The Gold Standard: Part II


“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value” – Alan Greenspan.

In this week’s Part II, where we turn our attention to The Gold Standard that Allan Greenspan suggests is the solution to the problem of inflation.

Part II

In Part I of this series, we argued that when any central authority obtains the monopoly right to create money, that central authority will tend to use that right to expand its own power by creating more money for its own gain – the result is inflation; a tax on society’s savings.

The mechanism by which this money printing monopoly is fully enjoyed, we called the fiat paper standard.

The dominance of fiat paper currencies, from the perspective of world history, is actually a relatively recent occurrence. Prior to World War I, where the enormous expenditures led all the warring governments to abandon the gold standard, the world’s monetary system had golden roots.

Gold has been used as money for millennia, across vastly different civilisations and geographies. Gold developed as money on the free market by being the commodity best suited to store value over time.

However, to better understand the origins of our modern day inflationary fiat paper standard and why gold is the antidote thereto, let’s briefly examine more recent monetary history.

Classical Gold Standard

In the 19tth and early 20th century, the world was on a gold standard – each national currency was defined as a weight of gold. For example, the US dollar was defined as 1/20 of a gold ounce (1834 – 1933), the British pound sterling as 1/4 of a gold ounce (1821 -1931), and so on.

You’ll notice that all of the currencies are not separate monies, but rather one homogeneous money – gold. Gold, and nothing else, was money. Anything else that circulated, like banknotes, were money substitutes – simply claims to a certain weight of gold (face value) that was stored in the vault.

As a quick practical example of this concept, consider the experience of submitting your coat to a fancy restaurant’s Coat Check. You receive a receipt that entitles you to claim your coat after your meal. The receipt is only a claim to your coat, and not your coat itself.

Carrying on, during the classical gold standard, the world experienced growth deflation as the money supply was limited by the supply of physical gold. Savings retained its value and were allowed to accumulate. This, in turn, led to investment that produced a greater supply of goods and services. Over time, prices declined with an increase in this supply of goods and services relative to the stable money supply.

Now, you may ask if life was so good on the classical gold standard, why on earth did it end?!

Pseudo Gold Standards

The problem is that, under the classical gold standard, governments were required to keep their promises – more precisely, keep national currencies (Dollars, Pounds etc) redeemable in gold. As suggested in Part I though, central authorities have an inherent tendency to inflate the supply of a currency that it monopolises and creates.

As history bears testament, to wage the catastrophic World War I (1914 – 1921), the warring governments did exactly that; inflated their supply of paper currency and quickly abandoned their pledge to redeem their paper for gold.

So, after World War I, the classical gold standard was no longer. What followed were a few attempts at anchoring paper currency to gold, such as the gold exchange standard where countries held US dollars and British pounds as reserves, and not gold itself. Only the US maintained a pure gold standard, as it entered the war late and did not enormously inflate the supply of dollars.

These pseudo gold standards were simply inflationary pyramid structures that soon collapsed, and plunged international economic order into chaos. With competing devaluations and trade barriers, unbalanced trade relationships started to overwhelm the international economy.

In 1933, the US also effectively abandoned the gold standard, with US President Franklin D. Rosevelt issuing an executive order whereby American citizens were prohibited from owning any gold. This protection of monopoly was enforced with a $10,000 fine or 10 years imprisonment, or both! The US kept gold convertibility to other governments, but devalued it from $20/oz to $35/oz.

The US saving grace in both World Wars was the fact that it entered the war late and supplied goods and services to the warring nations in exchange for gold; the real money. This allowed the dollar a form of superiority over other national currencies (read: money substitutes).

Bretton Woods

Fast forward to the end of World War II, with the world monetary system in chaos, a new international monetary order was required. At an international monetary conference at the Bretton Woods Resort, New Hampshire, in 1944, this order was conceived and driven through by the US.

Every currency in the world would be backed by the US dollar in a fixed exchange ratio. The US dollar, in turn, would be convertible to gold by other governments at $35/oz.

This meant that the US could now create money at will and effectively export inflation to the rest of the world, as the other countries would have to buy the dollars as reserves to back their local currency – the ultimate inflationary pyramid, with the US as benefactor.

So, as the 1950s and 1960s wore on, the US grew more inflationist, funding the Vietnam wars and the “Great Society” social programs by increasing the money supply and exporting its inflation to the rest of the world in exchange for real goods and services – no gold flows out, just paper baby!

But the world grew wise and, as the dollar became increasingly devalued, began to exercise the option of redeeming dollars in gold at $35/oz. Gold steadily flowed out of the US for two decades, dwindling the US gold stock from over $20 billion to $9 billion.

This reached a crescendo in 1971, when Germany left the Bretton Woods system, Switzerland redeemed $50 million of gold, and France sent a warship to New York to pick up $131 million worth of gold!

1971 – Nixon Shock

In response, on August 15, 1971, Richard Nixon “closed this gold window” meaning that the US officially reneged on its pledge to redeem dollars for gold under the Bretton Woods system.

Then, for the first time in history, the dollar (and world) was running entirely on fiat without any backing in gold – the fiat paper standard with floating exchange rates begins…

Over the next two years, the market price of gold ran to $241/oz, uncovering the significant devaluation of the dollar by the US government under Bretton Woods. And over the last half-century, the world suffered, unprecedented inflation.

It should be clear by now that this is scarcely a coincidence.

The Future

We are currently still trapped in the fiat paper system, with its erosive effect on our savings and purchasing power.

History teaches us that gold has been the only anchor that guarded against the inflationary leanings of central authorities. It teaches us that it was not the gold standard that failed, but rather the central authorities that destroyed the standard as it was too effective a brake on the authorities’ ambitions and expenditures.

So what does this mean for us?

Well, without a sound monetary anchor, such as gold, savings will remain unprotected at the behest of politicians’ printing presses. We are seeing the prospect of runaway inflation accompanied by monetary breakdown increasing globally (Venezuala and Zimbabwe being the most recent reminders).

This prospect can only be changed by a drastic alteration of the local and world monetary system: by a return to free-market, commodity money such as gold, and a strict separation of money and its supply from the central authority.

Whilst not the case, Alan Greenspan’s words will continue to ring true. It would be wise to take the protection of your savings into your own hand, and to answer the question posed in conclusion to Part I of this series: Got gold?