Today, the United States lives with federal budget deficits of more than $1 trillion each year, interest rates that are artificially held below market levels, aggregate debt that is growing much faster than the economy, and a chronic trade deficit that is larger than whole industries.
Yet each of these problems could be tamed and mollified, in my view, with a true gold standard. Of course, the world used to be on a type of gold standard known as the Bretton Woods Agreement. Tracing the history of this gold standard and its demise ultimately led me to one man — US President Richard Milhous Nixon — the man who untethered the chord linking currencies to gold; the man who sold the world fiat money.
What happened? How did we get from there to here? And what lessons can we draw from this relatively recent economic history to inform where we should be going?
On 15 August 1971, President Nixon announced to the world that the United States was closing the gold window in a move known as the Nixon Shock. You can watch it here:
Wow. Heady stuff. The American dollar was a “hostage in the hands of international speculators“? Hmmm . . . let’s get back to that. Note the sense of urgency he is creating with his language. “We will press for the necessary reforms to set up an urgently needed new international monetary system.” He then goes on to declare, “I am taking one further step to protect the dollar, to improve our balance of payments, and to increase jobs for America.” So, Tricky Dick (as he was known in politics) presented himself as a protector of the dollar, a warrior against inflation, and a jobs creator. That was his sales pitch. In reality, Nixon was doing the exact opposite, and, according to an analysis by Burton A. Abrams and James L. Butkiewicz of the University of Delaware, Nixon knew it. Thanks to the Nixon Tapes from the White House, we have a looking glass that gives great insight into Nixon’s true thoughts and feelings — and how they differ markedly from what he said publicly.
For instance, despite calling himself a Keynesian, he was also a monetarist — at least to the extent he thought it might help him get elected in 1972. He believed that easy monetary policy could reduce unemployment in the short run and knew that presidents have a hard time getting reelected when unemployment is high. On 26 July 1971, Nixon was captured on tape stating, “I’ve never seen anybody beaten on inflation in the United States. I’ve seen many people beaten on unemployment.” When Nixon took office, unemployment was only 3.4%, but after the recession in 1969–1970, unemployment rose to 6%, where it remained. Given that Nixon had publicly stated that he would improve employment, he was committed to getting the number down by election time. Even the great Milton Friedman, who is on tape urging caution to the president over his desire for easy money, couldn’t persuade him. The tapes further reveal that Nixon arranged credible threats to the then-Fed Chairman Arthur Burns’ power as head of the Federal Reserve, including: adverse leaks about Burns to the public; the appointment of easy-money, pro-Nixon doves to the Fed board; and threats of Burns not being reappointed at the end of his term.
Nixon and his Administration placed repeated pressure on Burns to ease monetary policy in late 1971 and early 1972 — with the goal of reducing unemployment in time for the election. For example, on 19 March 1971, Nixon urged Burns, “We’ve got to think of goosing it [the money supply] . . . late summer and fall of this year  and next year . As you know, there’s a hell of a lag.” So, the self-fashioned “inflation warrior” pressured the Fed to print money? Say it ain’t so. In one recording, Burns states, “If interest rates go down further through my actions . . . the probability as I see it is, they will go up later on in the year and in 1972. Housing, which is recovering very nicely, will go into a tailspin in 1972. Where will we be, as a country, and as a party and me personally?” Clearly, Burns is warning Nixon of the adverse longer-term consequences of easy money.
By December of 1971, Burns ultimately succumbed to the pressure, reducing the discount rate and accelerating the expansion of money supply. Moreover, the wage and price controls created the illusion of stability against a powerful backdrop of easy money. So much for the independence of the Fed. So much for the inflation warrior. So much for the defender of the US dollar. So much for the creator of jobs. These tapes clearly reveal that Nixon was looking out for himself at the expense of long-term benefits for the country and — because of the international monetary system — the world.
So, ignoring what Nixon said publicly, what did his policies actually do? Nixon’s package of proposals included:
- Closing the gold window (elimination of the Bretton Woods gold standard).
- Letting the dollar float.
- Placing a temporary freeze on prices and wages to “combat inflation.”
- Placing a temporary 10% tariff on imports to “improve balance of payments.”
Under the Bretton Woods system, foreigners could convert their local currencies into US dollars and then exchange these dollars for a certain amount of gold with the US Federal Reserve through the “gold window.” It was not a true gold standard, because governments did not necessarily maintain gold reserves in direct proportion to their currencies in circulation. It was, however, reasonably effective in keeping trade imbalances from forming across global economies and kept currencies tethered to something of fixed value. Here’s a snapshot of the US current account balance in the 10 years preceding the decision to close the gold window.
