Sunday, August 15, marked exactly 50 years since President Richard Nixon ended the use of gold as a monetary standard. This broke the link between the dollar and gold, wiped out the Bretton Woods system and eliminated the gold standard. Since then, the entire global financial system has been based on unsecured fiat money .
The end of the gold standard
In the early 1970s, the world’s major currencies were pegged to the US dollar, which the Federal Reserve was required to exchange at a rate of $35 per ounce of gold. As the price of gold began to rise since the middle of the century, 8 governments created, for the first time, a cartel known as the London Gold Pool, which tried to stop the rise in the price of gold.
The reason for the creation of the London Gold Pool was because the American gold reserves in Fort Knox had collapsed dramatically. By 1966, foreign central banks held $14 billion, while the Federal Reserve held $13.2 billion in gold. But only $3.2 billion could be used to convert dollars outside the United States. The remaining 10 billion was to be used for domestic transactions.
Thus, if governments around the world decided to exchange 25% of their dollars for gold, the Federal Reserve would not have enough of the precious metal to make its payments. Since the mid- 1960s , the United States was in a state of technical bankruptcy.
Gold – the brake on the arbitrariness of governments
The bankruptcy of the United States is reason enough for the political decision to abandon the gold standard. However, it is not the only reason. When the dollar was pegged to gold, the government’s hands were tied.
And in the 1960s and 1970s, the government certainly wanted to dig deep into the pockets of big-ticket projects the US was involved in, such as the Vietnam War .
For the financial system, this move is disastrous. As we will see below, the abandonment of the gold standard had only negative effects. The main victims, ordinary people.
The Beginning Of Inflation And The Destruction Of Purchasing Power
The economic definition of “inflation” is: “increase in the amount of money in circulation”. Under the gold standard, politicians cannot inflate currencies indefinitely. When this happens, holders of the notes exchange them for gold, which thins the central bank’s reserves. The result is a loss of currency collateral and a currency crisis.
Therefore, until the 20th century, the phenomenon of hyperinflation was unknown in the world. The only documented episode in history was in France in 1795. With the creation of modern central banks, until 1971 there were still a few examples of hyperinflation that remain infamous in the history books. After the end of the gold standard, practically half the world feels how oppressive it can be to double prices in a matter of days or sometimes hours.
Fiat money appears on the scene
When the great economist Ludwig von Mises wrote The Theory of Credit and Money in 1912, the possibility of using unsecured fiat money seemed like a mere theoretical hypothesis, not a real threat. Three and a half decades later, when he published his magnum opus, Human Action, his view was more or less the same.
But after August 15, 1971, the hypothetical risk materialized. Money loses its cover. Countries around the world can print as much as they want. Politicians and the central banks they run don’t hesitate to do it. The money supply went from 60% of GDP in 1960 to 100% of GDP in 2008. Judging by the dynamics, its next doubling will take place in a much shorter period.