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Regardless of what cable pundits may tell you, and courtesy of Wikipedia, here is the real historical reason why Gold Bullion, as well as Platinum, Silver and Palladium Bullion, matters so much for financial security in today’s economy.
After the end of World War II, the U.S. held $26 billion in gold reserves, of an estimated total of $40 billion (approx 60%). As world trade increased rapidly through the 1950s, the size of the gold base increased by only a few percent. In 1950, the U.S. balance of payments swung negative. The first U.S. response to the crisis was in the late 1950s when the Eisenhower administration placed import quotas on oil and other restrictions on trade outflows. More drastic measures were proposed, but not acted upon. However, with a mounting recession that began in 1958, this response alone was not sustainable. In 1960, with Kennedy’s election, a decade-long effort to maintain the Bretton Woods System at the $35/ounce price was begun.
The design of the Bretton Woods System was that nations could only enforce gold convertibility on the anchor currency—the United States’ dollar. Gold convertibility enforcement was not required, but instead, allowed. Nations could forgo converting dollars to gold, and instead hold dollars. Rather than full convertibility, it provided a fixed price for sales between central banks. However, there was still an open gold market. For the Bretton Woods system to remain workable, it would either have to alter the peg of the dollar to gold, or it would have to maintain the free market price for gold near the $35 per ounce official price. The greater the gap between free market gold prices and central bank gold prices, the greater the temptation to deal with internal economic issues by buying gold at the Bretton Woods price and selling it on the open market.
In 1960 Robert Triffin noticed that holding dollars was more valuable than gold because constant U.S. balance of payments deficits helped to keep the system liquid and fuel economic growth. What would later come to be known as Triffin’s Dilemma was predicted when Triffin noted that if the U.S. failed to keep running deficits the system would lose its liquidity, not be able to keep up with the world’s economic growth, and, thus, bring the system to a halt. But incurring such payment deficits also meant that, over time, the deficits would erode confidence in the dollar as the reserve currency created instability.
The first effort was the creation of the London Gold Pool on November 1 of 1961 between eight nations. The theory behind the pool was that spikes in the free market price of gold, set by the morning gold fix in London, could be controlled by having a pool of gold to sell on the open market, that would then be recovered when the price of gold dropped. Gold’s price spiked in response to events such as the Cuban Missile Crisis, and other smaller events, to as high as $40/ounce. The Kennedy administration drafted a radical change of the tax system to spur more production capacity and thus encourage exports. This culminated with the 1963 tax cut program, designed to maintain the $35 peg.
In 1967, there was an attack on the pound and a run on gold in the sterling area, and on November 18, 1967, the British government was forced to devalue the pound. U.S. President Lyndon Baines Johnson was faced with a brutal choice, either institute protectionist measures, including travel taxes, export subsidies and slashing the budget—or accept the risk of a “run on gold” and the dollar. From Johnson’s perspective: “The world supply of gold is insufficient to make the present system workable—particularly as the use of the dollar as a reserve currency is essential to create the required international liquidity to sustain world trade and growth.” He believed that the priorities of the United States were correct, and, although there were internal tensions in the Western alliance, that turning away from open trade would be more costly, economically and politically, than it was worth: “Our role of world leadership in a political and military sense is the only reason for our current embarrassment in an economic sense on the one hand and on the other the correction of the economic embarrassment under present monetary systems will result in an untenable position economically for our allies.”
While West Germany agreed not to purchase gold from the U.S., and agreed to hold dollars instead, the pressure on both the dollar and the pound sterling continued. In January 1968 Johnson imposed a series of measures designed to end gold outflow, and to increase U.S. exports. This was unsuccessful, however, as in mid-March 1968 a run on gold ensued, the London Gold Pool was dissolved, and a series of meetings attempted to rescue or reform the existing system. But, as long as the U.S. commitments to foreign deployment continued, particularly to Western Europe, there was little that could be done to maintain the gold peg.
All attempts to maintain the peg collapsed in November 1968, and a new policy program attempted to convert the Bretton Woods system into an enforcement mechanism of floating the gold peg, which would be set by either fiat policy or by a restriction to honor foreign accounts. The collapse of the gold pool and the refusal of the pool members to trade gold with private entities—on March 18, 1968 the Congress of the United States repealed the 25% requirement of gold backing of the dollar—as well as the US pledge to suspend gold sales to governments that trade in the private markets, led to the expansion of the private markets for international gold trade, in which the price of gold rose much higher than the official dollar price.[ The US gold reserves continued to be depleted due to the actions of some nations, notably France, who continued to build up their gold reserves.
