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39 Years Ago Today
The date was August 9th, 1974 when Richard Nixon resigned the Office of the President of the United States. Some people today might take the opportunity to argue over how Nixon abused the powers of the Oval Office, or how the Supreme Court began a judicial process in which they investigated the executive branch of United States government. The significance of this was this was the first time the high court went after a president, and many questioned whether the action was overreaching their mandate. However, since we are on the topic of Nixon (and because the lack of action in the markets last week very much exhibits the doldrums of summer) it is also important to discuss his role, during his presidency, in ending a gold exchange standard (known as Bretton Woods) and the transition to this current period of floating exchange rate regimes.
Towards the end World War II, the United States and other participating nations established a monetary regime known as a gold exchange standard. Different from a gold standard where an individual country’s currency or fraction of their currency is backed to their own gold reserves, a gold exchange standard had member nations exchange rates pegged to the US dollar, and the US dollar in turn was partially backed by gold. This began the US dollars reign as the world’s reserve currency as every other countries currency was relative to the US dollar. And from the setup of the regime, the idea was that US dollars were as good as gold, and vice versa.
Particularly in the postwar period, stability in exchange rates was pivotal to a period of sustained and stable economic growth in order to avoid a repeat of events following the First World War. During that period, countries had individual control over their exchange rates, which led to competitive devaluations and erection of trade barriers in order to direct domestic demand for home grown (or provided) goods (and services). David Ricardo’s 1817 On the Principles of Political Economy and Taxation written around a century earlier would reveal why this was a bad idea.
Amongst the many flaws surrounding the system of international finance during Bretton Woods, one key example was that pegged exchange rates were more suitable during times of slow and steady economic growth. As the world’s economies began to pick up speed, the gold exchange standard came into question. The US needed to continuously run deficits in order to ensure liquidity in global finance; however, US deficits undermined the value of their dollar relative to the price of gold. This was known as Triffin’s Dilemma, named after the economist Robert Triffin.
In addition to this, the US overburdened themselves with heavy social spending, and the expense of the Vietnam War. The Treasury was in desperate need of more money, which led to congress decreasing the fraction of gold backed to a US dollar. It’s no question this continued to shake the confidence of participants of this global monetary system, and thus led to French President, Charles de Gaulle along with others to begin calling on the US to exchange the dollars held in their foreign exchange reserves for gold.
It was Nixon’s executive order to close the gold window in 1971 as faith in the Bretton Woods Regime had dissipated. Ultimately, the perception of the US dollar being overvalued collapsed the link between the dollar and gold. And so begins the paradigm of the dollar and gold’s inverse relationship. Some forty-two years later, the result of a preponderance of fiat currency gives gold the standing of being a store of value rather than cash.