Bitcoin: A Paradigm Shift of the Global Monetary System? (Part 2/3)

In this article, I’ll be running through a brief history of the gold standard and why it was adopted and ultimately deserted. The aftermath of this decision will be covered in the final and third article. I hope you enjoy this bit of history as much as I did!

At one point in time, the world operated on the gold standard. For the period between 1834 to 1914, stable geo-political conditions enabled co-operation between countries to base their currencies value on holding physical gold reserves. With the outbreak of World War I and its’ subsequent end in 1918, many global economies, particularly the U.S experienced a period of economic boom. This period was also known as the roaring 20’s. The decade saw a leap in the living standards of Americans, buying their first refrigerators, vacuums, cars and homes. However, it also created a frenzied level of investment in the stock market, regular investors were highly leveraged, pushing prices higher at greater risk.

Eventually, the stock market crashed as company earnings failed to justify record stock market prices. On October 24th, 1929, the Dow Jones plunged 11%, before falling another 16% on the following ‘black Tuesday’. The Dow Jones eventually lost 90% of its value as investors and everyday Americans got wiped out financially.

The subsequent economic slump (also known as the great depression), lasted for more than three years before President Franklin D. Roosevelt passed executive order 6102, making it illegal for everyday Americans to hold more than 5 troy ounces of gold. All remaining gold was to be handed in to the government, where citizens were paid $20.67 which was the spot price at the time, (the same fixed price since 1834).

The purpose for seizing gold was so that the Federal Reserve could introduce quantitative easing and stimulus into the economy. With more gold reserves the fed could print more money into the economy and fund new infrastructure and government projects to create jobs, increased employment and ultimately, economic growth.

A couple of decades later in 1939, the invasion of Poland by the Nazis saw the beginning of the second World War, and another round of stimulus required to fund the allied military forces. Prior to the allied forces declaring victory in September of 1945, a conference was held in the town of Bretton Woods. Amongst the 44 allied nations a new monetary system was agreed. The Bretton Woods agreement outlined that allied countries would deposit their gold reserves with the U.S and in return, the U.S would exchange dollars for gold. This made international trade significantly easier as all other currencies could now tie their value to the U.S dollar rather than to each other and gold separately. Indeed, the U.S dollar at this time was ‘as good as gold’ and took top spot as the worlds’ new global reserve currency.

The U.S government was able to maintain a stable price of gold to the U.S dollar of about $35 per ounce for several decades until 1971 when during the Vietnam war, President Nixon needed to finance the massive cost of the military. In today’s dollar value, the Vietnam war is estimated to have cost the U.S ~$1tn [1]. With federal gold reserves quickly depleting, Nixon filed an executive order that would no longer convert dollars to gold at a fixed value, thus ending the gold standard and protecting America’s reserves.

To further embed the strength of the U.S dollar as the global reserve currency, around the same time in the early 70’s, the U.S government reached an agreement with the Saudi Arabian government to only allow the purchase of oil (for any country) to be made in U.S dollars. In return, the U.S offered Saudi Arabia all the weapons and protection they would need in a turbulent part of the middle east. This system where all foreign countries buying Saudi oil need to pay using U.S dollars is called the petro-dollar system and is still utilised today. (Lyn Alden has written extensively on the topic of the petro-dollar for those interested to learn more I highly recommend her article).

Since then, the worlds’ economy has yet to come up with a new monetary system and is largely organised around the dollar as a reserve currency. This in spite of the fact that a dollar isn’t tied to anything scarce, or anything at all for that matter. Perhaps the biggest issue of all though, is what consequences arise from having a free-floating currency that can be created in infinite quantities to deal with all our economic problems. Monetary inflation. I’ll be covering this in the third and final part of this series on money in the next article.

Thanks for reading!