Last Monday was the 40th anniversary of President Nixon’s unilateral decision to end the 1944 Bretton Woods system of international exchange which tied the US dollar to gold at a rate of $35 per ounce. We’ve been paying for it ever since and that the current international financial turmoil is evidence. Gold closed for the first time above $1,800 per ounce this week, meaning the dollar since Nixon’s time has depreciated to about 18 cents.
What hath Nixon wrought?
The economies of the post-World War II world had to be rebuilt and one way to do that quickly was through international trade. Free trade relied on a predictable conversion of international currencies since there was no “world currency” or world government that could issue currency and manage it. Therefore the architects of the Bretton Woods system set up a system of fixed exchange rates that allowed governments to buy or sell their gold at the price equivalent to $35 per ounce.
If a country was overstocked with dollars because of positive trade balance with the US, its central bank could present a pile of dollars to the central bank of the US (i.e. the Federal Reserve) and get it redeemed for gold at $35 per ounce instead of holding dollars. Why would central banks do this? Because they might believe the US was printing too many dollars – like Nixon did to pay for the Viet Nam war. There was obviously a limit, however, to how long the US Fed could exchange gold for dollars before it had none and therefore had no backing to its currency.
Faced with that fact, Nixon announced on August 15, 1971 that the US would no longer honor the Bretton Woods arrangement, thus breaking the links between the major world currencies and a real commodity like gold. The gold standard has not been used in any major economy since that time.
The dollar thereafter became “fiat currency,” backed by nothing but the “full faith and credit” of the federal government – a euphemism for its ability to tax its citizens. In effect the dollar was worth what people thought it was worth. This became known as the Nixon Shock in which the US dollar replaced gold as the sole backing of currencies and became the reserve currency for other sovereign states.
One advantage – some say the only advantage – of tying a currency to a gold standard is that it prevents a country from printing too much money. If the money supply rises too fast, then people will exchange the money being cheapened by its abundance for gold whose supply is fixed in the short term. Over-printing money will therefore cause the country’s treasury to eventually run out of gold – an incentive to turn off the printing presses. In the case of the US, the Fed would be restricted from enacting policies that significantly alter the growth of the money supply, which in turn limits the inflation rate of the country.
The gold standard also impacts foreign exchange markets. If Canada is on the gold standard and has set the price of gold at $100 Canadian an ounce and Mexico is also on the gold standard and set the price of gold at 5,000 pesos an ounce, then one Canadian Dollar must be worth 50 pesos. The widespread use among countries of gold standards therefore establishes a system of fixed exchange rates. If all countries are on a gold standard, there is then only one real currency, gold, from which all others derive their value. The stability that the gold standard imposes on the foreign exchange market is often cited as another of its benefits.
While the stability caused by the gold standard is among its greatest strengths, it is also one of its greatest weaknesses. If exchange rates between currencies are fixed, notwithstanding the changes in the economies of those countries, a profligate country is insulated from suffering the monetary consequences of trashing its economy. Moreover, a gold standard severely limits the stabilization policies the Federal Reserve can use to combat bona fide requirements to print money – like calming the stock market sell-off panic of 1987. These attributes cause countries with gold standards to have severe economic cycles.
So it might seem that the only benefit of the gold standard is that it prevents long-term inflation in a country by blocking the over-printing of money. However, some gold standard critics point out that even this benefit is questionable. If you don’t trust a central bank to keep inflation low, why should you trust it to remain on the gold standard for generations? Or to stick with the exchange to which the currency is tied?
But absent a gold-based currency, all sorts of currency skullduggery becomes available to a government. The US, for example, can inflate its way out of debt. Greece can’t do that; because it traded the drachma for the euro in 2001, and Greece can’t print euros. Many say the US ought to take advantage of this unique opportunity. Inflation, they argue, is good for debtors and bad for creditors, and we should not forget that the US is the world’s biggest debtor nation. Judicious money printing – what Fed Chairman Bernanke calls “quantitative easing” – supposedly lets the Fed control inflation somewhat. While inflation like taxes acts as a drag on economic growth, and while it hits the poor harder than any group in society, politicians can shrug their shoulders on election day and claim innocence in causing inflation which they can’t do when they raise taxes.
But investors around the world aren’t taken in by currency manipulations. They know the incompetence of the US in managing its financial affairs can explode into a fiscal crisis at any time. And they know demagogues like Obama penalize success by taxing it away and whining about corporate jets – all the while creating an economic climate that is hostile to business and causes it to park $1.5 trillion on the sidelines instead of creating jobs. The recent stock market roller coaster is symptomatic of what these policies cause: the flight to gold – the historic haven from inflation and government-caused bubbles.
