Death Of The Gold Standard - Breaking the Dollar podcast

This is Breaking The Dollar, the podcast that dismantles some of the biggest misconceptions about money. Presented by Gainesville Coins.

Hello and welcome back to Breaking The Dollar. I'm your host, Everett Millman.

Today's episode is going to touch on the gold standard, which is a topic that we've discussed in earlier episodes, so I'm not going to really get into the basics of what the gold standard is.

Again, I encourage you to go back and check our episodes on what is money and what makes gold valuable because I get more in detail in how the gold standard works in those episodes.

For the purposes of this discussion, I'll just recap that the gold standard meant the government promised to give you gold in exchange for your paper money.

This time, I really want to address the last part of that story, which is the supposed failure of the gold standard.

Why do we not have a goal center anymore? What are the criticisms of it?

And I think this is definitely relevant because in the long timescale of different systems of money we've had over human history, we haven't been off of a gold standard for all that long.

We did use some sort of gold standard mechanism fairly recently in the 20th century. And it is definitely an edifying exercise to look at why it broke down and why it ultimately didn't work and why we don't have a system like that today.

So our story really picks up in 1933. We're in the midst of the Great Depression and very infamously President Roosevelt, Franklin d Roosevelt issued executive order 6102 and this is more commonly known as the gold confiscation act.

Basically it said that every American citizen who held gold, whether it was in coins or bars, anything except for kind of collectible artwork, had to be turned into the government.

Now they didn't just completely take it and not compensate everyone. They did pay the official gold price, the price that gold had been fixed at four the previous 100 years. From 1834 up until 1934 an entire century, the price of gold was fixed by the US Government at $20.67 an ounce.

So everyone turned in their gold and or at least they were ordered to by law, and the government paid everyone out $20.67 per ounce.

Once the government had confiscated all of the gold held in the country, they changed the gold price to $35 an ounce. So if you just do some simple math, that means they could make a windfall if they decided to either sell that gold or just listed it on their balance sheet.

Now it is worth much more in dollar terms, but the flip side of that is it means that basically the dollar was devalued against gold, like almost 50%

As I walk you through the timeline and get a little later in this gold standard story. is that any time the gold standard was breached or anytime there was a major change to the arrangement, it was basically because the US Government was on the brink of insolvency in gold standard terms. That it can no longer abide by the agreement.

That's an interesting point that I want to emphasize about what made the gold standard useful is that it is an agreement.

It is a kind of a contract between different countries in the world that they all agree to use gold as a reference point, as a sort of backstop or trust that one government will not leverage its central bank and its money supply against all the others.

I read an article in Bloomberg this week actually, that it really wasn't focused on the gold standard, but it was talking about the different types of monetary systems that the world has used over the past hundred or 200 years and how they've been remarkably stable and successful.

It's only every seemingly 30 to 40 years that we get a breaking point where the system dramatically changes.

So what happened during the Great Depression in 1933 happened again about 40 years later and we will be getting to why that instance, the quote, unquote Nixon shock where the gold standard truly met its end.

Why that is a sort of recurring pattern of how the gold standard fails is that at some point that trust breaks down, at some point some country stops following the rules.

So although the modern criticisms of the gold standard are correct in pointing out that it is constraining on governments being able to spend money for social programs, it is also somewhat logistically a nightmare because you have to physically transport gold and base things off of this real commodity that places some constraints on how governments implement their monetary policy and economic policies.

And one of the parallels between the Great Depression and the early 1970s is that in both cases the US Government was implementing programs where it had to spend a lot of money.

In the 1930s FDR had several programs, like the New Deal, which is supposed to create a ton of jobs. You had the confiscation of gold and then a year later in 1934 they outright banned the private ownership of gold.

It was a similar situation in the 70s where President Nixon reneged on the agreement that the United States would trade gold for US dollars to other governments.

And getting back to my original point about why was this necessary is that we needed more money. We needed to be able to spend more money because the 1960s and 70s were filled with expensive government programs.

