“Gold is money. Everything else is credit.”
– J.P. Morgan, testimony before Congress in 1912
Exploring Economic Imbalances
Recent discussions have centered on America’s significant trade deficit and how President Trump’s tariff policies aim to mitigate it while revitalizing domestic manufacturing. However, the origins of this vast trade deficit often go unexamined. If the world still operated under a gold standard, such extreme imbalances would have likely been impossible.
Imagine a system where every dollar, yen, or euro was redeemable for an actual piece of gold held in a vault. This is the essence of the gold standard. In this framework, if the U.S. wished to import more than it exported, it would need to pay in gold. Consequently, gold would flow out of the U.S. and into the possession of its trading partners.
As U.S. gold reserves diminished, fewer dollars would circulate, increasing their value. Simultaneously, countries receiving gold would see their currency supply expand, thereby reducing their value. This dynamic would naturally rectify the trade imbalance: American goods would become more affordable for foreign consumers, while imports would grow pricier for Americans, fostering a gradual return to equilibrium. Thus, a substantial, ongoing trade deficit would be unfeasible as a country would eventually exhaust its gold reserves.
In contrast, today’s fiat currency system operates without backing from tangible assets. The value of money relies on trust in the issuing government, creating a situation prone to excess. The U.S., enjoying the unique privilege of its currency being the world’s reserve, can sustain a massive trade deficit by purchasing far more from abroad than it sells.
This is feasible because the U.S. can essentially pay for its imports using its own fiat currency. Other nations accept U.S. dollars knowing they can use them within various economic systems, such as purchasing U.S. Treasury bonds or stocks. Rather than transferring gold, we’re distributing paper (or digital) money. As a result, there’s no limit on the dollars available, enabling continuous purchasing that leads to an expansive trade deficit, unchecked by the corrective measures of a gold standard. Over time, this has led to a deeply skewed economic condition.
Trump represents a departure from past leadership, boldly addressing these issues. Unfortunately, his approach—tariffs—merely masks the underlying problem rather than resolving it. It’s akin to attempting to manage a flood with inadequate tools, creating a new set of complications.
To genuinely address the trade deficit, fiscal discipline is essential, advocating for a balanced budget and a stable money supply. However, such a shift contradicts a long-standing culture of financial overindulgence that has pervaded U.S. governance for over a century—perhaps even longer.
Let’s delve deeper…
FDR’s Gold Confiscation
In 1933, amidst the Great Depression, the federal government took drastic measures. With banks collapsing and unemployment soaring, President Franklin D. Roosevelt felt compelled to act.
At that time, the nation operated under a gold standard, meaning individuals could redeem dollars for a fixed amount of gold. Many prudent citizens, fearing economic collapse, began hoarding gold, placing their trust in it over banks.
However, FDR’s administration viewed this hoarding as detrimental. They believed it hindered economic recovery and limited the Federal Reserve’s ability to inject money into the economy.
Their response? A radical, unprecedented action.
On April 5, 1933, FDR issued Executive Order 6102, which prohibited private ownership of monetary gold, including coins and bullion. Citizens were mandated to surrender their gold for paper currency at a fixed rate of $20.67 per troy ounce.
This act was a significant violation of property rights and an outright assault on sound money principles. By confiscating gold, FDR stripped ordinary citizens of their most dependable store of value, compelling them to rely on government-issued fiat currency—thus increasing dependency on the state and its central bank.
The intention behind this confiscation? To devalue the dollar. Subsequently, the official price of gold rose to $35 per ounce in 1934, effectively diminishing the dollar’s value by nearly 40 percent. This made inflating the money supply easier, as the U.S. government effectively defaulted on the dollar by altering its content and value.
Nixon Ends the Gold Standard
Fast forward to the post-World War II era. In 1944, leading economic powers convened in Bretton Woods, New Hampshire, to design a new global monetary framework.
The Bretton Woods Agreement established a system where the U.S. dollar was pegged to gold at $35 an ounce, with other currencies tied to the dollar, establishing a quasi-gold standard. Under this arrangement, only foreign central banks could convert their dollars for gold from the U.S. Treasury, effectively positioning the dollar as the world’s primary reserve currency.
This system functioned adequately for a time. As the dominant economic power, the U.S. was able to maintain this structure. However, as the U.S. government began to lose fiscal control, continuously printing more money to fund social programs and the Vietnam War, issues arose.
Eventually, foreign officials, notably France’s Charles de Gaulle, became wary and started demanding gold in exchange for accumulating dollars, leading to a rapid depletion of America’s gold reserves.
Ultimately, the Bretton Woods Agreement was destined to fail. Any system allowing a central authority—the U.S. government, in this case—to create currency without a strict backing is inherently unstable. Governments are always tempted to overspend, resulting in inflation and potential crises.
This crisis culminated on August 15, 1971. Confronting a depletion of gold reserves, President Richard Nixon addressed the nation, announcing a “temporary” halt to the dollar’s convertibility into gold. This pivotal moment marked the end of the Bretton Woods system and severed any direct link between the U.S. dollar and gold, rendering the dollar a pure fiat currency—its value derived solely from government decree.
In altering the terms, the U.S. government effectively defaulted on the dollar once again.
The Era of Fiat Currency
Today, we find ourselves in a global landscape dominated by fiat currencies. Our transactions occur in dollars, euros, and yen, all devoid of physical backing. What does this imply for us in contemporary society?
A significant consequence is that money has transformed into a political instrument. Without the constraints of a gold standard, central banks can endlessly generate money as needed.
This authority—while sometimes heralded as a method for economic management—acts as the primary catalyst for inflation. Each new dollar introduced dilutes existing dollar values, essentially functioning as a hidden tax on dollar holders. It explains why your grandparents could purchase a soda for five cents while today’s prices are dramatically higher.
This incessant release of new money also precipitates boom-and-bust cycles. By adjusting interest rates and expanding the money supply, central banks engineer unsustainable economic booms based on misallocated investments made possible by cheap credit, inevitably resulting in economic recessions when the bubbles burst.
The historical events from FDR’s gold confiscation to Nixon’s disconnection of the dollar from gold represent more than mere political maneuvers. They signify profound shifts in the fundamental nature of money, effectively eroding financial autonomy.
In the current fiat realm, our financial stability hinges on political decisions and the whims of monetary policy. Ultimately, your money may not be as secure as it once felt under a gold standard.
As we navigate the implications of a world driven by fiat currency, it’s vital to reflect on the historical changes that led us here and the potential consequences of our financial choices.
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Sincerely,
MN Gordon
for Economic Prism