Were it not for Nixon, it is quite likely that we would not have suffered the financial crisis of the past four years; or the multiple crises that have rocked world economies. We likely would have avoided the recent stock market roller coaster and S&P downgrade, both of which came after the feeble debt ceiling settlement.
How?
When a bank creates credit for a private loan to a business or individual, it expands the money supply. If nothing else changed there would then be more money chasing the same quantity of goods – the prescription for inflation. The thing that prevents inflation in this case, however, is that the bank expects something in return for its loan – a return of its principal with interest. This means the borrower has to do something to get richer in the future in order to repay the loan with interest and do so fairly quickly – not decades down the road. The economic return created and the relative speed with which it’s created assures that the monetary system only increases the money supply in parallel with an increase in output – more goods – which is not inflationary. Should the borrower fail to get rich enough to repay the loan and defaults, the bank loses some of its capital and must restrict its future lending.
This is not the case when the government borrows money. Unlike business or individual borrowing, which may default because of incompetence or circumstances that can’t be controlled, the government is presumably always a good risk to the extent that it taxes its citizens to repay its loans. (People often forget that the government is a pauper supported by its productive class. Moreover, the US government has an outstanding record in its ability to collect taxes relative to that of other countries whose citizens make tax evasion an art form.)
A loan to the government increases the money supply just as a private sector loan. But that is where the similarity ends. Government borrowing is not compelled to create wealth to repay its obligations since taxpayers are its default protection – its collateral, if you will. And government borrowing is almost always wasted because its expenditures create no offsetting value for the economy. Defense spending, while judicious in a dangerous world, is waste. Welfare spending, while humanitarian, is waste. America’s nomenklatura may beat its collective breast and boast about the jobs government creates, but government creates “jobs” by hiring one person to dig a hole and another to fill it up. Then how about the millions on the government payroll who comprise its bureaucracy? Government pays people to administer its programs, most of which are waste – the equivalent of digging a hole and refilling it repeatedly. But government can’t create the equivalent to a private sector good or service or the value-creating jobs that produce those products and services.
Absent the linkage between money supply and the added value needed to get richer, which exists in private sector borrowing and spending, government borrowing and spending is always inflationary, doubly so because taxing also removes money from the private sector that would otherwise be productively deployed.
None other than Alan Greenspan recognized these defects and spoke in favor of a gold-based currency. In his essay “Gold and Economic Freedom” he wrote that the opposition to the gold standard by big government welfare state advocates was prompted by their recognition that the gold standard is incompatible with the chronic deficit spending needed to support the welfare state. The welfare state, he further notes, is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support its welfare schemes and that this confiscation is accomplished through taxation and inflation.
Over 40 years ago, Greenspan said welfare (which we call entitlements today) statists are quick to recognize that if they wish to retain political power, the amount of taxation had to be limited, and they had to resort to borrowing to support welfare and other programs. Borrowing became the drug for deficit spending, and the governments of industrialized economies are addicted to it.
A gold standard currency restricts the amount of deficit spending because every extension of credit must be offset by a claim on tangible assets. But absent a gold standard, the government issues bonds that are not backed by tangible assets. They are backed government's promise to repay debt out of future tax revenues – in effect mortgaging future generations who become the government’s collateral. As more and more is borrowed, then more and more bonds are printed and sold to creditors but only by increasing the interest rate. Year after year deficits pile up forming a fiscal coral reef that we call the national debt – now $14 trillion in the US.
By abandoning the gold standard, Nixon allowed future government statists like Obama to throw away the national debit card and opened the way for them to convert the banking system to an unlimited credit card. Treasury bonds replaced tangible assets and became treated as if they were what a deposit of gold formerly was.
Until recently, the US government recognized the danger in allowing its citizens to own gold and prevented it. Since growing the money supply increases inflation and inflation causes society’s earnings and savings to lose value, inflation is confiscation in disguise. Without the gold standard, there is no way to prevent this confiscation. Roosevelt realized that if everyone converted their bank deposits into gold (or silver, or another valuable commodity) and refused to accept paper money or checks as payment for obligations, the government could not create its massive borrowing potential by issuing Treasury bonds. Therefore, he issued his illegal and unconstitutional 1933 Executive Order 6102 forbidding private holdings of gold. President Ford sensibly repealed it in 1974.
In the first 19 months of the Obama administration, the federal debt held by the public increased by $2.53 trillion, which is more than the cumulative total of the national debt amassed by all US presidents from George Washington through Ronald Reagan. Most Americans understand that their currency is losing value and that their tangible assets – homes, stocks, personal property – are being undermined by government spending. That is why there is a flight to gold pushing its price over $1,800 per ounce with expectations that it could go above $2,000 if not more by year end.