There was the Vietnam War to pay for. There is all the civil rights legislation and great society legislation that Lyndon B Johnson started right before Nixon.

All of this put a strain on the government's budget. It didn't have enough money, if it adhered to the 40% rule of the gold standard.

At the same time honoring the agreement that other countries could take advantage of that arrangement that they could trade in their dollars for gold.

One of the international partners that really brought this system to its heels was France.

France continuously was trading in it's dollars for gold. The point was that we claimed to exchange gold for our dollars, but we didn't want anyone to.

It's sort of like a run on the bank idea that everything is fine as long as nobody takes advantage and tries to cash everything in at once and that's sort of what was beginning to happen and it's why the gold standard continued to break down.

Somebody didn't follow the rules, some part of the arrangement was breached.

So really the fault doesn't necessarily lie with the policy itself of having a gold standard.

Like I pointed out, it was a remarkably stable arrangement.

There's something called the Bretton Woods agreement that happened in 1944 towards the end of World War II. All of the major powers of the world, all those countries came together and agreed, they weren't all going to keep gold, they would simply keep dollars which were backed by gold.

So a sort of indirect gold standard that worked really well for quite a long time.

And it's not the policy that was necessarily broken, it was the good faith behavior of the people who were implementing it.

That human intervention is actually what brought that type of system down and it gets back to the pattern or the reasoning behind all of these failures of the gold standard.

It set a precedent for how much power the government could take over the economy and everyday people's lives.

That theme or that pattern has continued almost relentlessly to the present day.

Some prominent examples that are related to this idea of the government overstepping its authority are such as imminent domain laws where they can just take land. They will compensate you sort of like gold confiscation or the Patriot act where you're being compensated with greater security, but for less privacy.

Think about all the scandals with the NSA and just the general theme, and this is not a political or ideological statement, this is just objective fact.

Executive power and government power in general have been growing and growing over time. The government has more control over people's lives and over how the economy works than it ever had before. It's less of a free market.

That's why it's really not accurate to say that the gold standard itself failed.

Really, it's that we failed the gold standard.

In an almost philosophical way, I find it ironic that when we use the phrase gold standard today, how do we mean it?

It's always meant in a positive light.

You know, the gold standard of something is the best in the industry or the best possible arrangement.

So let's take our weekly question from the audience. In our little mailbox here.

We've got one from Kurt in College Station, Texas and he asks:

What is high frequency trading, HFT.

So that's interesting. Definitely already knew the abbreviation. High frequency trading has been getting a lot more publicity lately because technology has gotten better, but it's not that new of an idea.

It's basically that we use computers and automated algorithms to execute trades on markets. And the advantage of it is that you can react to information in data faster than the average human.

Secondly, you can execute that trade within milliseconds so that you are front running all other market activity and you can profit off of that.

And then thirdly, sort of the most publicized part of high frequency trading is that it causes these institutional traders and financial firms to fight over the fastest and closest connection to the stock exchanges. I'm talking literal cables and wires in order to have the fastest speed connection and the lengths that they go to are insane.

So really it is like a digital strategy. It is run by computers and algorithms, but it is also a physical battle over having the fastest line. And the closest connection to exchanges to execute trades.

The main criticism is that this takes sort of human intervention out of price, discovery and market activity, but at the same time it is also just the logical use of our new technologies. You just have to have access to that technology.

We could probably do a whole episode on that topic, so that was a good I'll think more about it and see if there are other interesting things that might help you understand why that's important to how markets work.

So as always, appreciate everyone out there listening. Thank you for tuning in and check out our next episode of Breaking The Dollar where we discuss market manipulation and how that goes on.

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Posted In: podcasts
Everett Millman

Everett Millman

Managing Editor | Analyst, Commodities and Finance

Everett has been the head content writer and market analyst at Gainesville Coins since 2013. He has a background in History and is deeply interested in how gold and silver have historically fit into the financial system.

In addition to blogging, Everett's work has been featured in Reuters, CNN Business, Bloomberg Radio, TD Ameritrade Network, CoinWeek, and has been referenced by the Washington Post.