The Century of the Dollar — The Turn to Managed Currency

Last time, we looked at the mechanism of the gold standard. Each nation’s currency was tied to a fixed quantity of gold, and through that gold the world’s currencies were linked by a single measuring rod. Built around nineteenth-century London, this order was a symbol of stability and, at the same time, a hard chain that bound each nation’s hands and feet.

That chain was cut apart over the first half of the twentieth century. The triggers were war and an unprecedented economic crisis. What this chapter portrays is the process by which money was gradually freed from the weight of gold, and eventually severed from it altogether. By what does money hold its value? When the firm backing of gold vanished, humanity was forced to confront that question head-on.

The Chains of Gold Come Loose — The Shock of the Great Depression

The First World War forced enormous military spending on every nation and temporarily suspended the gold standard. After the war, nations hurried back to the gold standard, eager to recover their former glory. But returning at the same parity as before the war did not match the shifts in each nation’s economic strength, and it piled strain upon strain.

That strain surfaced all at once in the global depression that began in 1929. The crisis, which began with a stock market crash, spread chains of bank failures and severe recession across the world. Under the gold standard, even nations suffering through a slump could not freely expand their currency. Bound by their gold holdings, they could not loosen monetary policy, and it is said this only deepened their plight.

One by one, nations that could no longer endure began to shed the chains of gold. In September 1931, Britain, the heart of global finance, left the gold standard. In step with this, countries with deep economic ties to Britain suspended the gold standard one after another. In America too, President Franklin Roosevelt, who took office in 1933, suspended the gold standard as part of his response to the depression.

The Blueprint for the Postwar World — The Bretton Woods System

In 1944, when the end of the Second World War was beginning to come into view, a conference was held to discuss how to rebuild the postwar global economy. The setting was Bretton Woods, a resort in the American state of New Hampshire. Representatives of forty-five nations, centered on the Allied powers, gathered to design a framework of international finance that would never again repeat the chaos of the 1930s.

What was born here was a new mechanism known as the Bretton Woods system. Its core lay in placing the American dollar at the center of the world. Only America guaranteed the exchange of dollars for gold, and its official price was set at thirty-five dollars per ounce of gold. Each nation’s currency was then fixed at an exchange ratio against this dollar. Japan, for example, was tied at a rate of three hundred sixty yen to the dollar.

In other words, each nation’s currency was indirectly linked to gold through the dollar. Only the dollar was directly tied to gold. A fixed exchange rate system anchored by the dollar began, in which nations around the world held their currency’s value against the dollar as the standard. To support this system, the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank) were also established.

Why was the dollar chosen? In contrast to a Europe and Japan exhausted by war, America had not made its homeland a battlefield and had preserved its productive power. Furthermore, it is said that most of the world’s gold had gathered in America. Backed by overwhelming economic strength and gold reserves, the dollar took the seat of the world’s key currency as ‘money as trustworthy as gold itself.’ Postwar trade and reconstruction advanced upon this dollar as their foundation.

Distrust of the Dollar — The Contradiction Swells

The Bretton Woods system powerfully supported the recovery of the postwar global economy. But a single contradiction lurked within this mechanism from the very start.

As world trade expanded, vast quantities of dollars were needed for settlement. Unless America supplied dollars to the world even at the cost of running deficits, trade would not turn. Yet the more dollars flooded the world, the stronger grew the doubt: ‘Can all of these dollars really be exchanged for gold?’ For there was a limit to the quantity of gold America could guarantee. The more it supplied dollars, the more confidence in the dollar wavered — this structural dilemma later came to be called the ‘Triffin dilemma,’ after the economist’s name.

Entering the 1960s, America swelled its spending on the costs of the Vietnam War and on domestic policy, and its balance of payments deteriorated. The dollars circulating in the world far exceeded America’s gold reserves, and nations began moving to convert their dollars into gold. America’s gold continued to flow out, and the foundation of the system quietly crumbled. The gap between the pretense that money was backed by gold and the reality had widened beyond any hope of bridging.

Parting with Gold — The Nixon Shock

That gap became decisive on August 15, 1971. President Nixon of America gave a televised address and announced that he would suspend the exchange of dollars for gold. This event, which shocked the world, came to be called the Nixon Shock.

It meant that America itself had let go of the very heart of the Bretton Woods system — the promise that the dollar was backed by gold. The official price of thirty-five dollars per ounce of gold met its effective end here.

Even after convertibility was suspended, nations did not immediately give up fixed exchange rates. In December 1971, at a conference held at the Smithsonian Institution in Washington, new exchange ratios were agreed upon. At this time the dollar was devalued, and the yen was changed from three hundred sixty to three hundred eight yen to the dollar. This framework is called the Smithsonian system. But a mechanism that maintained fixed rates while having lost its backing in gold could not last, and in 1973 the major nations moved one after another to floating exchange rates.

And so, in the latter half of the twentieth century, humanity’s money was at last completely severed from the metallic backing that had been its weight for five thousand years. A pure credit currency, its value guaranteed by nothing — that became the true nature of the money we use. Money that has lost its anchor in gold is no longer bound by the quantity of gold in the earth. Depending on the judgment of the one who issues it, it can be increased without limit. Money that has lost its backing in gold begins, after this, to multiply without limit.