On Sunday, Aug. 15, 1971, President Richard Nixon addressed a national television audience and articulated the need to take immediate action on three fronts:
■ create more and better jobs—by instituting a series of tax reductions and imposing a 10 percent across-the-board import tariff;
■ stop the rise in the cost of living—by imposing a 90-day price freeze; and
■ protect the U.S. dollar from the attacks of international money speculators—by ending the convertibility of the dollar into gold.
Each action the president took proved to be transitory except for ending the dollar’s gold convertibility. With the 50thanniversary of that long-ago Sunday evening upon us, I thought a little retrospection might be in order. Let’s start with a brief chronology of the dollar’s gold peg.
Pegging the dollar to gold
While the dollar had gold or silver backing for much of the 19th century, the Gold Standard Act of 1900 officially pegged the dollar’s gold content at “twenty-five and eight-tenths grains of gold, nine-tenths fine,” which translated to $20.67 per ounce. Gold could still freely move across borders, but outside the U.S. gold mostly traded in a tight range between $18.90 and $21.40 per ounce, as it had since 1833 and would continue to until the end of 1930.
In addition to creating its namesake institution, the Federal Reserve Act of 1913 also further strengthened the dollar’s gold linkage by stipulating that “every Federal reserve bank shall maintain reserves in gold or lawful money of not less than 35 per centum against its deposits and reserve in gold of not less than forty per centum against its Federal reserve notes in actual circulation.”
In the early 1930s, as the Great Depression ground along, the U.S. was faced with, in the words of President Franklin Roosevelt, “heavy and unwarranted withdrawals of gold and currency from our banking institutions for the purpose of hoarding; and Whereas continuous and increasingly extensive speculative activity abroad in foreign exchange has resulted in severe drains on the Nation’s stocks of gold; and Whereas these conditions have created a national emergency … it is in the best interests of all bank depositors that a period of respite be provided with a view to preventing further hoarding of coin, bullion or currency or speculation in foreign exchange. …”
To counter these developments, Roosevelt was empowered by the Emergency Banking Act of 1933 to regulate the “export, hoarding, melting, or earmarking of gold or silver coin or bullion or currency, by any person within the United States or any place subject to the jurisdiction thereof.” In addition, the secretary of the Treasury was empowered to “require any or all individuals, partnerships, associations and corporations to pay and deliver to the Treasurer of the United States any or all gold coin, gold bullion, and gold certificates owned by such individuals, partnerships, associations and corporations.” In short, the ownership of physical gold aside from industrial, artistic or jewelry use was deemed unlawful.
While U.S. citizens were no longer permitted to own gold, foreign governments were still eligible to exchange dollars for gold bullion. So, the country remained on the gold standard, but primarily with respect to international as opposed to domestic activity. One year later, the Gold Reserve Act of 1934 was passed, which:
■ abrogated all private contracts that required the payment of debt obligations in gold or gold certificates and decreed that all such gold payment obligations were amended to be settled in U.S. dollars rather than in gold coin; and
■ reduced the grams of gold backing each dollar, thereby raising the gold price from $20.67 to $35 per ounce.
Washington politicians often assert that the U.S. has never defaulted on its debt. But Webster’s Dictionary defines default as “the failure to fulfill an obligation.” The Gold Standard Act of 1900 obligated the U.S. to convert each dollar presented to it into “twenty-five and eight-tenths grains of gold.” Thirty-four years later, the U.S. unilaterally reduced the gold content by 59 percent. Thirty-seven years after that, the U.S. walked away from gold backing altogether. And while the U.S. paid American citizens the stated $20.67 per ounce for the gold it confiscated from them, international dollar holders were left with a significantly debased currency. I believe most objective observers would consider both the 1934 and 1971 debasement acts as “failures to fulfill an obligation.”
The dollar’s declining value
So, what were the consequences?
The Consumer Price Index was created by the Bureau of Labor Statistics in 1913. From then until the start of 1942, when a World War II shortage-driven inflation began to take root, the CPI grew at a compound annual rate of 1.6 percent. However, three quarters of the total price increase during those years took place during the 20 months of U.S. participation in World War I. Aside from the war years, inflation was pretty much non-existent over those three decades. Ditto for the post-World War II years. Prices increased 55 percent from the end of 1941 until the wartime shortages were alleviated by the end of 1948. From then until the end of 1965, when the Vietnam War began the heat up, prices rose at a 1.7 percent compound annual rate, with 40 percent of that increase accruing during the Korean War.
In short, the gold-backed dollar kept prices remarkably stable outside of the war years.
When the gold standard departed, inflation took over. Looking at symmetrical time periods preceding and subsequent to Nixon’s decoupling of the dollar from gold, whether 10, 20 or 50 years in duration, in each case inflation was materially more pronounced after the decoupling than it was when the dollar was gold-backed.
Whether this is due to causality or to the impact of extraneous events such as wars, industrialization, the rise of OPEC, regulatory changes or myriad other inputs is certainly open to debate. But, regardless of the cause, an Aug. 15, 1971 dollar is worth just 15 cents today. Over the 50 years that preceded the gold standard exit, in spite of two world wars, the Korean War and the Vietnam War, a 1921 dollar was still worth 43 cents on Aug. 15, 1971, nearly triple its post gold standard departure performance.
It’s ironic that this anniversary is arriving just as inflation is once again rearing its head after having been relatively dormant for several years, the operant word being “relatively.” As measured by the CPI, the dollar has lost 11 percent of its purchasing power over the last five years and 17 percent over the last decade. Some would argue—count me among them—that the CPI actually understates true inflation because of the way it measures housing costs. But that’s a subject for a future article.
Equally ironic is having this anniversary coincide with the explosion in cryptocurrency trading. One of the arguments against the gold standard, a reasonable one in my view, is the challenge of growing an economy with a currency constrained by a limited amount of available physical gold (or silver). And yet, bitcoin’s advocates tout its scarcity value—21 million bitcoin is the mathematically producible maximum—as one of its virtues, rendering bitcoin immune from central bank debasement. Of course, while it may be immune from monetary debasement, bitcoin certainly isn’t immune from governmental regulation or, potentially, even outright governmental banishment.
As Jim Grant of Grant’s Interest Rate Observer has often observed, we’ve transitioned from the gold standard to the PhD standard, entrusting the sanctity of the world’s fiat currencies to nothing more than the collective wisdom of central bankers, whose forecasting track record is certainly less than stellar. Central bankers were once the guardians of price stability. Today, in lieu of price stability, developed nation central bankers are actively pursuing 2 percent inflation. Monetary debasement has become stated policy. That should give everyone pause.
Sound central banking requires courage and backbone, coupled with political independence. The bright red line that once separated politics and central banking has dimmed considerably. Paul Volker is widely viewed as one of history’s great Federal Reserve chairmen. But in the current political climate, would a present-day Chairman Volker be permitted to pursue the policies he employed to tame the deeply embedded inflation of the late 1970s and early 1980s? I very much doubt it.
We live in a different world today, one in which short-term gratification supersedes longer-term virtue. We lack discipline. Today’s Washington wouldn’t have the courage to endure the short-term economic pain Volker’s Fed imposed on Americans as the medicine required to strengthen our economy for the longer term.
Fiftieth anniversaries are usually a time for reflection as well as celebration. That’s especially true with this one. There’s a lot to reflect on.
Geoff Rosenberger is retired co-founder of Clover Capital Management Inc.
Thanks for the history, education and insight. I still have a long way to go in understanding the financial markets and events.