Have We Effectively Recreated The Bretton Woods Gold Standard System?

In Full Archive by Nathan Lewis

(This item originally appeared at Forbes.com on October 20, 2018.)

Today, the idea of relinking the dollar’s value to gold is still well outside the mainstream. Most people don’t have much idea of why anyone would want to do that. This includes most economists.

This is strange: the United States followed the principle of the gold standard for nearly two hundred years, 1789 to 1971, and nothing bad came of it. The U.S. became a world superpower, economically and militarily. The U.S. dollar became the premier international currency, and New York became the world’s premier financial center. The last two decades of the gold standard era, the Bretton Woods period of 1944 to 1971, were among the most prosperous of all of American history. The U.S. middle class was as healthy as it had ever been; the wealthiest and most prosperous, one could argue, of any civilization in the history of the planet.

In 1970, the dollar was worth 1/35thof an ounce of gold (“$35 an ounce”), the same value it had maintained since 1934. President Franklin Roosevelt had devalued the dollar in 1933, in the middle of the Great Depression. The dollar’s value, previous to then, was $20.67/ounce. Except for a floating currency period during and after the Civil War, it had been basically the same value since 1789.

Since 1971, economists have had a lot of goofy ideas about how currencies should be managed. None of them have worked as well as the gold standard. None of them have worked very well at all. That’s why they have to keep coming up with new ones. They will probably continue in this fashion until the grownups tell them to cut it out.

Usually, when something works well – very well; extremely super well—and better than anything else that has ever been tried, people think it is a good idea. For some reason, economists today can’t quite get their minds around this. This is apparently because they are very stupid.

For most of U.S. history, people adhered to the idea of Stable Money. Money should be as stable in value as possible. It would be a neutral, unchanging medium of commerce, free of human manipulation, somewhat like the unchanging weight of the kilogram and unchanging length of the meter. The practical expression of this ideal was a currency whose value was defined in terms of gold. For millennia, gold had served as the nearest real-world proxy for this ideal of Stable Value. Since most other countries also used gold as their practical measure of Stable Value, the result was fixed exchange rates with other gold-linked currencies. This vastly simplified international trade and investment. In this way, governments achieved stability in an absolute sense (the avoidance of crippling monetary “inflation” and “deflation” caused by changed in the value of the money), and also in a relative sense, of maintaining fixed exchange rates with trading partners.

In the market economy, everything is organized via prices, profit margins, interest rates, and returns on capital. When this system works, it works very well. When it doesn’t work, it can be a disaster. Thus, we want it to work well. That is why we want prices to reflect supply and demand for an individual product or service, without the distortion that comes from changes in the value of the money. When the price of oil rises from $50 to $100 a barrel, it should reflect a change in the real supply and demand characteristics in the oil market, as measured in money of stable and unchanging value. When the rise in the price of oil is caused by a decline in the value of the currency, all sorts of problems erupt. As George Gilder described in beautiful detail in The Scandal of Money (2016), we want our money to be as “noiseless” as possible, so that the “signal” of business failure and success is clear and uncontaminated. When there is a lot of monetary “noise” – a currency of floating value – then the signals of price, profit and loss, interest rates and returns on capital become deranged. Not surprisingly, the economy doesn’t work very well.

President James Madison explained it like this:

The only adequate guarantee for the uniform and stable value of a paper currency is its convertibility into specie [gold]—the least fluctuating and the only universal currency.

It’s not really all that hard to understand.

Actually, most governments in the world have already embraced the principle of Stable Money. They do not have independent floating currencies. Just as the dollar was once linked to gold, most currencies today are linked to the dollar, euro, or some other external standard of value. The International Monetary Fund reported that in 2016, 52% of all world currencies were linked to the dollar, euro, or some other external standard such as a currency basket. Another 21% of all currencies were “stabilized.” This meant that they were allowed to vary somewhat against an external standard (this includes China, where some drift is allowed between the yuan and the dollar). Only 26% of currencies were “floating” according to the IMF; but even these were usually not allowed to drift very far.

And what about the dollar itself? Since about 2013, we seem to have had an informal gold standard system, the “Yellen gold standard.” The dollar’s stability vs. gold since that time has been very conspicuous; too conspicuous and persistent to be the likely outcome of happenstance. But whether by accident or by design, the result is the same. We have enjoyed an effective crude gold standard system.

Was that really so terrible? It seems pretty painless to me.

And so, we have a worldwide situation in which many currencies are linked to the dollar, and the dollar is linked to gold. This is a rough facsimile of what was set up intentionally at the Bretton Woods conference in 1944. This time, it seems to have come about mostly by trial and error.

This present state of equanimity may collapse at any time. Then, we will get another lesson in what happens when the value of money becomes unstable. This will go on, and on and on and on, until people finally figure out what James Madison was talking about.