Today we bring you Part VII of “A Brief Monetary History of the United States” from the Ron Paul Monetary Policy Anthology. The full series can be found at the following links:
Bretton Woods and Gold
In the aftermath of World War II, the United States cemented its position as the world’s largest and most powerful economy. The new international monetary order created at Bretton Woods, New Hampshire in 1946 was based in part on the gold-exchange standard of the 1920s, only with the dollar as the sole international reserve currency—since it was as good as gold. All countries tied their currencies to the dollar at fixed exchange rates, with the dollar being defined as FDR had left it, at 1/35 ounce of gold (i.e. $35 per ounce of gold). While individuals in the United States were still unable to own gold or to redeem their dollars for gold, foreign governments were able to cash in their dollars to the U.S. government and receive gold in return, a process that became known as the “gold window.” While the United States would pyramid its dollar issue on top of its gold reserves, other countries were supposed to hold dollars, and not gold, as their primary foreign exchange holdings.
Just like the gold-exchange standard of the 1920s, the system would work as long as everyone cooperated. Unfortunately, the temptation to print more money was too great for the United States to withstand; just as the U.K. did in the 1920s, the U.S. inflated its currency throughout the 1950s and 1960s. As long as no other countries came to the gold window to exchange their dollars for gold, the United States thought it could reap the benefits of inflation without the negative consequences. Since all other currencies were pegged to the dollar at a fixed exchange rate, inflation of the dollar would overvalue it in relation to other currencies, and other countries would have to purchase dollars to hold them as foreign exchange reserves to keep the pegged exchange rate the Bretton Woods system required. Thus the United States could pursue a beggar-thy-neighbor policy, increasing the amount of dollars in circulation in order to purchase more goods and services while pressuring other countries to hold those dollars and not redeem them for gold.
Gold Outflows of the 1960s
Increasing the amount of dollars, however, led to a decrease in purchasing power of each dollar in circulation. European countries began to realize that the dollar was increasingly losing value, and began to return their dollars to the United States for gold at the defined rate of $35 per ounce. American gold stocks plummeted, yet the response of American politicians was not to discontinue inflationary monetary policy, but rather to place increased pressure on European countries, particularly France, not to come to the gold window.
The United States sought to collude with other foreign countries in the creation of the London Gold Pool, a mechanism that attempted to maintain the $35 per ounce market price of gold through targeted buying and selling of gold on the market. This arrangement proved unsuccessful and collapsed in 1968. In its place, the United States and foreign governments sought to create an official two-tiered gold market, with central banks selling gold to each other at $35 per ounce while the free market gold price was free to fluctuate according to market conditions. As the market gold price very quickly rose above $40 per ounce, this created an arbitrage opportunity, as central banks could redeem their dollars for gold at $35 per ounce and then sell that gold onto the market for an easy profit.
Coinage Act of 1965
At the same time as the U.S. was hemorrhaging gold to Europe, the price of silver was climbing as well. Because of the decline in value of silver during the late 19th century, silver dimes, quarters, and half dollars had long had a face value far in excess of their silver value. Silver would have to be worth $1.29 per ounce in order for the silver content of dimes, quarters, and half dollars to equal its face value. In the Silver Purchase Act of 1946, the U.S. Treasury was authorized to purchase silver at $0.905 per ounce and to sell it at $0.91 per ounce. By the early 1960s, however, the price of silver on world markets had surpassed this level and was moving towards $1.29 per ounce. Rather than being a large purchaser of silver, the Treasury was now becoming a large seller, and was at risk of selling silver at a great loss.
While government silver sales were suspended in 1961, legislation was passed in 1963 to repeal the silver purchase acts, with the intention of eventually removing silver coinage from circulation. Realizing this, Americans began to hoard silver coins. Congress responded by passing the Coinage Act of 1965, which called for a half dollar containing 40% silver (as opposed to the previous 90%), and quarters and dimes which contained no silver whatsoever. While 1964-dated silver coinage continued to be minted through 1966, and the government publicly claimed that silver coinage would circulate alongside the new clad (copper and nickel) coinage, for all intents and purposes silver coins no longer circulated as money. They were pulled out of circulation almost as soon as they were minted, and millions of coins were melted down in the mid- to late-1960s as the silver price rose above $1.29 per ounce and it became profitable to melt the coins for their silver content.
Silver certificates continued to be redeemable at the Treasury for silver bullion, but only until June of 1968, after which time the government’s promise to redeem the certificates for silver was abrogated. From this point on, circulating coinage in the United States had no precious metal content, and circulating bills had no precious metal backing (since private citizens could not redeem bills for gold or silver). The domestic system of circulating money was now a completely fiat system.
The 1970s and Stagflation
The continuing outflows of gold throughout the late 1960s and into the early 1970s began to worry the federal government greatly. The Federal Reserve had severely inflated the money supply to accommodate the massive government debts resulting from President Johnson’s Great Society programs and from funding the Vietnam War. As the U.S. dollar devalued, redemption demands from France and other foreign countries for gold increased to such an extent that there was a very real threat that the entire gold supply of the United States government might be wiped out. Rather than restraining the inflation of the money supply, President Nixon responded to the gold outflows by announcing the closure of the gold window on August 15, 1971. From that day forward, foreign countries would no longer be able to redeem their dollar holdings for gold. The market price of gold skyrocketed in the aftermath of Nixon’s actions, with the monthly average gold price reaching above $60 per ounce by June of 1972, and $100 per ounce by May of 1973.
Freed from the limited constraints imposed by the gold-exchange standard of the Bretton Woods system, the Federal Reserve was free to continue inflating the money supply. Economic growth began to stagnate in the early 1970s, while unemployment began to rise and inflation hit double digits. At the time, mainstream economists believed in a tradeoff between unemployment and inflation, thinking that higher inflation rates led to lower unemployment rates, and vice versa. The 1970s saw the first instance of what came to be known as stagflation: the existence of high unemployment and high inflation rates at the same time. Whereas the overall money supply (as measured by M3) had increased by 50% over the five years prior to Nixon’s closing of the gold window, the money supply increased by 70% over the next five years, and nearly tripled by 1981. Unemployment had risen from 3.4% in 1969 to 6.1% by the time Nixon closed the gold window. By 1975 it rose to 9% and, after a modest drop back to 6% in the late 1970s, continued to climb to nearly 11% by 1982. It was only with the appointment of Paul Volcker as Chairman of the Federal Reserve that the rate of monetary growth was slowed significantly for a few years, as Volcker allowed the federal funds rate to reach over 20 percent.
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