Hey guys. So as promised – I will give a brief breakdown of
the gold standard. The gold standard was based on valuing money based on the
quantity of gold. The standard was largely dropped in 1976- spearheaded by US
President Nixon favouring neo-classical economics.
It is worthy of note though,
that most countries still hold large gold reserves.
Here’s a somewhat random quote that will hold much more
meaning as we delve more and more into the fall of the gold standard.
“All paper money returns to its intrinsic value.” –
Voltaire.
When gold was found at Sutter's Ranch in 1848, it inspired
the Gold Rush to California and the unification of western America. In
1861, U.S.
Treasury Secretary Salmon Chase printed the first U.S. paper currency.
In fact, by the mid-1800s, most countries wanted to
standardize transactions in the booming world trade market. They adopted the gold
standard. It guaranteed that the government would redeem any amount of
paper money for its value in gold. That meant transactions no longer had to be
done with
heavy gold bullion or coins. It also increased the trust needed for
successful global trade. Paper currency now had guaranteed value tied to
something real.
Unfortunately, gold prices and currency values dropped when
miners found new gold deposits.
In 1913, the Federal
Reserve was created to stabilize gold and currency values. Before it
could get up and running, World War I broke out, and European countries
suspended the gold standard so they could print enough money to pay for
their military involvement.
Unfortunately, printing money created hyperinflation.
After the war, countries realized the value of tying their
currency to a guaranteed value in gold. For that reason, most countries
returned to a modified gold standard. (History.com, "Gold Standard")
Once the Great
Depression hit with full force, countries once again had to abandon
the gold standard. When the stock
market crashed in 1929, investors began trading in currencies and commodities.
As the price
of gold rose, people exchanged their dollars for gold. It worsened
when banks began failing. People started hoarding
gold because they didn't trust any financial
institution. (Oddly familiar)
The Federal
Reserve kept raising interest
rates, trying to make dollars more valuable and dissuade people from
further depleting the U.S. gold reserves. These higher rates worsened the
Depression by making the cost of doing business more expensive. Many
companies went bankrupt, creating record levels of unemployment.
On March 3,1933, the newly-elected President
Roosevelt closed the banks in response to a run on the gold
reserves at the Federal Reserve Bank of New York. By the time banks re-opened
on March 13, they had turned in all their gold to the Federal Reserve and could
no longer redeem dollars for gold. No one could export gold.
On April 5, he ordered Americans to turn in their
gold in exchange for dollars. He did this to prohibit hoarding of
gold, and the redemption of gold by other countries. This created the gold
reserves at Fort
Knox, and made sure the U.S. held the world's largest supply of gold.
(Source: Cato Institute, The Rise and Fall of the Gold Standard in the U.S., June
20, 2013)
On January 30, 1934, the Gold Reserve Act prohibited private ownership of gold,
except under license. It allowed the government to pay its debts in
dollars, not gold. The President was authorized to devalue the gold
dollar by 40%. He increased the price of gold, which had been $20.67
per ounce for 100 years, to $35 per ounce. The government's gold reserves
increased in valued from $4.033 billion to $7.348
billion. This effectively devalued the dollar by 60%. (Source:
Bloomberg, How Franklin Roosevelt Secretly Ended the Gold Standard, March 21,
2013; FEE.org, Gold Policy in the 1930s)
The outbreak of World War II ended the Depression, allowing
countries to go back on a modified gold standard.
The 1944
Bretton Woods Agreement set the exchange value for all currencies in
terms of gold. It obligated member countries to convert foreign official
holdings of their currencies into gold at these par values. Gold was
set at $35 per ounce. For more, see Gold Price History.
The United States held most of the world's gold. As a
result, most countries simply pegged the value of their currency to the dollar
instead. Central
banks maintained fixed
exchange rates between their currencies and the dollar.
They did this
by buying their own country's currency in foreign
exchange markets if their currency became too low relative to the
dollar. If it became too high, they'd print more of their currency and sell it.
As a result, most countries no longer needed to exchange
their currency for gold. The dollar had replaced it. As a result, the value of the
dollar increased --- even though its worth in gold remained the same.
This made the
U.S. dollar the de facto world currency.
(Source: National Mining Association, History of Gold)
In 1960, the U.S. held $19.4 billion in gold reserves
(including $1.6 billion in the International
Monetary Fund), enough to cover the $18.7 billion in foreign dollars
outstanding.
However, as the U.S. economy prospered, Americans bought
more imported goods, paying in dollars. This large balance
of payments deficit worried foreign governments that the United States
would no longer back up the dollar in gold.
Also, the Soviet Union had become a large oil producer. It
was accumulating U.S. dollars in its foreign reserves since oil is priced in
dollar. It was afraid that the United Stated would seize its bank accounts as a
tactic in the Cold War. Therefore, the USSR deposited its dollar reserves in
European banks. These became known as eurodollars.
By 1970, the United States only held $14.5 billion in gold
against foreign dollar holdings of $45.7 billion. At the same time, President
Nixon's economic policies had created stagflation. This double-digit
inflation reduced the eurodollar's value. More and more banks started redeeming
their holdings for gold. The United States could no longer meets its
obligation. (Source: "Evolution of the Forex Market," OANDA)
The gold standard ended on August 15, 1971. That's when
Nixon changed the dollar/gold relationship to $38 per ounce. He no longer
allowed the Fed to redeem dollars with gold. That made the gold standard
virtually meaningless, since it was on paper only. The U.S. government repriced
gold to $42 per ounce in 1973, and then decoupled the value of the
dollar from gold altogether in 1976. The price of gold quickly
shot up to $120 per ounce in the free
market. (Source: Craig K. Elwell, "Brief History of
the Gold Standard in the United States," Congressional Research
Service, June 3, 2011. "Fuss Over Dollar Devaluation," Time, October
4, 1971)
Once the gold standard was dropped, countries began printing
more of their own currency. Inflation usually
resulted, but for the most part abandoning the gold standard created more economic
growth.
However, gold has never lost its appeal as an asset of
real value. Whenever recessions or
inflation looms, investors return to gold as a safe haven.
The gold standard lives on- in us. I will be talking of the fiat system next series, but as we have seen, wars kinda bought about fiat's origins.
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