It may not be possible to get our government back on a gold standard. But many of us are already there.
What hath Nixon wrought?
The economies of the post-World War II world had to be rebuilt and one way to do that quickly was through international trade. Free trade relied on a predictable conversion of international currencies since there was no “world currency” or world government that could issue currency and manage it. Therefore the architects of the Bretton Woods system set up a system of fixed exchange rates that allowed governments to buy or sell their gold at the price equivalent to $35 per ounce.
If a country was overstocked with dollars because of positive trade balance with the US, its central bank could present a pile of dollars to the central bank of the US (i.e. the Federal Reserve) and get it redeemed for gold at $35 per ounce instead of holding dollars. Why would central banks do this? Because they might believe the US was printing too many dollars – like Nixon did to pay for the Viet Nam war. There was obviously a limit, however, to how long the US Fed could exchange gold for dollars before it had none and therefore had no backing to its currency.
Faced with that fact, Nixon announced on August 15, 1971 that the US would no longer honor the Bretton Woods arrangement, thus breaking the links between the major world currencies and a real commodity like gold. The gold standard has not been used in any major economy since that time.
The dollar thereafter became “fiat currency,” backed by nothing but the “full faith and credit” of the federal government – a euphemism for its ability to tax its citizens. In effect the dollar was worth what people thought it was worth. This became known as the Nixon Shock in which the US dollar replaced gold as the sole backing of currencies and became the reserve currency for other sovereign states.
One advantage – some say the only advantage – of tying a currency to a gold standard is that it prevents a country from printing too much money. If the money supply rises too fast, then people will exchange the money being cheapened by its abundance for gold whose supply is fixed in the short term. Over-printing money will therefore cause the country’s treasury to eventually run out of gold – an incentive to turn off the printing presses. In the case of the US, the Fed would be restricted from enacting policies that significantly alter the growth of the money supply, which in turn limits the inflation rate of the country.
The gold standard also impacts foreign exchange markets. If Canada is on the gold standard and has set the price of gold at $100 Canadian an ounce and Mexico is also on the gold standard and set the price of gold at 5,000 pesos an ounce, then one Canadian Dollar must be worth 50 pesos. The widespread use among countries of gold standards therefore establishes a system of fixed exchange rates. If all countries are on a gold standard, there is then only one real currency, gold, from which all others derive their value. The stability that the gold standard imposes on the foreign exchange market is often cited as another of its benefits.
While the stability caused by the gold standard is among its greatest strengths, it is also one of its greatest weaknesses. If exchange rates between currencies are fixed, notwithstanding the changes in the economies of those countries, a profligate country is insulated from suffering the monetary consequences of trashing its economy. Moreover, a gold standard severely limits the stabilization policies the Federal Reserve can use to combat bona fide requirements to print money – like calming the stock market sell-off panic of 1987. These attributes cause countries with gold standards to have severe economic cycles.
So it might seem that the only benefit of the gold standard is that it prevents long-term inflation in a country by blocking the over-printing of money. However, some gold standard critics point out that even this benefit is questionable. If you don’t trust a central bank to keep inflation low, why should you trust it to remain on the gold standard for generations? Or to stick with the exchange to which the currency is tied?
But absent a gold-based currency, all sorts of currency skullduggery becomes available to a government. The US, for example, can inflate its way out of debt. Greece can’t do that; because it traded the drachma for the euro in 2001, and Greece can’t print euros. Many say the US ought to take advantage of this unique opportunity. Inflation, they argue, is good for debtors and bad for creditors, and we should not forget that the US is the world’s biggest debtor nation. Judicious money printing – what Fed Chairman Bernanke calls “quantitative easing” – supposedly lets the Fed control inflation somewhat. While inflation like taxes acts as a drag on economic growth, and while it hits the poor harder than any group in society, politicians can shrug their shoulders on election day and claim innocence in causing inflation which they can’t do when they raise taxes.
But investors around the world aren’t taken in by currency manipulations. They know the incompetence of the US in managing its financial affairs can explode into a fiscal crisis at any time. And they know demagogues like Obama penalize success by taxing it away and whining about corporate jets – all the while creating an economic climate that is hostile to business and causes it to park $1.5 trillion on the sidelines instead of creating jobs. The recent stock market roller coaster is symptomatic of what these policies cause: the flight to gold – the historic haven from inflation and government-caused bubbles.
Were it not for Nixon, it is quite likely that we would not have suffered the financial crisis of the past four years; or the multiple crises that have rocked world economies. We likely would have avoided the recent stock market roller coaster and S&P downgrade, both of which came after the feeble debt ceiling settlement.
