August marked the 50th anniversary of Nixon’s abandonment of the gold standard. This has caused so many problems for the economy… and the gold has not taken over?
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The 50th anniversary of the abandonment of the gold standard by Nixon
Last month marked the 50th anniversary of President Nixon’s suspension of the convertibility of the US dollar to gold. This decision broke the last and thin link between world currencies and the yellow metal, thus ending the ersatz of the gold standard that we still had at the time (the official end came in March 1973, marking the beginning of an era of free floating fiat currencies).
I wrote about the collapse of Bretton woods in the latest edition of Gold Market Snapshot, but since this was a truly revolutionary event that paved the way for today’s monetary conditions, it is worth mentioning the topic again.
You see, as weak as the watered-down post-war version of the gold standard was, it limited the ability of the U.S. central bank to increase the money income, because it was still possible for other participants in the system to exchange their dollars for gold. But Nixon “temporarily suspended” the convertibility of the dollar into gold, and as long as the gold is out, the mice will play. Without real constraints, the annual growth rate of the currency has reached double digits. The CPI inflation rate followed, and the big one stagflation 1970s, as shown in the graph below.
Moreover, without the discipline imposed by the gold standard, the central bank could much more easily monetize public debt. Governments could spend more, maintain budget deficits and increase their debt. In short, without gold as an anchor for monetary policy, we had more money printing, more debt, more inflation, and more severe financial crises.
Why is the price of gold not higher?
Now one might ask: if the current monetary system, or – as some analysts prefer to call it – the non-system is so bad, why is the price of gold not higher? Shouldn’t it be rallying, indicating how rotten our fiat-fueled economy is?
Well, there are a lot of answers to these questions. Note first that the price of gold has already jumped by around 4,100%, or more than 7.7% per year, on average, since 1971 (see graph below), which is really quite something!
Second, financial markets are big supporters of the current monetary system, how they like to let go Monetary Policy and central bank liquidity leaks. Remember that the US stock exchange welcomed the closing of the golden window increasing by 3% the day after Nixon’s infamous speech.
Third, even poor systems can run for a while. Communist economies did not collapse immediately, despite their obvious ineffectiveness. Le Bois Breton operated for almost 30 years despite its obvious flaws. In addition, some institutional changes have been implemented in order to strengthen the current system, such as independence of central banks, inflation targeting, ban on direct monetization of public debt, etc.
However, the probably most important reason is that the gold standard was somehow replaced by the US dollar standard, as the dollar replaced gold as the world’s reserve currency. In such a system, there is simply no alternative to the US dollar as a global reserve. This is because America has become even more central in global finance than it was in 1971 and because virtually all countries have monetary policies and fiscal policies (and some central banks like the BCE Where BoJ are even more radical than the fed). The strength of the greenback restricts the prices of gold denominated in dollars.
However, it should be remembered that unlike the gold standard, under which currencies were backed by gold (or: they were in fact defined as units of gold weight), today’s currencies rely only on the reputation of their issuers, which is not set in stone. This is in fact why the Bois Bretons finally collapsed. Initially, the United States had a great reputation and no one even dared to question Uncle Sam’s ability to convert dollars into gold. But the protracted war in Vietnam, Johnson’s big social programs, rising government spending and growing deficits undermined that reputation, and other countries began to demand gold for their dollars.
The same could happen in the future, especially as Trump left his mark on America’s reputation. With Biden pursuing the populist economic doctrine of his predecessor, the greenback is expected to face new headwinds. In addition, with ultra-low interest rates and colossal debt, the leeway to inflate economic bubble is limited. Although a return to the gold standard seems unlikely, the recurrence business cycles and economic crises are more than some. This is great news for gold.
In other words, the current system persists primarily through confidence in the ability of central banks to control inflation, even without the discipline of the gold standard. However, this belief can collapse one day. The Fed may be correct that the current high inflation is temporary. Corn otherwise, we could have the ‘Powell Shock’ which could bolster gold just like the Nixon Shock.
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Arkadiusz Sieron, PhD
Sunshine Profits: Effective investment through diligence and care.