The Day the Golden Chain Broke — The End of Bretton Woods

As we saw in the previous episode, the storm of the Great Depression exposed the rigidity of the gold standard and drew gold into the vaults of the state. The age in which individuals clutched gold coins came to an end, and gold transformed into a strategic material that moved only between governments and central banks. Before long the world rushed toward another great war, and nations once again entrusted gold with a final role in order to rebuild their ruined economies.

The stage of Episode 8 spans roughly thirty years, from the end of the Second World War. The world built a new monetary system centered on gold and the dollar, and it supported prosperity. Yet that system eventually could no longer bear the weight of its own success, and on a certain summer night in 1971 it was suddenly severed. When the chain that linked gold and the dollar broke, gold was freed from its fixed price and began to wander freely through the market.

The chain of gold and dollar, retied at Bretton Woods

In July 1944, while the Second World War was still going on, the representatives of more than forty Allied nations gathered at Bretton Woods, a small resort in the northeastern United States. How should the postwar world economy be rebuilt? The aim was to create a system that would never again repeat the chaos of the 1930s, when nations had thrown away the gold standard and rushed into competitive currency devaluations.

The pillar of the new system agreed upon here was to link gold and the dollar. The United States fixed one ounce of gold at 35 dollars and promised that it would, at any time, exchange the dollars held by foreign governments and central banks for gold at this price. And each nation fixed its own currency to the dollar at a set ratio. Only the dollar was directly tied to gold; other currencies were tied to gold indirectly through the dollar — this system is called the gold-exchange standard, or the gold-dollar standard.

Why did it take this form? The United States of that time is said to have carried much of the world’s industrial output and held most of the world’s gold reserves within its own borders. It was precisely because the dollar was backed by overwhelming economic power and gold that nations could tie their own currencies to the dollar with confidence. Here too, gold was placed as the final backing of trust. The dollar was seen as ‘as sure as gold itself,’ and rose to become the world’s key currency.

Trust creaks, and gold flows out

For a while after the war, this system worked splendidly. Trade expanded under fixed exchange rates, and the Western countries achieved high growth. The dollar was used to settle transactions all over the world, and nations hoarded dollars at hand as reserves. The dollar, backed by gold, flowed like the very blood of the world economy.

But that very success eventually became the seed of its unraveling. The larger the world economy grew, the more dollars were needed for transactions. For nations to obtain more dollars, the United States had to keep sending dollars abroad through trade and overseas spending. Thus, while dollars overflowed across the world, the amount of American gold backing them did not increase so easily.

As the 1960s began, America’s external payment deficits grew conspicuous. The cost of the Vietnam War and of domestic policies is said to have mounted as well. Before long, the suspicion spread that the total of dollars circulating abroad might exceed the value of the gold the United States held. ‘Can America really pay out gold at 35 dollars as promised?’ — nations that thought this way began to move to convert their dollars into gold. From America’s vaults, gold flowed out quietly, but steadily.

The chain linking gold and the dollar, stretched taut, had begun to creak little by little. There were efforts by major nations to cooperate in holding down the market price of gold, but the gap between the quantity of dollars overflowing the world and the limited quantity of gold had reached a point that could no longer be bridged by minor adjustments.

In 1971, the golden chain is severed

The tension reached its peak in 1971. In the summer of that year, the outflow of gold from the United States grew ever more serious. By accounts, Britain’s demand to convert a large sum of dollars into gold is said to have been the final push. If nations kept converting dollars into gold like this, America’s gold would run dry. The promise to keep paying out gold at a fixed price could no longer be kept — so the United States judged.

On August 15, 1971, President Nixon suddenly announced in a televised address that the exchange of dollars for gold would be suspended. Along with it, a series of economic measures was rolled out, including a surcharge on imports and a freeze on prices and wages. This event, which shocked the world, would later be called the Nixon Shock, or the Dollar Shock. The chain of gold and the dollar tied in 1944 was severed on this night by a political decision.

Afterward, there was at first an attempt to rebuild the system. In December of the same year, the finance ministers of the major nations gathered at the Smithsonian museum in Washington, and the Smithsonian Agreement was struck to rework the exchange rates. At this time the official price of gold was raised from 35 dollars to 38 dollars per ounce, in an effort to somehow preserve the framework of fixed rates. But the chain of trust, once broken, did not return to what it had been. The agreement did not last long, and in 1973 the major nations of Japan and Europe shifted one after another to floating exchange rates. It was the dawn of the era that continues to today, in which the value of currency is entrusted to the trading of the market.

Gold, freed from its price

With the chain of gold and the dollar broken, the standing of gold itself also greatly changed. Under the Bretton Woods system, the price of gold was fixed at 35 dollars an ounce and scarcely moved for a long time. Gold was, so to speak, a motionless anchor backing currency. But after the suspension of exchange, gold was freed from the bondage of an official price and came to be priced freely within the trading of the market.

Then the price of gold began to move as if releasing all at once the force that had been held down until then. The 1970s was an era in which two oil crises, fierce inflation, and international tensions overlapped. As the value of paper money wavered, people turned toward gold in search of a sure place to keep value. As a result, the price of gold, which had been held at 35 dollars, is said to have leapt up to a level of several hundred dollars per ounce by the start of 1980. Gold, with its fixed chain removed, transformed into an asset that swung violently within the swells of the market.

Yet this surge did not simply continue. As inflation settled and interest rates were raised, the price of gold fell greatly from its peak. Gold entrusted to the market could rise but could also fall — people newly learned such an ordinary movement of price. The true face of gold within the market, unseen in the days when it was protected by a fixed price, appeared here for the first time.

In this way gold, having for now ended its role as the anchor backing currency, stepped forward as one asset traded in the market. But the power with which gold grips the human heart and will not let go had not weakened in the slightest. Rather, precisely because an era had come in which paper money held its value by the credit of the state alone, the presence of gold at the opposite pole — ‘never rusting, never diminishing, bound to no nation’s convenience’ — began to take on a new meaning. Freed from its anchor, gold did not drift but headed toward its next role. Freed from its anchor to currency, gold finds a new role.