In 2021, it marked 50 years since the closure of the Bretton Woods system. On August 15, 1971, US President Richard Nixon announced the abolition of direct international convertibility of the dollar into gold. This event was called the "Nixon shock." He actually put an end to the gold standard, which lasted less than three decades. The yellow metal ceased to be money, and the dollar remained the main global reserve currency.
The reason for these radical shifts in American financial policy was crises in foreign policy relations and in the US domestic economy. By the late 1960s a significant trade deficit became the norm. The cost of consumer goods and services for many Americans has increased due to accelerating inflation. The Bretton Woods countries exchanged huge amounts of dollars for gold, depleting American reserves. Nixon was desperate to avoid a recession. There were serious disagreements in the administration over how to respond to pressing challenges. The decision taken by the president was supposed to be temporary. Formally, the Bretton Woods system was not abolished. However, by 1973, it was replaced by a system of floating exchange rates between currencies, which still exists today.
Since then, the yellow metal has proved to be a reliable investment asset. For 50 years, the price of gold has risen from $35 to $1800 per troy ounce. The average annual increase in quotes was more than 8%. Since the 2000s, precious metal has been superior in yield to stocks and bonds. Over the past decade, it has lagged slightly behind the return on risk assets. Experts of the legendary Perth Mint are confident that in the short term gold will rise in price. Before the collapse of the Bretton Woods system, yellow metal provided the value of the American currency. Today, the dollar is the main rival of gold. To understand how such a significant change occurred in the relationship between these two assets, you should turn to history.
US currency before and after the gold standard
Government intervention in the economy can significantly affect the state of the currency and lead to a rapid weakening of its purchasing power. To prove this point, let's show the history of the dollar. The value of the American currency was determined on the basis of the specific gravity of precious metals from the founding of the American republic until the outbreak of the Civil War in 1861. During the Civil War, the Union issued greenbacks - green banknotes that could not be exchanged for gold coins.
By 1879, the federal government restored the convertibility of paper dollars into gold (at a rate of $20.67 per troy ounce), and silver was demonetized. Further, in the United States and in several other Western countries, the so-called classical gold standard functioned from 1879 until the outbreak of World War I in 1914. According to it, all world powers exchanged national currencies for a certain amount of yellow metal.
One important event occurred in April 1933, when Franklin Delano Roosevelt, who took office, issued a decree on the confiscation of gold from US citizens and organizations. Those who decided to keep precious metal were threatened with imprisonment and a fine of $10 thousand. By 1934, the dollar was raised to $35 per ounce, which meant its devaluation by 41%. Americans were forbidden to sign contracts using the world price of gold as the basis for calculating payment in dollars.
So, after the American Civil War, the dollar gradually weakened. In the years 1922-1929. And until the great Depression and Roosevelt's interventions, the purchasing power of the dollar practically did not change, falling by less than 1% over the entire period.
The beginning of a new financial era
When the victory of the Allies in World War II became apparent, the United States used its advantages, economic power, and leverage to make the dollar the basis of the global exchange rate system. It was the American government that initiated the conclusion of the Bretton Woods Agreement. The American currency was provided with huge gold reserves, accumulated partly through sales to Europe of American ammunition in exchange for precious metal during the war. The United States owned more than half of the official world gold reserves - 574 million ounces (about 20 thousand tons).
In 1944, representatives of 44 countries met in Bretton Woods, New Hampshire, to develop and harmonize a new international monetary system, which became known as the Bretton Woods system. The new system was supposed to ensure stability of the exchange rate, prevent competitive devaluation and promote economic growth. In 1958, the Bretton Woods system became fully implemented by countries for calculating international operations. The United States guaranteed the exchange of American currency for yellow metal at a fixed rate of $35 per ounce. The countries participating in the agreement could legally exchange their surplus dollars for physical gold at any time. However, this privilege was extended only to central banks. Ordinary citizens and organizations were not allowed to exchange dollars for precious metal.
What caused the "Nixon shock"?
