The Yellow Brick Road & Reserve Banking
For those that believe in the power of happy coincidences, the answer to current woes might just lie in the 40th
– ruby – anniversary of the end of Bretton Woods in that it links us with another
ruby; namely those ruby slippers in the Wizard of Oz – which was said to be an allegory for the gold standard.
By Ross Norman AUGUST 15TH 2011 marked 40 years
since the end of the Bretton Woods agreement and the gold standard. Bretton Woods had been a financial discipline put in place to prevent central bankers from expanding the monetary supply in an irresponsible way and to force fiscal discipline upon policy makers. In effect Government became the guarantor of economic growth and the lender of last resort, supplanting gold. With the US economy in a parlous
state following its downgrading of its long term debt and with QE3 contemplated it is appropriate to consider how suitable the US dollar is as the global reserve currency and to ask if gold could once again play a role in re-instating monetary discipline. In his book A Monetary History
of the United States, Milton Friedman claimed that the global macroeconomic
performance
under the gold standard had been “remarkable” with real per capita income growth throughout the industrialized world at its highest since 1879. Inflation and interest rates were both contained. That may have been true but it is also easy to over romanticize an old order and it remains a moot point in considering whether a gold standard would fit todays needs. In 1944 at the outset of Bretton
Woods the US held 60% of global gold reserves and gold coverage for dollars printed by the Federal Reserve had fallen progressively from 55% to 22%. Under the agreement the US dollar had been pegged to all foreign currencies at a fixed exchange rate and gold was redeemable at a price
26 September 2011
of $35/oz – the US dollar had become ‘as good as gold’. The Federal Reserve were thus constrained from expanding their monetary base without first buying more gold to back those additional dollars and it placed a significant drag or financial constraint on monetary expansion. By the late 1960s this artificial construct came under strain as
a number of governments – especially under De Gaulle of France but also later Germany and Switzerland – redeemed their dollars for gold with the Federal Reserve. In addition, the US was struggling under the weight of a
growing trade deficit, rising inflation and the excessive cost of funding the Vietnam War (sound familiar?). On August 15th
1971
US President Nixon unilaterally decided without consultation with Congress to impose a wage freeze, plus a 10% duty on imports and then ‘closed the gold window’ ending convertibility (the so- called ‘Nixon Shock’) prompted possibly by rumours that Britain was about to redeem 300 tonnes of gold for dollars. In one sense, the decision to close the gold window was, in itself, a default by the US in that it reneged on the terms of its agreement with the international banking community and the Official sector.
Government became the guarantor of economic growth and the lender of last resort, supplanting gold
This crisis gave birth to the IMF and soon after gold ended
its convertibility while international currencies were also floated freely. However, the US dollar retained its role as the world’s principal reserve asset. Today the US dollar accounts for 61% of official allocated foreign exchange reserves, down from a peak of 73% in 2001 yet most trading in commodities is denominated in the benchmark US dollar. The initial impact of the unpegging of the dollar to gold was to
devalue the ‘greenback’ (and equally reduce the value of dollar holdings for many non-US central banks) which significantly increased the competitiveness of US manufacturing. The Nixon Shock was a success domestically and it ushered in a period of relative growth in prosperity as markets flourished ... for a while. In essence, the crisis gave birth to the concept of fiat currencies
(Latin for ‘let it be done’) – in other words its value is decreed by government giving them a power well beyond the original remit. Ironically, fiat currencies have a long history and originated in China in the 11th
Century during the Song Dynasty (they cannot say that they were not warned) but it died during a period of
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