50 years since the closure of the “gold window”

Source: Free-Photos, Pixabay

What happened and why

This year marked the 50th anniversary of President Nixon’s decision to unilaterally close the “gold window”. The impact of this move can hardly be overstated. It triggered a tectonic shift of momentous consequences and it changed not just the global economy and the monetary realities, but it also shaped modern politics and severely affected our society at large.

The Nixon Shock

In July 1944, representatives from 44 nations convened in the resort town of Bretton Woods, New Hampshire, to figure out how the global monetary system should be structured after the end of the war. The US took the clear lead during these talks, exploiting the considerable leverage it had over other countries devastated by WWII or even still occupied by Germany. After all, at that point, Americans were the creditors of the world and had accumulated tons of gold throughout the 1930s and during the war, as the US was widely seen as a safe haven amid the conflict and uncertainty that prevailed at the time.

Thus, the “Bretton Woods Agreement” was born, under which the U.S. pledged to convert into gold any dollars brought by other countries’ central banks at a rate of $35/oz, while the currencies of the other participating countries were to be convertible into USD at a fixed rate. What this meant in practice, was that the USD became the dominant reserve currency and the fundament of entire financial system of the West, while the gold peg was reduced to a “managed” version, through artificial price controls, that was always doomed to fail.

Indeed, the Bretton Woods system didn’t last long. It wasn’t fully implemented until 1958 and by the mid 60s it was already obvious that its days were numbered. The US gold stockpiles were dwindling as European central banks soon began redeeming their dollar claims, and there were real fears that US gold holdings might eventually be exhausted. Also, the Bretton Woods system, even though it was “managed” and much weaker form of the classical gold standard, did still at least partially keep government spending and deficits in check, something that Nixon resented, especially with a view to the next election.

And so, on August 15, 1971, President Richard Nixon announced his decision close the “gold window”, and end the convertibility of USD to gold. He thereby severed the final link between the US currency and any real asset that backed it and gave rise to the new era of totally unrestrained fiat money, that could be manipulated, printed and distributed on the whim of state central planners. In one fell swoop, money lost whatever integrity and reliability it had left and it was turned into a purely political tool, if not a weapon.

The end of sound money, or whatever was left of it

In his televised address to the nation and to the world, President Nixon justified his decision by claiming that “prosperity without war requires action on three fronts. We must create more and better jobs; we must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.”

As we all know by now, none of these goals were meat. In fact, the result of this unilateral move to extinguish the last vestiges of the gold standard achieved the exact opposite, on all fronts. It unleashed decades of inflationary policies, turbulence in currency markets, and it laid the foundations for an economic and financial system that is dangerously unstable, fragile and fundamentally unjust. All these implications are plain to see today, but the President’s actions were celebrated by the US establishment of the time. The Dow Jones Average rose the day after the address, while the New York Times unreservedly expressed its support, by writing “we unhesitatingly applaud the boldness with which the President has moved on all economic fronts.”

And yet, there were a few voices that spoke out, for common sense and Reason. As the Cato Institute outlined, “Milton Friedman wrote in his Newsweek column that the price controls “will end as all previous attempts to freeze prices and wages have ended, from the time of the Roman emperor Diocletian to the present, in utter failure.” Ayn Rand gave a lecture about the program titled “The Moratorium on Brains” and denounced it in her newsletter. Alan Reynolds, now a Cato senior fellow, wrote in National Review that wage and price controls were “tyranny … necessarily selective and discriminatory” and unworkable. Murray Rothbard declared in the New York Times that on August 15 “fascism came to America” and that the promise to control prices was “a fraud and a hoax” given that it was accompanied by a tariff increase.”

At the time, many opponents of the truly free market tried to shut down and stifle any and all dissenting views, dismissing all these concerns as hysterical overreactions and alarmist nonsense. That reaction is not unfamiliar to us today. It is lifted from the same playbook that is still in use, and the same strategy is being deployed against anyone who criticizes the “grand designs” of central planners or warns against the obvious consequences of their reckless policies and short-sighted “fixes” to long-term economic and monetary problems.

The lasting impact of the Nixon Shock

The economic and monetary consequences of Nixon’s decision to end the convertibility of the US dollar to gold are as numerous as they are severe. It marked the start of five decades of monetary and fiscal insanity and it unleashed unprecedented borrowing and deficit spending sprees. Debt-fueled “growth” became the name of the game and currency manipulation came to define both political strategies and central bank mandates.

The US, as well as most of its western peers, reached debt levels that were once thought to be simply impossible to sustain. Real purchasing power declined and official inflation figures were only kept in check thanks to crude but effective tampering with the CPI formula. Global financial crises became part of normal, daily life, taken for granted by the public, and seen almost as natural phenomenon that really isn’t anyone’s fault. Recessions are now occurring much more frequently, and even though they don’t last as long as they used to, that’s only because they are “patched” by adding even more debt and more incentives to take on more risk.

