The year is 1971: the dollar is officially convertible to gold at the rate of $35 an ounce. The London Gold Pool, set up to defend the convertibility of the dollar into gold, collapsed some three years earlier. A belligerent President de Gaulle in France is the first to withdraw from the London Gold Pool and subsequently orders the transfer of large reserves of gold bullion from New York to Paris. He does not, however, withdraw France from the Bretton Woods agreement.
Despite the best efforts of the United States and her allies between 1968 and 1971, a significant arbitrage opportunity continues to be present between the official gold price and the real price on some private markets. Gold and currency speculation hurt the Allies and eventually West Germany gives up on defending the dollar, abandons Bretton Woods, followed by Switzerland and France (again!). This is a very short summary of multiple ructions and currency crises between the 60s and early 70s. We forget very quickly.
In France, the Bretton Woods system was called “America’s exorbitant privilege” as it resulted in an “asymmetric financial system” where non-US citizens “see themselves supporting American living standards and subsidizing American multinationals”. As American economist Barry Eichengreen summarized: “It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one”.
US reserves of gold had dwindled from over 20 000 tons to just over 8100 tons. All spent defending the dollar. The Vietnam war is costing an absolute fortune and bleeding the US dry. Literally and figuratively. Unemployment is running at about 6% and inflation at 5.84%. Both seen as uncommonly high since WWII.
In 1971 Richard Nixon had two choices: either take steps to balance the books, I.e. drastically cut government expenditure, increase taxes, reduce US inflation by increasing interest rates, and restore faith in the dollar, or suspend the convertibility of the US dollar into gold. He chose the latter and did it without consultation with Allies. The announcement on 15th August 1971 was accompanied by a mandated freeze on all wages and prices for 90 days. Imagine that today! In addition, an additional import tax on all items of 10% was thought necessary to protect American products against cheaper imports.
On 15th August 1971, I was just over 12 yrs old. I remember my father, a normally typical restrained British chartered accountant (when that meant something) going absolutely nuts. He opened champagne, started singing and danced with my mum. Guess he knew it was coming but not when.
1971 marked the end of any pretence at backing currencies with gold. We now have fiat currencies backed by nothing but ’full faith and confidence’ in the issuing authority. The establishment of fully fledged fiat currencies has enabled all the debt based financial engineering we see around us today. It has worked as long as increase in money supply has been matched by increase in GDP: balanced growth. Problem is GDP growth cannot continue indefinitely without consequences for the environment and planet.
So what now?