At first, the Bretton Woods system worked properly. It played a key role in rebuilding the devastated economy in Europe and Japan. The central banks of these countries accumulated dollar reserves. By 1966, the financial institutions of the countries participating in the agreement kept $14 billion, while the US had a gold reserve worth $13.2 billion in cash. However, by 1971 the situation worsened.
By the mid-1960s industrial growth revived in Germany, Japan, France and Great Britain. Countries have overcome the post-war crisis, so competition in the world market has intensified. The rapid increase in exports from Europe and Japan reduced the US share in world trade, reducing demand for the US currency. In addition, the United States suffered due to the exhausting confrontation with the USSR and the heavy war in Vietnam. The country's social policy required immediate reforms. By the mid-1960s, the US share in the global economy fell from 35% to 27%. Foreign governments began to demand the exchange of their dollar assets for gold as inflation in the United States increased. The volume of dollars in world reserves has steadily decreased.
By the beginning of 1971, a noticeable increase in the deficit of the US trade and balance of payments was recorded. In April, the exchange rate of European currencies against the dollar in forward markets began to increase. Central banks in Europe have tried to reduce volatility in national currencies by buying more dollars and selling their currencies. In May, West Germany withdrew from the Bretton Woods system, not wanting to change the course of the German brand. In June, Switzerland bought $50 million worth of gold from the US Treasury. It was followed by France, which wanted to purchase a volume of precious metal worth $191 million. Closer to mid-August, the UK announced its desire to convert a record amount of cash into gold - $3 billion. This meant that the US Treasury was to provide the British government with 2,666 tons of precious metal. From the mid-1950s until 1970, the US gold reserve decreased by more than 2 times - from 20 thousand tons to less than 10 thousand tons. America was supposed to provide a tremendous amount of precious metal - more than 25% of the entire gold reserve. The American government did not make official statements about the intentions of exchanging British dollars for yellow metal. In this regard, on August 6, 1971, Henry Roiss, chairman of the Joint Economic Committee for Exchange and Payments, said that dollar quotes were overestimated. This caused chaos in financial markets. Given high-profile statements by dignitaries and instability in markets, the US authorities were afraid that the remaining gold reserves would be sold to foreign central banks due to the convertibility of dollars into precious metal.
On August 15, 1971, the US government officially suspended the conversion of the dollar into gold. It was replaced by a regime of relatively free-floating exchange rates, in which the value of currencies changes depending on the economic influence and political stability of the issuing country.
Implications of ending the Bretton Woods Gold Standard
Most of all, this event affected the cost of yellow precious metal. Its price has since begun to be set on the market, so the rate has risen rapidly. By 1975, President Gerald Rudolph Ford Jr. allowed Americans to have gold in private possession. So the ban in force since 1933 was lifted.
Since 1971, the course of precious metal has grown 50 times. From 1952 to early 1959, during the heyday of the Bretton Woods system, the dollar lost a total of 9% of its purchasing power, that is, about 1.2% per year. However, from the beginning of 1972 to 1979, that is, after the Nixon decision, the dollar lost a total of 40% of its value, or 7% per year.
Freed from fixed dollar obligations, the Fed began printing the currency without stopping, which led to higher inflation and economic instability. Since then, the US budget deficit has become a constant phenomenon. In 2011, Paul Walker, who replaced William Miller as Fed chairman in 1979, regretted the abolition of the Bretton Woods Agreement. However, the new floating exchange rate regime helped the US dollar. The US currency dominates world trade, and the vast majority of central banks elsewhere in the world use the dollar as a means of saving. This gives the United States a number of economic and political advantages. Some experts argue that the hegemony of the dollar will soon fall apart. The rise in inflation due to the pandemic has again actualized fears about the status of the dollar as a reserve currency. For example, in May 2021, the share of the dollar in the reserves of the central bank of Russia fell to a 25-year low - 59%.
In conclusion, although the "temporary" suspension of the dollar convertibility has been going on for 50 years, under international law, all dollar holdings of central banks created before the landmark decision, that is, on August 15, 1971, can still be converted into US Treasury gold.