FOR A LITTLE WHILE LONGER
There was a time not too long ago when the world’s monetary system relied on a standard economic unit of account which was a fixed on a known quality of gold – historically, the world’s most precious metal. It was called the ‘Gold Bullion Standard’. It was a system in which gold coins did not circulate, but in which monetary authorities of each country agreed to sell gold bullion on demand at a fixed price in exchange for the circulating currency. There was order and disci pline in the community of nations in the world.
The system was introduced as a result of the British Gold Standard Act of 1925. It lasted until September 19, 1931 or just about at the time of the Great Depression. That was when the United Kingdom abandoned it due to large outflows of its gold reserves across the Atlantic Ocean. In doing so, the British benefited from it largely because they could now use monetary policy to mani pulate their economy through the lowering of interest rates. Australia and New Zealand had also been forced off the gold standard by the same pressures connected with the Great Depression. Canada quickly followed suit but America, for a little time longer, held firm.
To their credit, the arrogant behaviour displayed by officialdom in other coun tries that were under the British Empire was, in the U.S.’s case, tempered and controlled. The Federal Reserve of the United defended the fixed price of dol lars in respect to the gold standard by raising interest rates, trying to increase the demand for dollars.
Its commitment and adherence to the gold standard explained why the U.S. did not engage in expansionary moneta ry policy as Cicero had warned the patricians of the Senate of Imperial Rome not to do by debasing the value of their currency.
To compete in the international economy, however, the United States of Amer ica maintained high interest rates which attracted international investors who bought foreign assets with gold. But in doing so, the greed of U.S. commercial banks led them to convert Federal Reserve Notes to gold. This maneuver, if you can call it that, effectively reduced the Federal Reserve’s own gold reserves, forcing a corresponding reduction in the amount of Federal Reserve Notes in circulation so much so that it led to a speculative attack on the U.S. dollar.
Consequently, many foreign and domestic depositors withdrew funds from U.S. banks and converted them too into gold or other assets. The beast that U.S. bankers created came back to bite them and consequently recovery in the United States was slower than in Britain, in part due to Congressional reluctance to abandon the gold standard and float the U.S. currency as Britain had done.
But temperance and prudence didn’t last very long. The U.S. Congress passed the Gold Reserve Act on 30 January 1934. The measure nationalized all gold by ordering the Federal Reserve banks to turn over their supply to the U.S. Treasury. In return the banks received gold certificates to be used as reserves against deposits and Federal Reserve notes. The act also empowered the presi dent of the U.S. at the time (President Hoover) to devalue the gold dollar so that it would have no more than 60 percent of its existing weight. Under this grant of authority, the president fixed the value of the gold dollar at 59.06 cents.
UNDER THE HANDS OF MEN
After the WWII, a similar system of a holding major currency to account for its value relative to all others was established under the Bretton Woods Agreement and many countries followed suit by fixing their exchange rates relative not to gold per se, but to the U.S. dollar instead.
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world’s major industrial states in the mid- 20th century following the conflagration and destruction wrought by the Axis Powers in World War II and the struggle of the 44 Allied nations led by the United States to overcome it. The Bretton Woods system was the first exam ple of a fully-negotiated monetary order intended to govern monetary relations among independent nation-states.
The Agreement was also backstopped by the Marshall Plan (officially the ‘Euro pean Recovery Program’ or ERP). It was a large-scale American program inten ded to aid Europe where the United States gave monetary support to help rebuild European economies after the end of that war and large also in order to combat the spread of Soviet commun ism.
The Plan’s aims were not only to rebuild a war-devastated region, but to remove trade barriers, modernize industry, and make Europe prosperous again. In exchange for such generous aid, the United States dollar became the reserve and trading currency in Europe and eventually, the rest of the world. Under the hands of men, the world would still be a sane and safe place to live in.
To make the new post-war Arrangement and the Plan work more smoothly, the U.S. promised to fix the price of gold at approximately $35 per ounce. Implicit ly, however, all currencies pegged to the U.S. dollar also had a fixed value in terms of gold. But, under the administration of the French President Charles de Gaulle up until 1970, France reduced its dollar reserves, trading them for gold from the U.S. government, thereby reducing U.S. economic influence abroad.
This situation, along with the fiscal strain of federal expenditures arising from the escalation of the Vietnam War the U.S. was deeply embroiled in the 1960s and 70s and the persistently negative balance of payments and trade deficits that it was also experiencing during the period, all led to a series of drastic, if not shock ing economic measures taken by U.S. President Richard Nixon in 1971.
IF YOU DON’T GET IT RIGHT
The ‘Nixon Shock’, as it was later known, opened the way for U.S. banks to en gage in what is called ‘fractional-reserve’ banking. It is a type of banking where by a bank does not retain all of a customer’s deposits within the bank. Funds re ceived by the bank are generally lent to other customers. This means that avail able funds called ‘bank reserves’ are only a fraction (called the ‘reserve ratio’) of the quantity of deposits at the bank.
As most bank deposits are treated as money in their own right, fractional re serve banking therefore increases the money supply. That’s when banks are said to create money. However, bank runs – or when problems are more wide spread, leads to a systemic crisis that do occur in fractional-reserve banking systems. Unfortunately for us, fractional-reserve banking is the most common form of banking and is practiced in almost all countries.
And so, repeated bank failures and financial crises since the 1960s have led to the creation of central banks – public institutions that have the authority to regulate commercial banks, impose reserve requirements, act as lender-of-last-resort and print money at will even if there exists a consensus that attempts to directly control the amount of money in an economy can oftentimes backfire particularly if you don’t get it right, which is more often the case.
When that happens, the lives of people are dislocated. That’s equally frighten ing. Read on.