However, one last obstacle remained: the pegging of paper money to gold. Throughout the entire twentieth century, the gold standard limped along on both legs. It was destroyed in the 1930s by Roosevelt and finished off by Nixon in 1971. From that point on, the “fiat unit”—a simple name with no real content, the very thing we discussed at the beginning of this note—was imposed on people by decree as money. The dream of every ruler since the Roman emperors had come true: states entered the era of unlimited money issuance.
For readers unfamiliar with this topic, I will provide a very brief chronology of the gold standard’s elimination.
Governments granted central banks a monopoly on issuing banknotes—those warehouse receipts for gold. This led private banks, which actually issued these receipts, to begin storing their reserves at the central bank. Gold gradually ended up in the vaults of central banks. All these procedures were legalized and even mandated for banks, which eagerly embraced them, since the central bank was (and made a point of emphasizing this) a “bank for banks.” It provided them with liquidity when they encountered the inevitable problems arising from fractional reserve banking. Around the same time, the practice of “suspending gold convertibility” began.
The most serious blow came with Britain’s exit from the gold standard during the First World War. But even worse were the British authorities’ attempts to revalue the pound, which had become much debased during the war, while refusing to abandon their inflationary policies. This astonishing activity led to the creation of the first palliative of the gold standard—the “gold exchange” standard, adopted at the Genoa Conference of 1922. It meant that the classical gold standard was preserved only in the USA. Britain redeemed pounds only in gold bars (suitable, obviously, for very large transactions) and dollars; other currencies were redeemed with pounds. This was the beginning of a long decline; a similar system underwent several changes, and there was less and less gold in it.
The decisive blow to the gold standard was the American president’s right to “change the gold content of the dollar,” which Roosevelt extracted from Congress in 1933. Moreover, Americans were prohibited from owning gold (except for jewelry); effectively, it was confiscated. When Roosevelt exercised this right, he triggered the second wave of the Great Depression, but that is another story. Ours, however, is drawing to a close. After the inevitable collapse of the “gold exchange” standard in 1931, the world found itself in chaos: competing devaluations, currency blocs, and so on.
The most well-known such system was Bretton Woods, based on the dollar being worth one thirty-fifth of an ounce of gold. Dollars could be exchanged for gold only at the request of the central banks of participating countries. Bretton Woods emerged largely because after the war, the US gold reserve was substantial—about $25 billion. The pyramid therefore seemed quite viable. The system allowed the US government to pursue an aggressively inflationary policy after the war. The dollar’s real value was falling; Europeans and Japan suffered from this, as they sought to maintain a stricter monetary policy. These countries were forced to hold their reserves in dollars, the quantity of which kept growing due to US policy.
The central banks of these countries constantly demanded redemption of their dollars. As a result, by the 1960s, only $9 billion remained from the original $20 billion gold reserve. Meanwhile, there were far more dollars in existence. By the end of the 1960s, Europe alone held $80 billion (the so-called “Eurodollars”). This forced dollar holders to sell them on the gold market. To maintain the price of $35 per ounce—the price that underpinned the entire system—the USA was forced to constantly pour gold onto the market. Eventually, through strong political pressure, the USA compelled the central banks of other countries to stop purchasing gold on the free market and to “fix” its price at $35 per ounce in settlements between central banks.
This decision only prolonged the death agony of the Bretton Woods system. European central banks threatened to demand redemption of their dollars. In response, President Nixon announced that dollars would no longer be exchanged for gold. In 1971, the dollar became definitively paper.
Interestingly, supporters of paper money—from Keynesians to monetarists—had predicted that if the free gold market was “untied” from the dollar (in their view, it was precisely the gold backing of the dollar that was “propping up” the price of gold), the price of gold would fall. However, the price of gold on the free market never dropped below $35, and by 1973 had already reached $125 per ounce—something that, according to the monetarists, was theoretically impossible.
Subsequently, all attempts to regulate “exchange rates” came down to two options: either “free competition” of devaluations, or fixed exchange rates.
Now let us consider the harm that central banks and state monopoly on money inflict upon us.