What Happened In 1971?
By Moon Hodler
If you spend enough time talking about Bitcoin, you will notice the year 1971 mentioned again and again. Fifty years ago, US President Richard Nixon addressed the nation on August 15, 1971, and temporarily suspended the convertibility of the US dollar for gold. This article will detail the events leading up to 1971 as well as why Nixon’s speech is such a significant moment in world monetary history.
The Federal Reserve System of the United States was created in 1913 with the passing of the Federal Reserve Act. It is worth noting that the creation of the Federal Reserve occurs 16 years prior to the Great Depression. (The relationship between the two will need to be explored in detail in a separate essay.) The Federal Reserve was created after a series of ‘smaller’ depressions in the late 1800s and early 1900s. Due to a combination of complicated real-world and banking-industry events, the United States found itself in what is known as The Panic of 1907. Private companies, using money borrowed from banks, had grown too large, too fast. Some powerful men committed financial crimes. Companies failed, and more than one man committed suicide. After the companies failed, banks across the country began to fail as they ran out of cash.
The US Treasury issued aid to the banks in the amount of 25 million dollars, while J.P. Morgan and other powerful industrialists including John D. Rockefeller raised 30 million dollars of private money to distribute to banks. This kept them from failing. The result of this experiment seemed favourable, and six years later, the Federal Reserve System was formalized. To provide some perspective, the price of one ounce of gold in 1914 in US dollars was $18.99. The price of gold (or, the value of the US dollar) remained stable until around 1933, when it nearly doubled to $34.69. There the price remained, more or less, for several more decades, until 1971 when it reached $40.62, then $58.42 the year after, and $154.00 by the year 1974. It is important to note that the value of gold was not increasing. Rather, the value of the US dollar was decreasing. Imagine All of the gold in circulation on one side, and all of the cash in circulation on the other, and what you have is a cash-to-gold ratio. Naturally, the cash-to-gold ratio changes over time. As people and corporations mine for gold, the quantity of gold in circulation inflates, or increases. On average, gold mining introduces 1.5% to 2.0% more gold into circulation each year. This is grossly disproportionate to the amount of cash that was and is being introduced into circulation each year. As there is much more new money than new gold introduced to circulation each year, it takes more dollars to equal an ounce of gold in the cash-to-gold ratio. This translates to a devaluation of the cash. But why was the US Government printing so many more dollars?
During the Great Depression, the government found it difficult to print money as they desired because every dollar in circulation was publicly known to be tied to a corresponding quantity of gold. On April 5, 1933, US President Franklin D. Roosevelt signed Executive Order 6102, stating “All persons are to deliver on or before May 1, 1933 all gold coin, gold bullion, and gold certificates now owned by them to the Federal Reserve Bank, branch, or agency, or to any member bank of the Federal Reserve System.” Essentially, the US government was confiscating its citizen’s gold. All but small amounts of gold had to be turned in for $20.67 an ounce. Then in 1934, the government fixed the price of gold at $34.69 an ounce, which raised the value of their gold reserves by about 70%, allowing them to excuse the printing of more cash.
The Federal Reserve, at the direction of the United States Congress, prints money and introduces it into circulation. The primary purpose of this (besides the replacement of damaged and/or destroyed money) is to alleviate the affects of recessions and depressions, and to end them as quickly as possible. As human behavior dictates, politicians would often prefer to fix a problem before their next election. However, as the Federal Reserve prints and circulates more cash to ‘solve problems,’ they are inflating the overall quantity of cash in circulation (think money-to-gold ratio). This is actual theft of value.
World War II was a very expensive war, and a great amount of money was needed to fund it. The Federal Reserve provided a lot of cash, and by 1944, they had printed so much money that the US dollar had lost 60% of its purchasing power, or relative value. During July of 1944, world leaders gathered in Bretton Woods, New Hampshire, to discuss how the world would rebuild following the war. The United States had been accumulating much of Europe’s gold reserves to keep safe as Hitler’s army ransacked the continent. The possession of so much of the world’s gold gave the United States great bargaining power. It was at Bretton Woods that the International Monetary Fund (IMF), and what would later become the World Bank, were legislated into existence. Various trade agreements were made. It was also agreed upon that international currency exchange rates, specifically the US dollar, would be pegged to gold, at which time one ounce of gold was equal to $33.85. Other countries agreed to maintain fixed exchange rates with the dollar.
During the 1960’s, the United States was again involved in a costly war, this time in Vietnam. This was a hugely unpopular war among Americans. To fund the war, President Lyndon Johnson had the Federal Reserve turn on the money printers. At this point, the amount of dollars in circulation far exceeded the amount of gold that the United States possessed, which was at the time 75% of all the gold in the world. As European countries realized this, they began to send their US dollars back to the United States in exchange for gold which the US dollars were supposed to be backed by. The problem was, there was not enough gold to cover all of the dollars that had by now been printed and circulated out into the world. Something had to be done, so on a Sunday night in August of 1971, President Nixon addressed the nation on television, “temporarily” suspending the convertibility of US dollars to gold. During his 18-minute speech, the word gold was only mentioned once, and 50 years later, we are still unable to exchange our US dollars for gold.
The effects of the US dollar divorcing itself from gold have been exponential. The graph above shows that even though productivity has continued to increase at a constant rate, wages for workers have remained stagnant since the early 1970s. The Federal Reserve prints so much money that it's value is continually driven down, causing the price of goods to rise, all while wages have remained, on average, the same. This leads to greater wealth inequality as the producers charge more from consumers, while paying their workers the same wage.
After 50 years, a return to the gold standard seems unlikely without a wide-scale collapse of the financial system. And although a wide-scale collapse of the system seems inevitable, a return to the gold system does not. In the age of the internet, there are faster, cheaper, more secure, ways to store and transfer value. Satoshi Nakamoto called it Bitcoin.