All in all, that fateful move by Nixon to sever the last link between any national currency and gold has been behind most of the serious economic problems we face today. However, there was another effect that the Nixon shock had on the global economy and on modern politics that goes largely under discussed. That move also marked the beginning of the obvious and shameless politicization of monetary policy.

Nixon’s decision to close the gold window was motivated by transparently political reasons. He knew very well that a recession could cost him the 1972 election and this was just one in a long series of attempts to prevent it. Other strategies included strong arming the Arthur Burns, then the Federal Reserve chairman, to lower interest rates, while he also instituted wage and price controls to keep inflation under control. When it became clear that none of these desperate efforts would deliver the growth and unemployment drop he needed, he resorted to “brute force”, by tearing down the Bretton Woods System.

A slippery slope

While Nixon was mostly applauded at home for his decision to unilaterally break the US promise to convert dollars into gold, the reaction internationally was mainly one of outrage. At the time it was hard for most people to imagine that political games could reach that far into the realm of monetary policy and in such a blatant, cavalier and reckless way.

And yet, politically speaking, not only was the US not punished for it, but it came to reap immense benefits from that move. It handed the nation an exorbitant advantage, as it cemented the USD as the world’s reserve currency. To this day, it is this global demand for dollars for trade, banking, and reserves that allows the country to finance its chronic deficit in international trade, as well as sustain its growing budget gap. Even more importantly, the USD’s dominance has given the nation a vast geopolitical edge, which, to a very large extent, explains its position as the world’s biggest superpower.

These huge political gains on the international stage, combined with the freedom to print money at will to pay for crowd pleasing government expenditures at home, served as a valuable lesson to the next generation of politicians, not just in the US, but all over the world. It became clear that the currency can play a much more interesting and useful role if it was brought under the direct control of whomever happens to be in power at the time. It can be manipulated, controlled and deployed as just another policy transmission tool and it can make impossible promises seem realistic.

From Nixon to MMT

In this light, it is really not surprising at all to see the natural evolution of this line of political thought. It was a slow and gradual process, but over the decades, the link between money and anything tangible did fade away in most people’s minds. The overall financial illiteracy of the general population, the abysmal state of public education and the near-total lack of monetary history understanding have all helped guarantee that very few voices would be raised against the “consensus”. It has come to be widely accepted that the government and its central bank are and should be in complete control of a nation’s money and that this monopoly is essential for the economy to function.

Given this concession, it is not hard to see how we moved even further into economic and monetary surrealism. After all, if the government manipulating the currency is a good thing, why not do more of it? If inflation doesn’t matter, why should deficits? This is, after all, the main argument behind the increasingly popular Modern Monetary Theory and while it is economically nonsensical, it is politically entirely reasonable.

It is all nested in the core idea of decoupling the currency from anything real or tangible and supplanting whatever value or legitimacy this backing would offer with blind faith in the government. It has nothing to do with economic forces or with the intricate dynamics of the monetary system.

MMT, as well as all the centralization-pushing policy “nudges” that preceded it and set the stage for it, might be posing as an economic theory, but it is an ideological and philosophical shift that figures into the same political agenda. In this sense, it is nothing new. Since time immemorial leaders and rulers of all stripes clearly understood that whoever controls the money controls the people too.

The Nixon Shock: Where we stand today

A lot has been said and written about the inflationary effects that the closure of the gold window had on the real economy and on ordinary people’s lives. And rightfully so, as this has been among the most devastating consequences of the end of the gold standard and it affected countless workers and savers who have been seeing their incomes wither over time, thanks to the hidden tax of inflation.

However, there was another major shift that was triggered by the Nixon shock and it had very serious political and social implications, that we can still clearly observe today. The total removal of any real constraints on the dollar and other currencies has resulted in the unprecedented explosion of debt worldwide, while it also unleashed the era of limitless printing and reckless manipulation of the currency. This handed central planners the ultimate weapon in their efforts to centralize and concentrate power and control. After all, whoever controls the currency, controls everything else too.

All kinds of grand designs, poorly thought out policies, politically motivated government programs and vote-hunting excesses became not just possible, but the norm. Inane schemes, wasteful projects and misguided ideas that would have otherwise been stopped in their tracks simply by the limitations of a gold-backed currency, can now be easily paid for. Inefficiencies, malinvestments and a debt burden that future generations will never be able to cope with, are of course among the main problems of this shift. And yet, there is an even darker side to it: the state monopoly on money and the absolute and exclusive control over it, doesn’t just allow politicians to pay for their extravagant campaign promises and give out “free lunches”. It also enables them to enforce abusive, aggressive and even outright coercive policies that would have otherwise been practically impossible to carry out.

