My baby gives me the finance blues,

Tax me to the limit of my revenues.

—The Grateful Dead

It was the end of an era. The demise of the dollar began with what is tantamount to an international margin call—and even the most unsophisticated investor knows the words “margin” and “call” are bad when put together in one phrase. Simply put, your guy at the brokerage firm calls to tell you that your assets are in trouble. You've got two choices: either deposit more money into your account, or sell off one of your assets to stay afloat. If you don't have more money to put in…well, you can do the math yourself.

On August 15, 1971, the United States didn't have the gold reserves it said it had. And it was worried that it would have less even sooner.¹

The French president at the time, Charles de Gaulle, wanted gold, not American dollars. De Gaulle recognized the Johnson administration was trying to fight two wars at one time: the Vietnam War in Southeast Asia and “the War on Poverty” at home. Maybe he'd had some insight since the French defeat at Dien Bien Phu in 1954.

Wars are expensive. So are social policies. The United States was running up deficits. In turn, the dollar was getting less valuable. De Gualle recognized it was for political decisions, not because of some intrinsic economic phenomena. Economic history shows us that governments get emboldened to spend more than their currency can handle.

One can almost imagine de Gaulle saying in a thick French accent, “I'm not going to support the policies, so I will take the gold.” Those were the terms of the Bretton Woods Agreement.

If the United States would continue to be the dominant Western economy, then it would also have to be good stewards of its own money.

De Gaulle referred to the Bretton Woods exchange rate system as a “privilège exorbitant” that gave the United States a substantial advantage in the global economy. Barry Eichengreen writes that the world under Bretton Woods was an “asymmetric financial system” in his book Exorbitant Privilege. The French found “themselves supporting American living standards and subsidizing American multinationals.'” Time magazine too reported in 1965:

Treasury Secretary Douglas Dillon made the first public admission that the U.S. payments deficit in 1964 moved higher than anyone had expected. It totaled about $3 billion, all of which the U.S. is legally committed to exchange for U.S. gold on demand. The Federal Reserve announced that the U.S. gold supply declined last week by $100 million, to a 26‐year low of $15.1 billion.

Under a gold standard the U.S. would no longer be able to pay its foreign debts in dollars, but only in gold. U.S. businessmen would have to curtail their investments in foreign companies. (De Gaulle last week called such U.S. investments “a form of expropriation”).²

President de Gaulle recognized that the global monetary system was rigged against the French franc, even if they were allies in the war. By 1968, de Gaulle had pulled the French out of the London Gold Pool in an effort to exchange francs for gold directly.

PRIVILÈGE REVOKED

We can look at gold in a couple of ways: as the basis for solid asset value or as a tangible investment with its own supply and demand market. Many people today shy away from gold because of the incredible price movement between 1971 and 1980. This occurred following two important and critical events.

In 1971, President Nixon took the United States off the gold standard (meaning we could print as much money as we want, right?). And then in 1974, President Gerald Ford removed a 40‐year‐old restriction on Americans' right to own gold.

Looking back to 1933, the Great Depression caused a serious gold shortage. The Emergency Banking Relief Act of 1933 was passed “to provide relief in the existing national emergency in banking and for other purposes… .”³

The bill required all citizens to turn over gold coin and currency in exchange for Federal Reserve notes. Refusing to turn over gold carried a $10,000 fine and 10 years in jail. This unusual move was intended to prevent the public from hoarding gold bullion. The solution was a simple one: make it illegal to own gold directly. But as is often the case when a government acts under emergency powers, this critical law started the ball rolling toward the trouble our dollar is in today.

Once Nixon dismantled the Bretton Woods system effectively ending the post‐war gold standard and Ford removed the restriction on owning gold, the price shot up from the regulated $35 per ounce. It topped out above $800 by January 1980. Adjusted for inflation, that's $2,499 in 2022 dollars. And remains gold's highest historical price. By 1999, it had dropped to $235. In 2012, following the bailout period gold returned to $2,308. Then during the mid‐pandemic month of August 2020, gold returned again to $2,250. For now, we should not look at gold price gyrations as a market‐driven phenomenon. The climb and subsequent fall and dramatic rise again and then again were caused by government intervention over a 40‐year period. Here are four compelling arguments:

1. The trade gap. The US trade surplus of years ago disappeared in 1977 never to return. After years of strong surplus in trade, it all changed only six years after the removal of the gold standard. Here's what is troubling about all of this: Because the Fed is free to decide how much money to print up, it means that our ever‐growing IOUs are becoming worth less and less. We buy more and more on credit, and our IOUs are piling up. The days when currency was backed by gold are gone, and the United States has become a riverboat gambler, drunk and losing, demanding more and more credit to continue playing. Let's not overlook the historical reality: When the dollar's value falls, gold's value rises. As our trade deficit gets ever higher and as the Fed continues printing IOUs, the value begins to soften. The more currency put into circulation, the greater the dilution and the worse the situation becomes. But as we've seen, for the price of gold, this is good news.
2. The budget deficit. Where is the government getting all of that money it continues to spend? The $1.4 trillion budget deficit in the bailout year 2009 depended on the incredibly low interest rates that have been the centerpiece of the Fed's monetary policy since the financial crisis. Over the next decade, the best Congress could do was spend $441 billion more than they brought in. That number, achieved in 2015, would have been horrifying itself before the bailouts. It only gets worse from there. During the pandemic year of 2020 the government ran a deficit of $3.1 trillion. The numbers are so big they don't bother anyone anymore. New academic theories, like the Modern Monetary Theory, have arisen to justify—even encourage—their existence. Still, even in 2020, low interest rates accommodated these nosebleed deficits. But, we hesitate to ask, what happens when rates start to climb as they did in earnest in 2022 as the Fed sought to “fight” inflation? Remember, inflation is a measure of the number of IOUs in the economy. Each year's budget deficit only adds more IOUs, adds to the national debt, and further fuels inflation. The budget itself sinks deeper and deeper into the hole. Who is going to make those interest payments in the future? The higher the debt, the higher the interest. And the higher the interest rate, the greater the impact on the taxpayer—you and me and our children. It's called “crowding out”: more taxes must go toward interest payments leaving less room for spending on the government programs politicians have promised. The math is not encouraging.
3. A limited world supply. Gold is a limited commodity, unlike currency. As long as the Fed has access to printing presses, it is able to continue pumping adrenaline into the economy. But gold is real money in every sense, and its value is enhanced because there is only so much of it. This is the most important difference between currency and money. Now that we are off the gold standard, the Fed believes it can ignore currency valuation and continue on the “full faith and credit” system. As an investment, the dollar is becoming more and more suspect. In comparison, as dollar troubles get worse, the limited supply of gold will become more valuable. Cause and effect—that is what drives market values. Dollars fall; gold rises. It's unavoidable.
4. The currency value of gold. Most people can appreciate the difference between an IOU and actual money. If your boss handed you an IOU on payday, you would not be happy. You'd rather be able to cash a check and use the money. But in fact, the dollar is an IOU, and we're all trading these IOUs as currency without any real backing. We are going to see an increasing trend among foreign central banks to buy gold in exchange for dollars, as they did following the Russian invasion of Ukraine. This gradually increasing demand for gold will have the unavoidable impact of increasing gold's market value. How high can it go? Only time will tell, but the weakening dollar is encouraging for gold investors.

Back in 1971, if Nixon had removed the restriction on gold value at $35 an ounce and allowed it to find its value in the open market, that would have done more to fix the international monetary problem. But removing the restriction on gold value was not considered a viable option, for two reasons:

First, it would have meant the United States was telling other countries (those with undervalued currencies) to raise their prices on exports to the United States. And that would never have gone over well in countries that, at the time, were being subsidized by the US dollar, economically speaking.

Second, the change would have drastically affected world markets of natural resources, including oil—doubling the barrel price of oil. That would not have gone over well, either—although a few years later, we did in fact experience double‐digit inflation and long lines at the pump as a consequence of going off the gold standard.

Nixon's decision was viewed as the only alternative to devaluing the dollar. Currency markets already recognized that US dollars had been inflated. In December 1971, leaders of the so‐called Group of Ten industrialized nations met in Washington, DC, to officially change currency values based on the per‐ounce value of gold raised from $35 to $38. The dollar was lowered 7.89%, while the German mark was raised 13.57%, and the Japanese yen went up 16.9%.

Removing the US dollar from the Bretton Woods system was an attempt at solving the problem of falling currencies overseas. The currency exchange between US dollars and European and Japanese currencies was a drain on US trade. This is opposite to the problem we face today: The dollar is falling for those who use it, meaning what you want to buy gets more expensive. But the dollar is also gaining value against other currencies in the world as a way to settle trade accounts. It can be confusing. Confusing is the nature of the fiat system.

President Nixon's own admission when he signed the act that ended the Bretton Woods exchange rate system was historic. “We're all Keyensians now,” referring to the idea that even those who had politically supported free market initiatives a la Mises and Hayek were giving in to political incentives. Nixon appears beaten in the films of the episode. Perhaps, because of years of championing, at least while campaigning for office, the old right idea of less government intervention in the economy, fewer taxes, more individual freedom. As a student of history, and irony, it's outstanding how great and offensive the Nixon administration was. Studying the era is also perplexing. We're constantly reminded of Lord Acton's comment that “absolute power corrupts absolutely.” It's even worse when your goal is just power for its own sake. At least Acton was critiquing monarchies. In monarchies there is meant to be a God‐given grant to power. In democracies, or republics like the United States, you have to get gritty. It's not pretty.

