Yesterday we talked about the nature of money… and we noted that we haven’t had sound money for quite some time now.
So today let’s look at a brief monetary history to see how that came to be. This is something that nearly every University in the western world has either ignored or swept under the rug to keep us ignorant – so let’s take a minute to briefly pull the curtain back today.
We’ll look at the history of money from an American perspective. But only because the dollar has served as the world’s reserve currency since 1944.
And we have to start with this – what is a “dollar”?
In 1792 the United States Coinage Act defined the US dollar as 371.25 grains of pure silver. If this seems strangely specific, there’s a reason why.
The primary currency used at the time was the Spanish silver dollar. It was a coin that contained exactly 371.25 grains of silver.
The Coinage Act based the US dollar on the Spanish dollar since it already circulated widely in America. It also pegged the ratio of silver to gold at 15:1.
From there, the same Act created the US Mint. It’s job was to make gold and silver coins based on this precise measurement.
The US also experimented with a central bank and a national banking system in the century following the US Coinage Act. There were plenty of nuances and tons of intrigue involved here… but we’ll keep it simple today.
During this period US banks would issue paper notes (private currency) backed by the common coins in circulation. Their promise was that if somebody came into the bank with one of their notes, that person could redeem the paper for gold and silver.
But some of these banks created more paper than they had gold and silver backing for. Given the competitive nature of the system, those banks would inevitably go under for inflating their paper currency after everybody found out about it.
Whenever a bank went bust like this, it wiped out innocent people holding that bank’s notes. The propagandists emphasized this when they later set out to establish the Federal Reserve Cartel. We’ll talk about that in just a minute. But the key here is that all bank notes were once backed by gold and silver.
Fast forward to 1900 and the US officially went on the classical gold standard. The Gold Standard Act defined the US dollar as 25.8 grains of gold nine/tenths fine.
This was a purposeful shift away from silver. Per the classical gold standard, most transactions were settled in gold coins and private bank notes backed by gold.
That is, until the Federal Reserve came to be in 1913.
G. Edward Griffin’s The Creature From Jekyll Island provides fantastic insight into the back-room dealings the brought the Fed into existence. It was very much a sleight-of-hand play. Case in point – it’s not federal and there are no reserves.
We don’t have the space to go into those details today. But I highly recommend that book for anyone interested in this subject.
They key here is that the Federal Reserve Act prohibited private banks from issuing their own bank notes. In their place, the Fed began issuing “Federal Reserve Notes”. They were paper currency 100% redeemable in gold… at first.
But twenty years later, in 1933, President Franklin Roosevelt issued an executive order that made private gold ownership illegal. At that point Federal Reserve Notes were no longer redeemable in gold.
And per FDR’s order, all Americans were required by law to deliver all their gold coins, gold bullion, and gold certificates to the Fed or a member bank. The exchange rate was $20.67 paper dollars per ounce of gold.
And the executive order had teeth. The penalty for failing to turn in gold would result in fines and imprisonment.
This effectively removed gold from the domestic economy. But foreign central banks could still redeem their Federal Reserve Notes for gold bullion through what was called the gold window.
Meanwhile, the world wars forced nations to abandon the classical gold standard around the world. That’s because the combatant nations printed money to pay for the wars. As a result, each nation’s currency fell dramatically in relation to gold.
This left a major vacuum. Absent the gold standard, what would the international financial order look like?
In 1944, representatives from 44 nations of the world met in Bretton Woods, New Hampshire to discuss just that subject. They agreed to what was called “The Bretton Woods System”. It established the US dollar as the international reserve currency.
Per this agreement, the US dollar replaced gold as the medium for international trade settlement. That meant all international goods would be bought and sold in US dollars no matter which nations were doing the buying and selling.
The new system pegged the dollar to gold at $35 per ounce. Then foreign entities could redeem their dollars for gold through the ‘gold window’ at that rate.
Bretton Woods bestowed an enormous privilege upon the United States as it created a global demand for dollars. Suddenly all nations needed to hold dollars to purchase foreign goods.
This created a situation where the US government could borrow money very cheaply to increase its spending. That’s because there was now a massive global market for U.S. Treasury bonds – which are nothing more than a loan to the US government.
The US used this dynamic to finance President Lyndon Johnson’s “Great Society” programs. That was the beginning of the Welfare State in America.
The US also ramped up military spending to finance the wars in Korea and Vietnam. That gave rise to what President Eisenhower called the “military-industrial complex”.
To finance this increased spending, the US government issued debt and ran trade deficits. Under the classical gold standard, this would have required the US Treasury to pay its creditors in gold. But under Bretton Woods, the US government could simply print new dollars and ship them overseas to make its payments.
That worked for a little while. But eventually other nations began to fear that the US government’s excessive spending would lead to a revaluation of the dollar to gold.
Think about it this way…
They pegged the dollar to gold at $35 per ounce, but the US government kept creating more and more new dollars from nothing. This prompted foreign nations to increasingly exchange their dollars for gold through the gold window.
As a result, gold began to flow out of the US Treasury. And this led President Johnson to sign the Gold Reserve Requirements Elimination Act in 1968. This legislation eliminated the requirement that 25% of all Federal Reserve Notes be backed by gold in reserves.
That was a precursor to what happened in 1971.
On August 15, 1971, President Richard Nixon closed the international gold window. Nixon assured the world that this was just a temporary measure. And he took to the television in an attempt to maintain confidence in the US dollar.
“Your dollar will be worth just as much tomorrow as it is today.” Nixon proclaimed on television with a straight face. “The effect of this action, in other words, will be to stabilize the dollar.”
Of course, nothing Nixon said was true. The gold window never reopened – and that thrust the world onto a 100% fiat monetary system. The word fiat is Latin for “let it be done”.
In other words, our dollar became something that was only money because the government said it should be.
Tomorrow we’ll look at the consequences of this…
-Joe Withrow
P.S. My book Beyond the Nest Egg takes a deep dive into how the perversion of our money impacts our approach to financial planning. If you’re interested, you can find it on Amazon right here: https://www.amazon.com/Beyond-Nest-Egg-Financially-Independent-ebook/dp/B0CG7VYRV7/