Wars, invasions, occupations and decades of foreign interventionism are the most obvious examples. As western citizens, we have become so used to this policy direction over the years that we don’t even question how it is practically possible or what would it take for it not to be. Moral constraints are clearly nowhere to be found among the political class, nor are there any tools for the people to directly and effectively express their objections, not in a representative democracy anyway. The only way to stop or even prevent these atrocities, especially when they are totally unnecessary and only fueled by greed and the prospect of political gain, is the inability to finance them.

And while decisions like that cost millions of lives and destroy countless others, ravaging entire nations and condemning whole societies to years violence and poverty, the impact on the West is minimal. Here, the power of the pursestrings has largely been used to support the growth of the welfare state. Domestically, we’ve only seen this monopoly at work to pay for all those “free lunches”, for all the subsidies and government programs aimed at swaying voters or appeasing interest groups. If there is a “carrot and stick” analogy to be found in this absolute power over money, we’ve been getting the carrot for decades. Or at least that was the case until 2020. Because ever since the pandemic hit, we also got to see what the stick feels like too.

As Jim Reid, head of thematic research at Deutsche Bank pointed out in a client note, “There is no way we could have locked down economies, and furloughed employees in the pandemic under a gold-based system.” Of course, it’s true. Without the ability to spend unprecedented amounts and inject trillions into the economy to keep it artificially afloat, there is no conceivable way that governments could ever have just pulled the switch and ordered people to simply stop working, stop producing, stop earning a living. No rational human would ever comply with that order and no government, no matter how mighty, would be realistically able to enforce it. All the lockdowns, the border closures, the stay at home directives and the forced business closures were only possible thanks to the limitless printing, borrowing and spending.

The Nixon Shock: The way forward

President Nixon’s unilateral decision to sever the last link between the dollar and gold had wide ranging and long lasting consequences for the global economy and for the entire monetary system. The end of sound money facilitated and accelerated the concentration of power at the top and the ability to manipulate the currency allowed politicians and central planners to further expand the state’s reach and push ahead with populist, reckless and wasteful policies.

For decades, this trend seemed to be irreversible. The political advantages of fiat money have been consistently and increasingly abused, while at the same time, the government’s interference in people’s everyday lives, financial freedoms and business activities grew stronger and stronger. Today, however, 50 years later, there are many good reasons to hope for a much brighter and freer future, and all of them have sprung from the crypto revolution, from the rise of the blockchain and from the wider public acceptance and awareness of the potential of decentralized systems.

The money of tomorrow

Ever since Bitcoin entered the mainstream consciousness a few years ago with the first crypto boom, a growing number of ordinary people became curious about the underlying technology and recognized the many advantages it has to offer. From privacy and transparency, to “cutting out the middleman” in their transactions, this new form of money had a lot of interesting and practical benefits that were obvious even to normal citizens and ordinary savers without any special technical knowledge or understanding of the intricacies of the underlying technology.

While the ease of use, the convenience and the accessibility of crypto were enough to convince countless people to jump on board and start investing and using various digital currencies, the most important and truly revolutionary advantage was the independence and the insulation they offered from any central authority. This extremely important in the context of sound money and on the question of whether it is possible for us to ever return to it, after the end of the gold standard.

Even if it was politically and practically realistic for any government to go back to the traditional gold standard, this system, although much preferable to the current one, would still be vulnerable and fully exposed to the whims of the next batch of politicians who come to power and to their own agendas and strategic aims. The currency would still be under the control of a central bank and there would always be a risk of the gold link being suddenly severed again or manipulated and weaponized once it didn’t make political sense anymore.

This seismic shift that was triggered by the crypto boom made it possible to conceive of a new and much better system than anything that existed before. Not only can we develop and freely use fully-gold backed currencies, but this time, these currencies can exist in what is essentially an interference-free vacuum. They can’t be tampered with, they can’t be restricted or otherwise manipulated, they can’t be centrally controlled and they certainly can’t be unilaterally devalued.

Free choice, free society

Central planners and their supporters like to argue that national currencies are different from any other product or commodity in the market. They have a special, foundational place in the entire economic structure and they’re too important to allow market participants themselves to determine their real value by allowing other alternatives to directly compete with them. Naturally, that argument is patently politically motivated and the only good reason to support this monopoly is that it secures and ensures government power and policy transmission. National currencies, especially fiat ones, have nothing special to offer to the end user who is forced to transact in them exclusively. They solve no problems that a private, decentralized alternative cannot. If anything, they actually create new ones.

The freedom to choose what kind of currency one uses for what kind of economic activity or financial goal is of paramount importance to the establishment of a truly sustainable, vibrant and healthy society. Different needs can be served by different transaction or investment vehicles and one size most definitely doesn’t fit all. For instance, one may choose to save and to preserve the value of his assets over the long term by holding a gold-backed cryptocurrency. Others may turn to Bitcoin or a similar alternative for quick and cheap transfers, and others still may use a niche token for transactions within a specific platform or ecosystem.

Whatever one’s individual needs and choices might be, and they will definitely be very different from their neighbor’s, the mere existence of these choices is the most essential element in constructing a better system.

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