubbornly stayed. In June 1971, the New York Times had published the Pentagon Papers, showing the US administration had repeatedly and secretly increased American involvement in the Vietnam War. Nixon was feeling vulnerable on many fronts. Moreover, the “gold pool”, a consortium of central banks organised in 1961 to carry out purchases and sales of gold to peg the market to the official price, had fallen apart.
Nixon believed that easy monetary policy would reduce unemployment. So he closed the gold window; permitted the Dollar to float; imposed a temporary freeze on prices and wages to “combat inflation”; and put a temporary 10% tariff on imports to “improve balance of payments”.
Today President Nixon’s promises ring hollow. There are strong parallels between 1971 and 2021. In 1971 the US was disengaging from Vietnam, a war that cost the US an estimated $843.63 billion (£608 billion); the US is now pulling out of Afghanistan, which has cost an estimated $910.47 billion (£656 billion). The US consumer price index (the official inflation rate) for 1971 averaged 4.38%; today it’s about 5%. In 1971 the Cold War between the US and the USSR was raging; today a new Cold War — between the US and China — is on the cards. So much has changed in 50 years; Nixon could not have foreseen the internet, Covid-19, electric cars, private space travel, climate change anxieties, cryptocurrencies, the 2008 financial crash, and much else besides.
In the 50 years since President Nixon’s TV address to the nation, the purchasing power of the US Dollar has plunged, thanks to inflation over the five decades totalling more than 554%. To buy the same amount of stuff you could get for $100 (£72) in 1971 you would need around $654 (£472) today. Wages have progressively fallen behind inflation.
Some standard is needed
Operating a gold standard — pegging a currency to the amount of gold held by a government — imposes a discipline (opponents argue too harsh a discipline) on government actions. Under a gold standard the creation of more currency — creating more Dollars, for example — requires obtaining more gold, which raises the market price of gold, and stimulates more gold mining to produce backing for that newly-minted currency. The US was on some form of gold or metallic standard for 179 years, between 1792 and 1971; during that time the US economy grew an average 3.9% a year. Since 1971 under a fiat money regime economic growth has averaged 2.8% a year, i.e. an economy that is about $8 trillion smaller than it would otherwise have been.
In a gold standard system gold provides a standard of value, a standard that everyone can share. But a gold standard ties the hand of governments. In a regime of floating exchange rates such as we have today there is no independent, objective entity that can counteract the temptation for central bankers to increase (and thus devalue) fiat money supply. Central bankers and their government backers want the freedom to construct economic policy according to current events. So, in a period of severe crisis (such as with Covid-19) they argue it is vital to be able to “splash the cash” to bring the economy back to life — or prevent its collapse. With the Covid-19 pandemic unfunded government spending — racking up huge debts — no doubt prevented many people from economic hardship. But we are left wondering how those debts will be repaid — will they be inflated away? Will they ever be repaid? Will more debts be incurred to repay the original debt?
Ultimately, what President Nixon did was to throw the fate of gold into the hands of private individuals. This ‘privatisation’ of gold swept certainty away from exchange rates, which now float in a kind of untethered ever-changing chaos, from which foreign currency traders make a killing. But departing from gold as a standard against which fiat currencies are measured has dramatically failed to provide price or employment stability. And the US federal debt is rapidly moving to $30 trillion; it was $398 billion in 1971. Fifty years ago the US debt-to gross domestic product ratio was 34%; today it’s almost 130%.
At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline. We have seen since last Friday how gold reacts to wider market conditions. Gold prices dropped when the Federal Reserve announced in 2014 it was wrapping up its controversial stimulus program after the financial crisis of 2008, the first “taper tantrum”. Last week all the financial markets talked about was a similar end to the current round of Fed quantitative easing. That’s what brought gold down — but it is important to realise that we have seen this before; and gold moved higher after markets had their “tantrum” and settled down after 2014. The gold price started rising again from 2018; maybe a similar pattern is once again building?
There are sensible arguments both for and against a gold standard, but the idea that we could return to one now is probably dead. 50 years on from the death of the gold standard, people argue that gold could never again be considered money, a means of exchange in daily life. That was true until the development of Glint, which has embraced this privatisation of gold and is positioning gold as an alternative everyday currency. With Glint it is possible to buy, sell and spend in gold, which has again become a viable form of money. President Nixon got re-elected, so finally killing the gold standard achieved his main goal. The gold “standard” meanwhile has simply shifted from government control into private hands.