Of course, the wage and price controls of the Nixon era did not work. Yes, Nixon won reelection in 1972, but unemployment did not fall, and inflation did not go away (in fact, it got worse). The administration reimposed the freeze controls that had failed before, then quietly canceled them in April 1974, only four months before Nixon resigned. By then, unfortunately, the unavoidable expansion in inflation, unemployment, and a falling dollar had begun.⁴

We have to remember the meaning of the dollar's peg to gold and why it served such an important role in international economic policy. The gold standard was a means by which countries agreed to fix the value of their currency, based on amounts of gold reserves. The abandonment of the gold standard during World War I when most countries involved in the fighting financed their war effort with inflationary money—IOUs—eventually contributed to the massive devaluation in the 1920s and worldwide depression of the 1930s. We should learn from history. Abandoning the gold standard devastates the world economy. Let's watch what happens from there.

FULL FAITH AND CREDIT

The US monetary system, and by extension that of the global monetary system, as well, reverted to one of “fiat money”—a system in which the government dictates the value of a currency rather than pegging it to the value of gold (or other precious metal) reserves. The decision was the beginning of what we call the Great Dollar Standard Era: the moment the American greenback was no longer backed by gold. It was henceforth backed by the “full faith and credit of the US government.” The Federal Reserve, a private bank, is the steward of that full faith and credit.

Mostly, we don't carry them anymore, but if, in fact, you do have a dollar in your wallet, you'll see it is simply a promissory note. Check what it says at the top of the bill itself: “Federal Reserve Note.” The American dollars in circulation are all just a bunch of IOUs. That would be fine if gold reserves were sitting tight in Fort Knox to back them up… but they are not. The value of the dollar is floating. “Floating on what?” you might ask. And you'd be right to ask.

Prior to 1971, most of the world's currencies were backed by gold because they were pegged to the US dollar. The dollar was redeemable in gold.

We know that supply and demand alter the value of every commodity in an efficient economic system. As demand increases for a unit of exchange, the price rises. This is an efficient system. Demand pushes the price up, and supply pushes the price down.

When paper money is in use, the whole efficiency of the economic system goes out the window. As long as the government can print more money, it can continue to expand a consumption base in spite of any supply and demand, and in spite of the limited supply of gold itself. Again, we're not arguing for gold as a base for value. We're not ones to argue against history either. Gold has been used as money for a lot longer than the dollar. Or Bitcoin, for that matter.

Let's just be clear. The Fed and Treasury keep printing money. In what space of history will that not catch up with them? We could name names, but does that matter? It's a systemic issue. Who even asks these people what they're up to? The day will come when “we” will have to pay off those IOUs.

As we like to point out in The Wiggin Sessions, the gold standard was a useful and important economic tool. The fact that gold existed only in limited supply meant that governments could not simply print all the money they wanted to, regardless of the political challenge or ambition.

So what went wrong? Why did Richard Nixon dismantle the Bretton Woods exchange rate system? And why was it perhaps the greatest mistake in the history of American money? The whole basis for money itself—currency as a means of exchange—is based on tangible value. Without getting too philosophical, the value of your money is not the green bills we carry around, or the digits we have on our credit cards; it's a matter of trust.

Before I write this next statement I would like to assert that I'm not a “gold bug.” Gold has been money for thousands of years. No fiat money system has ever succeeded, which we'll see later. History has shown time and again that excessive government spending eventually makes paper money worthless. But that doesn't have to mean that gold is the end all of your financial picture. Our purpose here is to understand why fiat money has failed historically.

We'll admit. An argument against the gold standard is based on gold's rarity. You can't fight wars on the gold standard, for example. Nor can you expand the economy of credit and speculation. We cannot expect any economic expansion as long as we are held back by a commodity in limited supply, the argument goes.

So then you get banking without borders. Money is not “printed” anymore. It's just digits moved from one screen to another. Money without borders, without restraint, eventually, exceeds its own life cycle. It becomes worthless, as we have seen time and again—in Rome, China, Spain, France, Germany, and now the United States. Why do we still believe it can work?

The fiat money system in effect in the United States today makes this point. It may be interesting to note that today many economists fear that a return to the gold standard or institution of an international monetary system could actually trigger a depression—a collapse of the financial economy. It is no simple matter to revert to a more sensible standard. Consequences are inevitable.

