From Gold to Dollar to Libra? — A Glimpse at the History of Currency
Is Bitcoin a currency? That is the key question people were asking throughout 2017. Since Libra debuted last week as a digital currency, this question is once again back in the spotlight. Below is my attempt at understanding what currency really means, by going back to 1944.
01 The Bretton Woods Conference
It was July 1944 in Bretton Woods, New Hampshire. The gorgeous Mount Washington Hotel sat under the blue sky. Looking out from its windows, expanses of green grass reached toward forested hills. When the wind blew, the grass slightly tilted, tranquilly whispering in the air.
Amidst this peaceful setting, 730 delegates from 44 allied nations gathered together. With WWII rapidly progressing toward an allied victory, the nations began to plan the post-war world order. The delegates at Bretton Woods would design the international monetary system to be built after WWII. The conference lasted for 22 days. Results from this conference were mainly three agreements:
- Adjustable pegged FX market: Dollar is pegged to Gold at $35 per oz + Other currencies are at almost pegged to Dollar, only allowing small fluctuates
- Create IMF to promote stability of exchange rates and financial flows
- Create IBRD to help post-war reconstruction
Since the U.S. was the superpower left after WWII, and with a gold reserve amount ~$26Bn at the time (an astonishing ~65% of the global gold reserve), it only seems logical to peg other currencies to Dollar. The Bretton Woods Agreement thus marked the beginning of a new era in which USD becomes a global currency.
02 The Nixon Shock
Thanks in part to stable exchange rates, the global economy recovered quickly after the war. U.S. imports of goods soared dramatically over the next decade. To support those imports, U.S. inevitably printed more dollars. However, the amount of gold did not increase much. As a result, by 1960, one could trade gold at $40 per oz on the London exchange.
Charles de Gaulle was the first man in a high position who pointed out the convertibility problem. In February 1965, he gathered journalists from around the globe and charged the U.S. with not holding enough gold in reserve for convertibility. He himself announced his intention to exchange France’s U.S. dollar reserves for gold at the official exchange rate. It wasn’t until the summer of 1971 when a “bank run” seems likely. To look at some numbers:
- From 1950 to 1969, U.S. share of the world’s economic output dropped from 35% to 27%
- Negative trade balance of over $8Bn
- Growing public debt incurred by the Vietnam War reached $52Bn by 1971
- Inflation close to 6%
Further, with reelection on the horizon, President Nixon did not want to raise interest rates and risk a recession. With all these forces at work, the next step was inevitable. In August 1971, President Nixon directed U.S. Treasury to suspend the conversion between dollar and gold. This, marked the end of an era where currency was backed by physical assets, and a new era began.
Interestingly, one would probably ask, if it is possible to go back to Gold? After all, it was U.S. who had a problem, right? Well, probably not, said the Triffin Dilemma. In short, the Triffin Dilemma stated that if there is no trade deficit, then Dollar would lose its liquidity and would not be able to support global growth; and if the trade deficit is continuing, then the Dollar would lose its credibility in the long run.
03 Dollar, and Oil!
After the Nixon announcement, we entered into an era of floating currencies (to be discussed more in section 04). However, the dollar still acts as a main currency in international trades, largely thanks to oil.
The first oil crisis began in October 1973 when OPEC proclaimed an oil embargo. The embargo was targeted at nations perceived as supporting Israel during the Yom Kippur War, including U.S. Further, oil prices sky-rocked in the early 1970s, creating more trade deficit for importers, again, including U.S. In the middle of the financial turmoil, in July 1974, William Simon, newly appointed U.S. Treasury secretary, and his deputy, Gerry Parsky, met with leaders from Saudi Arabia. The purpose of this meeting, according to a Bloomberg article, was “the U.S. would buy oil from Saudi Arabia and provide the kingdom military aid and equipment. In return, the Saudis would plow billions of their petrodollar revenue back into U.S. Treasuries”.
Results of this agreement were significant in my mind:
- Since Saudi Arabia is the biggest exported in OPEC, dollar soon became the currency for oil trading, and thus made dollar the dominant currency in global trades.
- Saudi became a key lender to the U.S, allowing the U.S. to borrow at a low funding cost. By 1977, Saudi Arabia had accumulated ~ 20% of all Treasuries held abroad.
04 In Government, We Trust
Till this day, we use currencies issued and controlled by the government. There is no backing no anything. Purely trust. We call it, fiat currency. In the end, who doesn’t like solving economic crisis by just hitting ‘Print’. However, inflation could be a huge headache. We see that in Sudan, Venezuela, Argentina, etc. For those of us living in the U.S., this is again interesting as Yellen describes low U.S. inflation as a mystery after they print, print, and print.
05 The Future
So what’s next for global currency? Is it Bitcoin, i.e. programmable money, that we “trust”? Is it Libra that we embrace? Or, is it government issued digital fiat that we end up with? If we go down this chain of questions, do we actually end up anywhere different than where we are today?
Questions? Comments? Opinions? Hit me up. Leave me a message here or find me on Wechat: laura_mliu. All rights reserved. No reproduction without permission. Special thanks to Nicholas Yoder for proofreading.
