Although it happened more than 40 years ago, many Americans still rue the day back in 1971 when U.S. President Richard M. Nixon effectively took this country off the so-called ”gold standard.”
Under a true gold standard, paper notes are “convertible” into pre-determined, fixed quantities of the “yellow metal.”
What actually happened back in 1971 was that President Nixon – facing huge budget and trade deficits, and a plunging dollar – enacted a series of economic moves, including the unilateral cancellation of the direct convertibility of the U.S. dollar into gold.
By slamming the “gold window” shut, Nixon also brought down the curtain on the existing Bretton Woods system of global financial exchange.
The fallout was immediate, creating a situation that financial historians still refer to as the “Nixon Shock.”
Proponents of the gold standard say the real damage is still being wrought: That decision four decades ago led directly to the uncertainty, volatility and irresponsibility that we see in the U.S. economy and global financial markets today.
Whether you agree or not is a topic for another time.
But what I’m here to tell you today is that the world’s central banks have quietly – almost secretly – returned the world to a new version of the gold standard.
Who destroyed the U.S. middle class?
The difficulties experienced by the great middle in the U.S. can be, in my opinion, traced to the delinking of the U.S. dollar from gold in 1971. Now, I know a lot of people are going to say that is ridiculous. But, one reason I say that is, even by the U.S. government’s own statistics, the income of the median full-time male worker begins to stagnate at exactly that point, after rising by huge amounts during the 1950s and 1960s.
The median U.S. full-time male income was $47,715 in 2010. In 1969, it was $44,455. The 1969 numbers are of course “adjusted for inflation,” and you know that the government’s inflation adjustments are thoroughly low-balled. With slightly more honest statistics, the trend would not be flat, but instead downward over the past forty years.
Another way of looking at it is in terms of ounces of gold. After all, gold was the monetary basis of the United States for 182 years, from 1789 to 1971, so why shouldn’t we use that as a measure of how much people are really getting paid?
Our median worker, in 1969, made $8,668 nominal. But, in those days, the dollar was worth 1/35th of an ounce of gold. It works out to 248 ounces of gold. In 2010, the dollar’s value was, on average, about 1/1224th of an ounce of gold, and the full-time male worker was making only 39 ounces of gold. This figure exaggerates the situation somewhat, due to the rapid decline of the dollar vs. gold in recent years, but it describes, I would say, the economic reality of the situation.
Let’s take a look at some history.
August 15 marks the 40th anniversary of the United States' abandonment of the last vestiges of the gold standard (actually a gold-exchange standard under the Bretton Woods system ratified by Congress in 1945 or, as Gary North describes it in a LewRockwell.com column on the subject, a "government promise standard.").
In President Richard Nixon's address to the nation on that fateful day in 1971, where he compounded his economic error by imposing wage and price controls and a 10% tariff on imported goods, he announced:
I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary [John] Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interests of monetary stability and in the best interests of the United States.
(See a video clip of Tricky Dick's address on the Monday edition of CNBC's "The Kudlow Report" here.)
Note that the "speculators" were blamed for the nation's economic ills—just as they were during the financial and housing crisis of 2008 and the European debt crisis now—rather than unsustainable central bank credit expansions and government spending. Note also that this government directive was purportedly a temporary measure. Now where have we heard that before?
The Bretton Woods system was not a classical gold standard, so it ultimately proved to be unsustainable (see this Mises.org article by Robert P. Murphy for a concise description of the Bretton Woods system and its shortcomings), but the fiat (paper) money system that replaced it was destined to be even worse. Freed of any constraints on printing ever more money out of thin air, the United States, through the Federal Reserve, has run the printing presses with impunity (as has the rest of the world), resulting in higher inflation and an even more rapid devaluation of the currency.
As Lewis E. Lehrman notes in his Wall Street Journal article today, the dollar has lost 82% of its purchasing power since the government abandoned the Bretton Woods system (see the chart from the article below).
The economy has also suffered in terms of inflation, economic growth, and unemployment since going to a pure fiat money system.
As of Monday morning, we managed to survive four decades of fiat money — though, given the chaos in markets in recent weeks, it is anyone’s guess how much longer it will last.
On August 15, 1971, with the US public finances straitened by the cost of the war in Vietnam, Richard Nixon finally cut the link between the US dollar and gold. Until then, the US Treasury was duty bound to exchange an ounce of gold with central banks willing to pay them $35.
Suddenly, for the first time in history, the level of the world’s currencies depended not on the value of gold or some other tangible commodity but on the amount of trust investors had in that currency. Central banks were allowed to set monetary policy based on their instincts rather than on the need to keep their currency in line with gold.
It was one of those seminal moments whose significance has only gradually become apparent, obscured as it was at the time by Vietnam and then Watergate. But the more one examines economic history, the more obvious it is that this was one of the most important policy decisions in modern history.
Were it not for that decision, it is quite feasible that we would not have suffered the financial crisis of the past four years; or indeed the crisis after crisis that have beset the world’s markets. We might not have just faced the most volatile few weeks in markets since 2008.
It isn’t that the previous Bretton Woods regime – in which currencies around the world were also pegged to gold, by way of the dollar — was perfect.
Far from it. But understanding the problems with the imperfect international monetary system we inherited from Nixon can help enlighten us on so many of the fundamental problems the world economy is facing: Why, for instance, does the West borrow so much and the East save excessively? Why do we seem to be fighting a losing battle with inflation? Why is protectionism on the rise again?
Let’s start with first principles: for as long as anyone can remember, politicians have sought to spend more than they can afford. Since the invention of money they have discovered ever more ingenious ways to do so.
The initial method involved debasing the currency. Henry VIII earned his nickname ‘Old Coppernose’ because he added so much copper to what were supposed to be silver coins that eventually it would show through on the nose of his portrait.
These bouts of debasement typically end in disaster, as faith is lost in the currency, inflation shoots through the roof and the economy collapses, after which politicians introduce a new, more credible system.