By the early 1970s, as the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. was running a balance of payments deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, which, because of foreign arbitrage of the U.S. dollar, caused governmental gold coverage of the paper dollar to decline 33 percentage points, from 55% to 22%. That, in the view of Neoclassical Economists and the Austrian School, represented the point where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits.
In 1971, the U.S. government again printed more dollars (a 10% increase) and then sent them overseas, to pay for the nation’s military spending and private investments. In the first six months of 1971, $22 billion dollars in assets left the U.S. In May 1971, inflation-wary West Germany was the first member country to leave the Bretton Woods system — unwilling to deflate the Deutsche Mark to prop up the dollar. In order to prevent the dumping of the Deutsche Mark on the open market, West Germany did not consult with the international monetary community before making the change. In the next three months, West Germany’s move strengthened their economy; simultaneously, the dollar dropped 7.5% against the Deutsche Mark.
Because of the excess printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America’s “promise to pay” – that is, the redemption of their dollars for gold. Switzerland redeemed $50 million of paper for gold in July. France, in particular, repeatedly made aggressive demands, and acquired $191 million in gold, further depleting the gold reserves of the U.S. On 5 August 1971, Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against foreign price-gougers. Still, on 9 August 1971, as the dollar dropped in value against European currencies, Switzerland withdrew the Swiss franc from the Bretton Woods system.
To stabilize the economy and combat runaway inflation, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, “closed the gold window”, ending convertibility between US dollars and gold. The President and fifteen advisors made that decision without consulting the members of the international monetary system, so the international community informally named it the Nixon shock. Given the importance of the announcement — and its impact upon foreign currencies — presidential advisors recalled that they spent more time deciding when to announce publicly the controversial plan, than they spent creating the plan. He was advised that the practical decision was to make an announcement before the stock markets opened on Monday (and just when Asian markets also were opening trading for the day). On August 15, 1971, that speech and the price-control plans proved very popular and raised the public’s spirit. The President was credited with finally rescuing the American public from price-gougers, and from a foreign-caused exchange crisis.
By December 1971, the import surcharge was dropped, as part of a general revaluation of the major currencies, which thereafter were allowed 2.25% devaluations from the agreed exchange rate. By March 1976, the world’s major currencies were floating — in other words, the currency exchange rates no longer were governments’ principal means of administering monetary policy.
In political scientist David McNally’s analysis of the post-2007 financial crisis he cites the end of the Bretton Woods dollar-gold convertibility as the modern source of monetary volatility and consequent unregulated financialization. That volatility necessitated the rise of risk-hedging financial instruments, such as derivatives (including credit default swaps). Thus as the value of the dollar was no longer based on gold, it became based instead on projected future value. The US economy and its firms become financialized (dependent on interest-paying financial transactions) to accommodate and take advantage of the risk inherent in the future value of the dollar as the basis for present value. Further, financialized firms and investors gained profits from speculating on that risk. Especially after the 1997 East Asian overaccumulation crisis necessitated loosening credit in the US so that working-class Americans could prop up global demand, working-class debt was packaged by banks and hedge funds and sold to themselves (banks and hedge funds), as well as to pension funds, investors, and financialized corporations. During Alan Greenspan’s tenure as president of the Federal Reserve (1987–2005) alone, private and public debt in the US quadrupled to $43 trillion. When the bubble burst in 2007, capital fled the US. Private capital flows were reduced by $1.1 trillion in the third quarter of 2007. There remain continued problems with valuing assets in the US, especially given public and private debt, the unabated diminishment of American working class purchasing power, and ongoing military expenditure. Forty years after the Nixon Shock, McNalley predicts the rise of competition among currency blocs for greater control of financial markets and global monetary privileges.
The return to a gold standard is supported by many followers of the Austrian School, Objectivists and Libertarians largely because they object to the role of the government in issuing fiat currency through central banks. A significant number of gold standard advocates also call for a mandated end to fractional reserve banking.