- A Brief Monetary History
Prior to the 20th century, most of the world operated on the gold standard through which international trades were settled in gold.
While not perfect, the classical gold standard kept nations mostly honest in their nancial dealings with each other. It also forced nations to live within their means.
Large trade de cits had to be settled in gold, which drained gold from the nation’s reserves. Conversely, a trade surplus added gold to the nation’s reserves. This system placed limits on national debt.
World War I e ectively put an end to the classical gold standard in 1914. To nance the war e ort, the countries involved “printed” new money that was not convertible to gold. Trade settlement in gold was suspended inde nitely.
Most nations attempted to go back to the gold standard once the war was over. But the excessive money-printing caused their national currencies to diminish in value signi cantly. That meant nations would have to peg their currency to gold at a higher ratio than before, thus admitting the currency had lost value. Instead, the war combatants scrapped the gold standard.
During the same period, the shift towards central planning in America led to the creation of the Federal Reserve System in 1913.
The Federal Reserve is not a government agency. It is actually
a group of private central banks that act as one unit. The U.S. government granted the Fed a legal monopoly on the issuance of currency.
In other words, the Fed is permitted to create U.S. dollars as it sees t. Anyone else who attempts this will go to jail for counterfeiting.
The Federal Reserve was also tasked with being a “banker’s
bank,” which meant the Fed would loan newly created money to commercial banks that got in trouble. They thought this would make the system stronger.
Instead, it created “moral hazard” within the banking system. Commercial banks knew that the Fed would bail them out if needed... so lending standards diminished over time. It became easier and easier for risky borrowers to get a loan.
This is the dynamic that ultimately caused the nancial crisis of 2008. Wall Street, backed by the Fed—and the government—made too many loans to too many risky borrowers. Then it chopped up those risky loans and packaged them into complex derivatives.
And they kept doing this until it all blew up in 2008.
Rather than learn their lesson, the monetary authorities transferred the banking losses to the public with bailouts and quantitative easing programs to keep the system going.
But we need to back up for a minute. Those bank bailouts and quantitative easing programs would not have been possible 100 years ago. There were several changes to the monetary system that had to occur rst.
The U.S. dollar was backed by gold when the Fed was rst created in 1913. Americans could trade their dollars for gold anytime they wanted to at rst.
But then, in 1933, President Franklin Delano Roosevelt (FDR) issued an executive order that made it illegal for Americans to own gold. In fact, Americans were required to sell their gold to the government for $20.67.
After it had bought all the gold domestically, the U.S. Treasury announced that foreign central banks would still be able to trade dollars for gold... but it raised the conversion rate to $35 per ounce.
This in ux of gold for cheap gave the U.S. government a strong seat at the Bretton Woods conference in 1944. At this conference, representatives from 44 nations met in Bretton Woods, New Hampshire to discuss a new international monetary system.
They agreed upon the “Bretton Woods System” that established the U.S. dollar as the world’s reserve currency.
As the world’s sole reserve currency, the dollar replaced gold as the medium for international trade settlement. This meant that all international goods would be bought and sold in U.S. dollars... no matter which nations were doing the buying and selling. The dollar would remain pegged to gold at $35 per ounce, and other nations could redeem their dollars for gold through the “gold window.”
The dollar’s convertibility into gold on demand was to serve as a “check” on the United States. The link to gold is what gave the other countries con dence in the U.S. dollar.
The Bretton Woods System bestowed an enormous privilege upon the United States because it created a global demand for dollars. All nations needed to hold U.S. dollars to facilitate foreign trade.
This dynamic made trade de cits irrelevant for the United States. Under the gold standard, trade de cits required the U.S. to send
its gold to another country. Under Bretton Woods, trade de cits required the U.S. to send its dollars to another country. And the U.S. could just print new dollars to ship out if it needed to.
This arti cial global demand for dollars is what powered Lyndon Johnson’s “guns and butter” campaign that ramped up in the 1950s.
The U.S. military went to war with Korea and Vietnam overseas. That was the “guns” part. At the same time, the Great Society welfare programs launched domestically. That was the “butter.”
These initiatives were extremely expensive. As they progressed, the U.S. government created more and more new dollars to pay for them.
But foreign countries took notice. They began to worry about the value of the dollars they were holding. And rumors of the U.S. unilaterally changing the gold conversion ratio spread.
Here’s former French President Charles de Gaulle in 1965:
The fact that many countries accept as principle, dollars being as good as gold, for the payment of the di erences existing to their advantage in the American balance of trade... this fact leads Americans to get into debt and to get into debt for free at the expense of other countries... We consider necessary that international trade be established as it was the case before the great misfortunes of the world, on an indisputable monetary base, and one that does not bear the mark of any particular country. Which base? In truth, no one sees how one could really have any standard criterion other than gold!
France and other concerned nations began to rapidly exchange their dollars for gold through the gold window. It was a global “bank run” on the dollar and gold rapidly owed out of U.S. vaults.
By 1971, the U.S. Treasury only had enough gold to cover 22% of all dollars outstanding. It was about to run out of money.
The Birth of the Petrodollar
On August 15, 1971, President Richard Nixon closed the international gold window to stop the out ow of gold. Nixon assured the world that this closure would only be temporary.
“Your dollar will be worth just as much tomorrow as it is today,” Nixon proclaimed on television with a straight face. “The e ect of this action, in other words, will be to stabilize the dollar.”
But Nixon had a trick up his sleeves.
Along with his Secretary of State Henry Kissinger, Nixon struck a deal with the Saudi Royal Family. The Saudis agreed to price all international oil sales exclusively in U.S. dollars. They would refuse settlement in all other currencies. In return, the U.S. would provide military protection and military-grade weapons.
This deal e ectively kept the U.S. dollar as the world’s reserve currency, even with the breakdown of the Bretton Woods System.
By 1975, all OPEC nations followed suit and agreed to settle oil trades exclusively in dollars. These were the largest oil producers in the world, and they only accepted dollars. Which meant all other countries still needed to obtain dollars to purchase oil.
This is where we stand today.
We are in the midst of a global experiment with at money.
Since 1971, the U.S. dollar and all other currencies have been created from nothing by government decree. That is the de nition of “ at” currency.
All restraints on currency creation have been removed.
It took a little while for governments to catch on. But throughout the 1980s, national governments realized they had unlimited money to spend.
And spend they did.
But their money-for-nothing policies were not without consequences. Prices for goods and services exploded across the board as new money ooded into the economy.
That is why the hamburger that cost $0.45 in 1971 costs $5 today.
The obscured fact is that this is not a case of rising prices. Your dollars are actually losing value over time—thus requiring more dollars to buy the same item. Price in ation is an arti cial monetary event.
To come full circle, the U.S. dollar has lost 96% of its value since the Federal Reserve opened its doors in 1913. Stated another way, the dollar could purchase nearly 50 times more goods and services back in 1913 than it can today.
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