The history of the Gold Standard & explosion of debt
A journey through the attempt to peg fiat currencies to gold
The discovery of gold flakes in the American River at the base of the Sierra Nevada Mountains in 1848 sparked what would become known as the California Gold Rush. In 1861 the United States treasury secretary Salmon Chase was printing paper currency and the Gold Standard Act mandated that gold would be the only commodity accepted to redeem that paper currency. The law set the value of gold at $20.67 per ounce.
Around this period other countries began adopting gold standards ensuring that their governments would redeem their paper currency for an equivalent value in gold. This had the effect of improving the speed of business as heavy golden coins or bullion did not need to be handled and this improved international trust in the developing global trade markets. The ultimate effect of gold standards were to give value to paper money as it was backed by something physical. One problem with this system however, was that the value of paper money dropped whenever new deposits of gold were discovered.
The founding of the Federal Reserve is something that is not widely discussed and is beyond the remit of this article, but the history is fascinating and deserves investigation. The Federal Reserve was ostensibly created in 1913 to stabilize gold and currency values however, it is clear that the Federal Reserve has been used for other less publicized purposes.
During World War I the gold standard was suspended in European countries to enable them to print enough money to fund their wartime expenditure. This overprinting of unbacked paper money in some cases lead to hyperinflation and highlighted the value of pegging paper currencies to a guaranteed value in gold. This ultimately led to a return to the gold standard.
The Great Depression created another challenge for the gold standard. The legendary stock market crash of 1929 lead to a rise in the price of gold. The ensuing rush by people desperate to redeem their dollars for gold lead to banks failing and a culture of hoarding gold as the result of the failing community trust in financial institutions. In response, the Federal Reserve went through a series of interest rate hikes. Their stated goal was to increase the value of the dollar and make dollars more desirable to avoid United States gold reserves being further depleted. The adverse result was that the increased expense of doing business in dollars made the depression worse and lead to bankruptcies, massive unemployment, and widespread misery.
President Franklin D. Roosevelt closed United States banks on March 3, 1933, in response to a run on gold reserves at the Federal Reserve bank of New York. When the banks reopened 10 days later on March 13 all the gold reserves had been consolidated to the secretive Federal Reserve. Banks were no longer allowed to redeem dollars for physical gold and exporting gold was expressly prohibited.
In a further push towards consolidating gold reserves, Roosevelt ordered United States citizens to exchange their gold for paper money on April 5, 1933. The reported goal was to prohibit gold hoarding and stop the flow of gold overseas. All this consolidated United States gold had to be stored somewhere and this was the foundation of the infamous Fort Knox facility. The volume of gold consolidated at Fort Knox was supposedly the world’s largest collection, although there is a growing mistrust over the credibility of the audits that have been conducted.
January 30, 1934 saw the introduction of the Gold Reserve Act which made it necessary for Americans to obtain a license to own physical gold. This enabled the government to repay its debts in dollars instead of gold and devalued the value of the dollar by 40%. By increasing the price of gold, which had remained stable for 100 years at $20.67 per ounce to $35 per ounce, Roosevelt effectively increased the value of the government’s gold reserves from just over $4 billion to over $7.3 billion and devalued the dollar. With the end of the depression in 1939, the United States and other countries were able to return to modified gold standards.
A decade later in 1944, the infamous Bretton Woods Agreement defined the value of exchange for all currencies in gold and mandated that signatory countries convert the foreign official holdings of currencies into gold at the set values. The price of gold was internationally agreed to be $35 per ounce. Because the United States was the holder of the most gold in the world, other countries pegged their currencies to the dollar rather than gold. To maintain stable exchange rates against the dollar foreign central banks would buy or sell their own currencies in foreign exchange markets. Pegging to the dollar was useful for improving international trade.
As the dollar came to replace gold for international exchange, the value of the dollar increased while its worth in gold remained static. By this point, the United States dollar had become the world currency with enormous impacts on further global markets such as oil.
By 1960 the balance between the United States’ gold reserves and the value of the foreign dollars outstanding was positive and other countries knew that the United States was in a position to honor its debts in gold. With an increasingly prosperous economy, the United States was consuming increasing volumes of imported goods creating concern for foreign governments that the United States might not be able to back up their dollar payments with gold.
A further complication arose during the cold war. The Soviet Union was a large oil producer and because oil is traded in dollars, they accumulated vast quantities of United States currency. These dollars were deposited in European banks to stop the Soviet Union’s accounts from being frozen as a strategy by the United States. The deposits came to be known as Eurodollars.
A decade later by 1970, the United States’ foreign dollar holdings were almost three times the value of their stored gold. The economic policies of President Nixon were the cause of double-digit inflation known as stagflation. The inflation had the result of devaluing the Eurodollars. Banks began redeeming dollar holdings for gold and the United States was unable to meet their obligations.
The death of the gold standard began on August 15, 1971, with Nixon changing the value of an ounce of gold in dollars to $38 and prohibiting the Federal Reserve from redeeming dollars with gold. The gold standard became effectively defunct and the United States raised the value of dollars to gold again to $42 in 1973. Finally, in 1976 the dollar was completely decoupled from the value of gold and the spot rate of gold rocketed to $120 per ounce.
Without gold to back their currencies countries began printing more and more paper money. This has led to inflation which is essentially a hidden tax for the population as the real purchasing power of their fiat currencies is eroded year on year. Conversely, the value of gold has soared reaching a record high of almost $2,000 per ounce.
The relationship is clear — the value of gold has increased while the value of fiat currencies has decreased. Economic stability requires a long-term perspective and the choice between an appreciating asset or a depreciating asset is a choice between success or failure.
Perhaps it is worth remembering the words of the legendary financier JP Morgan:
“Money is gold and nothing else.”