The dollar is the monetary unit of the greatest economy in the history of the world – the United States. After the Second World War, there was a Bretton Woods Agreement regarding the world monetary system and the US dollar emerged as the global reserve currency replacing that of the British Pounds Sterling. The dollar was also on a gold standard, which meant that the dollar was convertible to gold. During that period, the US built up the world. The US was the world’s banker and had the largest trade surplus in the world. It had about 50% of the world’s gold, was the world’s largest manufacturer. In fact, 8 states in the US as at 1950 accounted for 25% of world GDP. The US had a stable monetary policy where the Fed didn’t adopt an expansionary monetary policy. The US government during Dwight Eisenhower was running up very low budget deficits and as a result had a low debt-to-GDP ratio. This continued in the Kennedy administration and the US was still the world’s banker. In fact, the dollar was considered as good as gold. The price of gold was pegged at $35/ounce.
On August 15th 1971, the world changed. President Nixon removed America from the the gold standard. This has come to be known as the Nixon Shock. This action immediately made the dollar to become a fiat currency backed by nothing. This was due to the massive budget deficit and trade deficit was running at that time. This was in fact the first time in the 20th century the US was running these simultaneously. Removing the dollar from gold meant gold was subject to market forces. Nixon claimed that it was because the speculators waging a war on the dollar which in fact was due to the constant budget deficits the US government was running up. It was a defensive move in order to prevent foreign countries from redeeming their dollars with gold and protect the nation’s gold vault. In fact, France staged a massive assault on America’s gold redeeming about $121 million worth of gold at a point. Nixon lied to the people saying that the closure of the gold window will not see a devaluation of their dollars but in reality, it unleashed inflation and when Jimmy Carter came to power inflation was running at 15%. This gave the Fed new powers to expand money supply as they deemed fit and also adopt a low-interest rate environment. A low interest rate environment creates a perfect environment for another bubble brewing up in the nearest future. The removal of the dollar from the gold standard amounted to a technical default by the government. This also meant that the US government could consistently run budget deficits and do so without checks. there was no measure in place to check reckless government spending. This unleashed inflation which severely devalued the dollar. This is shown in the increase in the price of gold from about $35/ounce in 1971 to $850/ounce at the end of the decade. Adjusted for inflation gold is undervalued even at today’s spot-price of about $1900/ounce which should actually be about $2200/ounce when adjusted for inflation. The run on gold showed two things that happened in the decade – inflation and uncertainty. In the 1970s, the US was grappling with stagflation (high inflation and high unemployment) and the money supply by the Fed was increased exponentially to finance the massive budget deficits the US government was facing which therefore unleashed inflation. The 1970s was characterised with uncertainties as a result of the Vietnam War and investors were also banned from converting their dollars to gold which meant that there was also a mixture of uncertainty and a premium for gold. In this period, gold was as glittery as ever.
The removal of the dollar from the gold standard increased the uncertainty in the international market. People tend to forget that the economic problems that we have now resulted from the closure of the “gold window.” The inflation unleashed as a result coupled with the high unemployment rate was responsible for the gradual inequality the world especially in the US and as a result has resulted in the stagnation or reduction of real wages among the working class in the US.