It would not be easy for the major currencies to return to an organized Bretton Woods exchange rate system. The growth that occurred in the post–World War II era is possible. It can only happen with money that is outside the political system. (Yes, we'll talk about Bitcoin and cryptocurrencies later in the book.)

The official reason for dismantling the Bretton Woods exchange rate system going off the gold standard was relatively simple: to stop dollar speculators and encourage US trade partners to peg their currencies directly to the US dollar without the dollar peg to gold; in other words, it was an attempt at getting foreign governments to realign their currency values and trust in the full faith and credit of the US government. Why? Nixon recognized that relying on gold as settlement for international exchange of goods and services inhibited expansion of the US economy and the US outsized share of above ground gold was rapidly dwindling.

If we recognize that currency is simply a form of IOU—literally “I owe you”—against the value of goods and services we exchange, then we can see why the tables have turned.

In 1971, the major foreign currencies were devalued against the dollar and gold. The abandonment of the gold standard had a far deeper and longer‐lasting effect than the inflationary adjustments of the 1970s. Why? Because our “money approximate” dollar circulated based on commodity reserves (gold and silver). That went away.

Nixon was concerned that the gold standard inhibited our ability to compete with devalued currencies in other nations. The US government was known to issue currency above reserves by speculating, offsetting long positions in dollars with short positions in gold, and gambling that it was unlikely that demands would be made against currency reserves. But that's exactly what happened. In the days before Nixon's decision, the British ambassador presented a demand for conversion of $3 billion in currency into gold.

When Nixon dismantled the Bretton Woods exchange rate system, he also tried to stabilize the economy with a series of ill‐fated price controls. Historically, these government controls are known as the “Nixon Shock.” He wanted to curb the inflation kicked off in 1965 by massive government spending intended to support President Johnson's Great Society. By 1971, inflation was increasing. For the first time in the post‐war period, everyday Americans actually worried about what inflation might do to their net worth or their ability to buy the things they wanted at a reasonable price, much as today. Think 5%–6% interest rates are bad? Think 13%–14%.

Listening to his Fed chairman, then Arthur Burns, Nixon believed what he'd been told: that the traditional view of money was wrong and the key to economic recovery was government control over prices and wages.

The misguided belief that wage and price controls would fix the economy by reducing inflation and creating new jobs turned out to be, well, wrong—not to mention an affront to Nixon's Republican principles that were supposed to favor a free market. The decision to impose controls was part of a plan to stimulate new employment in time for the 1972 presidential election. Burns warned Nixon that going off the gold standard would be viewed in Moscow and in the Russian press—at the height of the Cold War—as a bad sign for the United States. He warned, “Pravda would write that this was a sign of the collapse of capitalism. It's a curiosity of history that government controls were meant to preserve the free market. And, theoretically an antidote to the government controlled economy of the US' Cold War foe, the USSR.

Thankfully, while it has taken more than 50 years for the evidence to present itself fully, the decisions made by Nixon in 1971 set the process in motion. Capitalism as it was did not collapse immediately.

The concept of a free and open market is challenged in one important respect today: The US dollar's value is falling for everyday Americans and remains a question mark in the eyes of foreign banks and investors who use it as a store of value. There is also much trepidation about the rising second largest economy in the world, China. There is also concerns caused by the sanctions imposed on Russia following the invasion of Ukraine. The Russians would rather not use the dollar as a pricing tool for their oil, gas, and precious metals anymore.

John Maynard Keynes believed the government, through banking, interest rate manipulation, and outright decree—remember “fiat” means “by decree”—was the best way to stabilize the economy for all. In a real sense, it was a top down view of how the economy worked. Rather than let the free market work, Keynes wanted to control the value of money and the exchanges it was traded on and what it was traded for.

The period of the early 1970s was the start of a very unsettled time, based on both economic and political strife. In hindsight, it seems obvious that the decision to go off the gold standard was devastating, or at least destabilizing. It didn't lead to the immediate fall of capitalism, but now—more than 30 years later—it has brought us to the precipice, and perhaps the decline, in the dominance of the world economy the United States has enjoyed since the end of World War II. But hindsight is 20/20.

Moreover, inflation and its triggers have opened the door to ideology that is openly opposed to capitalism as a system of progress, innovation, and improvement of the daily lives of people who are not part of the top‐down system of governing.

The next period of rapid inflation—today!—will be recognizable and deeply familiar to readers of this book in the early 2020s—a period of runaway inflation comparable only to the period in the 1970s and early 1980s following the dismantling of Bretton Woods. And when the wheels seemed to be coming off from the global economy.