How?
When a bank creates credit for a private loan to a business or individual, it expands the money supply. If nothing else changed there would then be more money chasing the same quantity of goods – the prescription for inflation. The thing that prevents inflation in this case, however, is that the bank expects something in return for its loan – a return of its principal with interest. This means the borrower has to do something to get richer in the future in order to repay the loan with interest and do so fairly quickly – not decades down the road. The economic return created and the relative speed with which it’s created assures that the monetary system only increases the money supply in parallel with an increase in output – more goods – which is not inflationary. Should the borrower fail to get rich enough to repay the loan and defaults, the bank loses some of its capital and must restrict its future lending.
This is not the case when the government borrows money. Unlike business or individual borrowing, which may default because of incompetence or circumstances that can’t be controlled, the government is presumably always a good risk to the extent that it taxes its citizens to repay its loans. (People often forget that the government is a pauper supported by its productive class. Moreover, the US government has an outstanding record in its ability to collect taxes relative to that of other countries whose citizens make tax evasion an art form.)
A loan to the government increases the money supply just as a private sector loan. But that is where the similarity ends. Government borrowing is not compelled to create wealth to repay its obligations since taxpayers are its default protection – its collateral, if you will. And government borrowing is almost always wasted because its expenditures create no offsetting value for the economy. Defense spending, while judicious in a dangerous world, is waste. Welfare spending, while humanitarian, is waste. America’s nomenklatura may beat its collective breast and boast about the jobs government creates, but government creates “jobs” by hiring one person to dig a hole and another to fill it up. Then how about the millions on the government payroll who comprise its bureaucracy? Government pays people to administer its programs, most of which are waste – the equivalent of digging a hole and refilling it repeatedly. But government can’t create the equivalent to a private sector good or service or the value-creating jobs that produce those products and services.
Absent the linkage between money supply and the added value needed to get richer, which exists in private sector borrowing and spending, government borrowing and spending is always inflationary, doubly so because taxing also removes money from the private sector that would otherwise be productively deployed.
None other than Alan Greenspan recognized these defects and spoke in favor of a gold-based currency. In his essay “Gold and Economic Freedom” he wrote that the opposition to the gold standard by big government welfare state advocates was prompted by their recognition that the gold standard is incompatible with the chronic deficit spending needed to support the welfare state. The welfare state, he further notes, is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support its welfare schemes and that this confiscation is accomplished through taxation and inflation.
Over 40 years ago, Greenspan said welfare (which we call entitlements today) statists are quick to recognize that if they wish to retain political power, the amount of taxation had to be limited, and they had to resort to borrowing to support welfare and other programs. Borrowing became the drug for deficit spending, and the governments of industrialized economies are addicted to it.
A gold standard currency restricts the amount of deficit spending because every extension of credit must be offset by a claim on tangible assets. But absent a gold standard, the government issues bonds that are not backed by tangible assets. They are backed government's promise to repay debt out of future tax revenues – in effect mortgaging future generations who become the government’s collateral. As more and more is borrowed, then more and more bonds are printed and sold to creditors but only by increasing the interest rate. Year after year deficits pile up forming a fiscal coral reef that we call the national debt – now $14 trillion in the US.
By abandoning the gold standard, Nixon allowed future government statists like Obama to throw away the national debit card and opened the way for them to convert the banking system to an unlimited credit card. Treasury bonds replaced tangible assets and became treated as if they were what a deposit of gold formerly was.
Until recently, the US government recognized the danger in allowing its citizens to own gold and prevented it. Since growing the money supply increases inflation and inflation causes society’s earnings and savings to lose value, inflation is confiscation in disguise. Without the gold standard, there is no way to prevent this confiscation. Roosevelt realized that if everyone converted their bank deposits into gold (or silver, or another valuable commodity) and refused to accept paper money or checks as payment for obligations, the government could not create its massive borrowing potential by issuing Treasury bonds. Therefore, he issued his illegal and unconstitutional 1933 Executive Order 6102 forbidding private holdings of gold. President Ford sensibly repealed it in 1974.
In the first 19 months of the Obama administration, the federal debt held by the public increased by $2.53 trillion, which is more than the cumulative total of the national debt amassed by all US presidents from George Washington through Ronald Reagan. Most Americans understand that their currency is losing value and that their tangible assets – homes, stocks, personal property – are being undermined by government spending. That is why there is a flight to gold pushing its price over $1,800 per ounce with expectations that it could go above $2,000 if not more by year end.
It may not be possible to get our government back on a gold standard. But many of us are already there.
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