Opinions

Money Does Matter: The End of the Gold

Standard Led to a Lower Standard of Living
by André Marques | Mises.org
August 25th 2022, 6:28 am

When the Nixon administration ended the dollar's ties to gold, it was yet another sad chapter in the
US government's abuse of its currency

And the government learned nothing

Image Credit: Peter M. Fisher / Getty

On August 15, 1971, Richard Nixon announced that the US dollar (USD) would no
longer be redeemable in gold.
This was supposed to be temporary. And yet, 51 years later, here we are. The gold
standard was gradually destroyed in the twentieth century. Now people are
experiencing the consequences: less purchasing power, more economic cycles, and a
weaker economy.
In the chapter 4 of his book What Has Government Done to Our Money?, Murray
Rothbard goes over the steps the government took to end the gold standard over the
twentieth century, from the end of the classical gold standard to the closing of the gold
window in 1971.
The Classical Gold Standard (1815–1914)

The classical gold standard tended to prevent the government from running budget
deficits and going into debt, as it could not easily create inflation. In 1913, the Federal
Reserve (Fed) was born. When the US entered the World War I, US dollars were printed
at an excess of the gold reserves. At this point, the US got off the classical gold standard
and this money printing contributed to the depression of 1920–21.

The Gold Exchange Standard (1926–31)

In this regime, the USD and the pound sterling (GBP) were the two currencies of
reference (“key currencies”). The US went back to the classical gold standard
(converting USD into gold). GBP and other currencies were not convertible into gold
(except for large bars). The Great Britain converted GBP to USD and the other European
countries converted their currencies to GBP. So, the Great Britain inflated GBP and the
other European countries did the same with their respective currencies (a “pyramiding”
of GBP on USD and of other European currencies on GBP). Consequently, as
Rothbard stated:
Britain and Europe were permitted to inflate unchecked, and British deficits could
pile up unrestrained by the market discipline of the gold standard…. Britain was able
to induce the United States to inflate dollars so as not to lose many dollar reserves
or gold to the United States. As sterling balances piled up in France, the United
States, and elsewhere, the slightest loss of confidence in the … inflationary
structure was bound to lead to general collapse. This is precisely what happened in
1931; the failure of inflated banks throughout Europe, and the attempt of “hard
money” France to cash in its sterling balances for gold, led Britain to go off the gold
standard completely. Britain was soon followed by the other countries of Europe.

Fluctuating Fiat Currencies (1931–45)

In 1933–34 the US abandoned the classical gold standard once again. The USD was
defined as 1/35 of an ounce of gold and only foreign governments and central banks
could convert it into gold. So, there was a certain link to gold, but the US was in a
floating exchange rate regime. As Rothbard stated, by cutting the ties to gold, this
regime
leave[s] the absolute control of each national currency in the hands of its …
government [which can] allow its currency to fluctuate freely with respect to all
other fiat currencies … [The flaw] is to hand total control of the money supply to [the
government], and then to … expect that it will refrain from using that power.
the disastrous experience of … the 1930s world of fiat paper and economic warfare, led
the United States authorities to [aim] the restoration of a viable international monetary
order

Bretton Woods and the New Gold Exchange Standard (1945–68)

Thus, enter the Bretton Woods system (conceived and implemented by the US at a
conference in Bretton Woods, New Hampshire in 1944, and ratified by the US Congress
in 1945). It was similar to the gold exchange standard, but with the USD being the only
“key currency,” priced at $35 an ounce of gold and being redeemable in gold only by
foreign governments and central banks.
However, this system eventually met its end. The US inflated the USD (“pyramided” it on
its gold reserves), and other governments held USD as their reserves and “pyramided”
their currencies on those dollars. And throughout the 1960s, the US constantly inflated
the dollar in absolute terms and relative to Europe and Japan. This decade was marked
by the “War on Poverty,” the Vietnam War, and space programs.
To finance all this, the US started running large budget deficits, with the Fed monetizing
the debt (expanding the money supply). However, the Western European countries that
had adopted more solid monetary policies (Western Germany, Switzerland, France and
Italy), started to oppose the obligation to accumulate dollars. Europe began to redeem
dollars in gold, and the Bretton Woods system began to collapse in 1968 (ending in
1971, when Nixon suspended the redemption of the USD in gold).

The Closing of the Gold Window and the Rise of the Floating Exchange Rate Regime
(1971–?)

In order to keep the redemption of the USD in gold, the US government had two
options:

1. Cut spending and taxes to reduce the budget deficit. The supply of money would
decrease, and the USD would appreciate, which would allow prices to fall to levels
that would be consistent with an ounce of gold at $35 and restore demand for the
currency.
2. Dollar devaluation. This would mean that the price of an ounce of gold would have
to rise to a level that would be consistent with the supply of USD and the higher
prices for goods and services. But this would require the government to reduce the
budget deficit to prevent future devaluations.
Both options were inconvenient for the government. Thus, in February 1973, after two
devaluations of the USD that raised the price of an ounce of gold to $42.22, the closing
of the gold window became permanent. Therefore, the USD returned to the floating
exchange rate regime (as in 1931–45, but with no link to gold).
As a result, the USD devalued and the 1970s were marked by stagflation. In 1980, the
price of an ounce of gold was $850. The price of oil rose from just under $3 a barrel in
1970 to just under $40 in 1980. The Consumer Price Index (CPI) was over 14 percent in
1980 (chart 1). It was only in the early 1980s that the CPI began to decline, when Paul
Volcker, Fed chairman at the time, raised the federal funds rate to almost 20 percent
(chart 2).
Chart 1: Consumer Price Index (1965–85)

Source: Trading Economics; author’s own elaboration.

Chart 2: Federal Funds Rate (1970–88)

Source: FRED; author’s own elaboration.

However, in 1980, the US federal debt was “only” $930.2 billion (chart 3). Thus, it was
possible to significantly increase interest rates without causing major impacts on the
economy. Today, the federal debt is above $30.5 trillion. The Fed can’t raise rates
without crashing the economy. The US has gone from being the world’s biggest
creditor in the early 1970s to the world’s biggest debtor today (the US has more debt
than all other governments in the world combined).
Chart 3: Federal Debt for the United States (1970–2021)

Source: FRED; author’s own elaboration.

As the federal funds rate rose, the USD appreciated and there was a restoration of
confidence in the currency. This (along with the fact that the US dollar was already the
currency in which oil and other commodities were priced) allowed the USD to remain
the main world reserve currency. And this, along with the fact that the USD has been
unbacked since 1971, has allowed the US to inflate it over time, destroying its value. As
of August 3, 2022, the ounce of gold costs $1765:
Chart 4: Price of Gold (In US Dollars)
Price of 1 Kg – 1Kg = 2.20462 Pounds (Left Axis); Price of an Ounce (Right Axis).
Source: goldprice.org; author’s own elaboration.

Conclusion

The consequences of the end of the gold standard began to be felt in the 1970s. The
devaluation of the USD substantially reduced Americans’ real wages. Before 1970,
usually only one member of a family was able to support it. From the 1970s onwards,
this began to change to the point where today this is only possible for wealthier
people. Despite all the technological advancements, the standard of living today is
lower than in the 1950s and the 1960s, as today, in order to live and to buy things
they want or need, people need to work a lot more (and even go into debt). If the USD
had not been devalued since 1913 (or even if it had been appreciated, which is what
tends to occur when there is no monetary expansion), the standard of living would be
much higher today.

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