There are historical and dramatic events revealed to the world in thunder that cannot be ignored, such was the morning of August 6, above the skies of Hiroshima. But there are no less dramatic events that pass almost unnoticed as they occur. Such was August 15, 1971.
It all started in July 1944. In a small town in New Hampshire the victorious nations gathered in the war to determine the monetary arrangements of the future. At the conference, a new monetary system was agreed upon, according to which gold returned to being the basis of the global monetary system. To secure the agreement, named after the “Burton Woods Method” convention center, the United States undertook to convert dollars into gold at a fixed rate. This conversion commitment was to central banks. Exchange rates are fixed between all currencies and the US dollar.
In June 1945 another law was changed, the one that required a 40% gold backing on the money in circulation. From now on only a 25% backup is required. The Burton Woods system and American law together thus ensured a limited supply of money. By the end of World War II most countries, except the US, were devastated, only massive American aid could help them re-energize their economies. This was given in the form of the Marshall Plan. By the mid-1950s the devastated economies of Germany and Japan began to recover. With the Burton Woods method, the lack of a clear mechanism for internal changes in currency exchange rates.
Constant pressures on fixed exchange rates
Economies cannot exist without imports and exports, according to their areas of expertise and relative advantage. When a country maintains a continuous export surplus, the amount of barrage in its possession increases (in exchange for exports). And as exporters seek to convert it, demand for local currency increases and its price rises, compared to the price of foreign currency that falls. In the age of the classical gold standard such an imbalance was addressed by an internal mechanism known as the “price-space-flow mechanism”, but the Burton Woods agreements did not contain mechanisms for dealing with currency exchange rates stemming from a persistent imbalance in the major economic balance sheets.
In the decades after the war, the “economic miracle” took place in Germany and Japan, and by 1960, GDP per capita had tripled. This jump led to continued pressures on the currency exchange rates set out in the agreement. Simultaneously with the remarkable recovery of Japan and Germany the American economy began to creak. Continued and high spending on the Vietnam War and extensive social programs have led to ongoing government deficits and the value of the dollar has deteriorated. An ounce of gold at $ 35 was suddenly a good deal and central banks began sending the declining dollars back to Washington asking for gold in return.
The US sought to solve the problem by devaluing the dollar against the gold but many countries in the agreement objected, they saw the proposal as an American attempt to export its deficits to other countries. The gold that the US government has promised to sell at a fixed price has become a real bargain. French President de Gaulle even offered to send the French navy to accompany the gold shipments to France. In response, President Johnson decided to take action and asked Congress to release America’s “locked” gold reserves so that it could meet the conversion commitment that had already become a matter of prestige.
“There was no real discussion about the policy presented”
In August 1968, Congress acceded to the president’s request and passed the law to repeal the Gold Reserve Requirements Elimination Act and the obligation to maintain 25% gold coverage for money in circulation was repealed. With it, virtually any legal ceiling on the amount of money that can be produced has been abolished. While the law has increased the gold supply available to the U.S. to meet its Burton Woods obligations, conversion requirements from central banks around the world have continued to flow at an increasing rate.
By the end of 1968 President Johnson was completely exhausted from the entangled war in Vietnam and announced that he would not seek to run in the upcoming elections. Thus, on January 20, 1969, Richard Nixon was sworn in as the next president of the United States. In the summer of 1971, the pressure increased so much that the administration feared that the reserves of gold reserves would disappear within a few weeks. Van Conley, the colorful and former Democratic governor of Texas, to Camp David, William Sapphire, Nixon’s speechwriter, described what happened in his memoirs: “The president was the first to speak. After Nixon spoke to Secretary of the Treasury Conley, he explained the new policy. The meeting was very short, it ended in less than two hours … As for the decline in gold, the president explicitly said that we have no idea what the outcome of this move will be. “
Deputy Treasury Secretary Paul Walker, later chairman of the Federal Reserve, wrote, “There was no real discussion of the policy presented.” Capitalism and America hit such a strategic blow that they would never recover from it, and even if the process took decades, just as in the third century AD in Rome, the seeds of destruction were sown and no force could prevent them from doing their slow but inevitable action.
On Sunday evening, August 15, President Nixon went on the air and announced to the world that “in recent weeks international speculators have banned a war on the dollar … therefore I have ordered the finance minister to suspend the dollar’s conversion commitment to gold.” And so, unilaterally, an international agreement defining the entire world monetary regime came to an end.
The age of the Fiat money came into the world
For about six thousand years of history, since the ancient cultures of Muspotamia, there has been the marvelous human creation known as silver, based on the metals silver and gold. With the President’s declaration, this money is dead and the “era of fiat money” (from the Latin word meaning “this is the order”, of the sovereign) came into the world. The fuse was ignited and now had only to let time and human nature do their thing.
Maybe gold is nothing more than a “barbaric relic,” in the words of economist Keynes, and it might not have made any sense, in the words of Milton Friedman, to “invest human life and so many resources to carve gold from the depths of the earth just to bury it again in Fort Knox.” One key feature that has made it the basis of all economies throughout history, its rarity. No matter how many politicians will want to spend it and how many central bankers will want to print more of it, gold cannot be produced from the air. And so the supply of money that resulted from it was limited and final, whatever the interest rate or reserve ratio of the banks in partial reserve, whatever.
And although fifty years will pass, and perhaps even more will be required, until this change is well realized, America will not return to its financial strength again. Federal government debt will increase 78 times, as much as in terms of GDP. Similarly, the debt of the entire American economy will increase. The dollar will lose about 98% of its value against the gold and over 83% in terms of the official index. 1975 will also be the last year for America. Since then it has been sinking into a growing trade deficit, which will wreak havoc on at least half of the population. In almost every economic graph 1971 can be seen as a point where adverse change began. How and why? In the sequel.
The writer is a lawyer by education who deals with and is involved in technology. Manages an investment fund in cryptocurrencies, and lives in Silicon Valley. Author of the book A Brief History of
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