United States Current Account Balance % GDP (1961–1970)
Sources: St. Louis Federal Reserve, CFA Institute.
Note that the United States maintained a small surplus before exiting the gold standard. How sad and pathetic that Nixon got away with claiming that there was an urgent problem. Now consider what happened to the US current account balance in the years following the departure from the gold standard.
United States: Current Account Balance % GDP (1960–2011)
Sources: St. Louis Federal Reserve, CFA Institute.
Just as both Arthur Burns and Milton Friedman had warned, in the years immediately following this new policy, the world endured sharply rising inflation and elevated interest rates — and the balance of payments swung from a persistent surplus to a chronic deficit.
Had Bretton Woods remained intact, these events would not have happened. Under a gold standard, trade deficit countries (such as the United States today) pay trade surplus countries in gold to compensate them for the exchange of goods. This is the balancing mechanism of a gold standard, and it prevents countries from misallocating capital. Under the floating exchange rate system, if countries should let their currencies float, exchange rates would change until trade deficits and surpluses shrink toward zero.
For Nixon, departing from the gold standard meant that the Fed was free to expand monetary policy much more easily. For the United States, it meant that trade gaps need not be resolved — ever — which is why we see the emergence of persistent, large, and growing trade deficits in the United States. Lastly, for the rest of the world, the loss of the gold exchange standard meant that they could maintain persistent trade surpluses with countries like the United States and thereby increase local employment and trade off exchange rates and inflation.
Under a floating exchange system, if country A fails to print as much currency as country B, either their currency appreciates or they experience inflation “imported” from country B. Escalating government debt, however, can help offset this inflation. Have you ever considered what might happen to inflation if a government never raised any federal debt and simply printed every dollar (or other currency unit) that they required to meet their spending needs on a pay-as-you-go basis? All else being equal, inflation would be greater. Likewise, as government debt rises, inflation is less than it otherwise would be. So, you can think of government debt as a reservoir of potential future inflation.
Consequently, after the departure from Bretton Woods, countries could afford to be more lax about exchange rate policy. For countries that maintained their peg to the dollar, easy money in the United States meant inflation at home. However, to the degree they were willing to use debt, they could mollify the effects of monetary inflation. Over time, the United States has used easy monetary policy in part to foster economic growth and in part to finance yawning federal budget deficits. The consequence of all this has been an ever-increasing debt load relative to GDP, standing at about 358% total debt to GDP today. Of that, government debt is now greater than GDP at over $16 trillion.
Nevertheless, until recently, each additional dollar of government debt could at least grow aggregate GDP — even if the ROI was weak. This is no longer true as incremental debt is proving to displace other forms of spending. Interest rates can not get much lower and the debt burden can not get much higher without unleashing the kinetic energy of the latent inflation stored within.
Ever since the fateful day that Nixon announced he was closing the gold window, the United States and the rest of the world have been operating on a fiat monetary system (meaning money is not backed by gold or anything else). Consequently, trade deficits and surpluses are persistent, and gold no longer stands between the politicians and the value of a currency.
As with credit markets, trust is at the core of a fiat monetary system. Should that trust deteriorate, the value of a currency can change rapidly. If and when that trust deteriorates, it happens quickly. The current system has made the value of the dollar a hostage to politicians, not to the currency markets or “international speculators,” as Nixon wanted the public to believe.
Over the years, whole countries (typically in developing economies) have built much of their economies around exports back to the developed world, including countries like the United States, who in turn are net importers — naturally creating vested interests in the status quo. Excluding services, which currently run an annual surplus, and focusing only on goods, the United States runs an approximately $700 billion trade deficit annually.
Assuming that US businesses on average could produce these goods — which they would under a gold standard — for about $200,000 in revenue per employee, the United States would create about 3.5 mm new jobs. But rather than fix the monetary system, today’s Federal Reserve is pursuing very aggressive monetary policy by which they have more than tripled the monetary base in just the last four and half years and pushed interest rates down to near zero.
Today’s massive trade imbalances, ongoing trillion dollar budget deficits, and the escalation of debt and money printing only makes the system more and more unstable. That’s a harsh and lasting legacy of a slick salesman — all so that he could get reelected. Of course, no system is perfect, and certainly the Bretton Woods system as well as a classical gold standard are imperfect too. However, we can protect the value of our currencies, improve the balance of payments worldwide, and increase jobs and real economic growth. Just like Tricky Dick said. Only this time, with a gold standard. It’s not too late.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Photo credit: National Archives at College Park