The History of US Money by Michael Browning


By Michael Browning

For a hundred years from 1871 to 1971, global trade was settled either directly in gold, or (after 1944) in U.S. dollar reserves which were redeemable for gold. The exceptions were in periods of war, when governments often suspended gold convertibility in order to raise funds by borrowing and currency printing. After widespread suspensions during the U.S. War Between the States and the Franco-Prussian War of 1870 in Europe, both continents had decided by 1871 to re-establish the gold convertibility of their currencies. With the major currencies defined in terms of gold or silver, the exchange rates between them were fixed and constant. For convenience, the British pound sterling often served as the basis for valuing international transactions, and as a substitute exchange medium in place of gold. This greatly facilitated world trade during the late 19th century, coinciding with strong technological progress and rising prosperity.

Nevertheless, this generally prosperous period was punctuated by panics roughly every twenty years. After the panic of 1907, when private banker J.P. Morgan intervened as a lender of last resort, banks began agitating for a statutory lender of last resort. What they finally decided upon in 1913 was a federally-sponsored cartel. But to cover up the cartel aspect during a period of anti-trust agitation, they resorted to the deception of calling it the Federal Reserve, which sounded governmental. Yet the capital stock of the Federal Reserve was held by its member banks, not the US government nor the public, which remains the case today. So the Federal Reserve actually is a federally-sponsored banking cartel, licensed to print currency on behalf of the U.S. Treasury, as well as to lend money into existence.

World War I led to widespread suspensions of gold convertibility. Still, trade accounts between countries continued to be settled by gold exchanges where possible. Most countries re-established convertibility in the 1920s. Some, such as Great Britain, made the error of re-establishing convertibility at the prewar parity, which meant that wartime inflation had to be painfully sweated out via falling wages, leading to social unrest. In the U.S., which had received a large inflow of gold, an inexperienced Federal Reserve stood by passively while a prodigious speculative Bubble developed during the 1920s.

In the 1930s, in a situation which is echoed today, severe price competition in the wake of the 1920s Bubble collapse meant that a strong currency was a great disadvantage to exporting nations. To pay for imports, each country had to export. This ushered in a decade of "competitive devaluations." The U.S., whose gold-backed dollar was strong in the early 1930s, suffered more severe economic contraction than most countries did. Unchecked bank failures, which shrank the money supply by nearly a third in three years, made the U.S. dollar even stronger. Despite being chartered as a lender of last resort, the Federal Reserve failed to halt a catastrophic banking collapse.

Newly-elected President Roosevelt finally decided to enter the devaluation contest in 1933. Whereas each dollar for decades had been worth just over 1.37 grams of gold, by 1935 Roosevelt had devalued the dollar by decree to be worth only 0.81 gram of gold – meaning that it required 69% more dollars to buy the same amount of gold. This was bad news for dollar holders, but a boon for gold holders, who saw each ounce of gold increase in nominal value from $20.67 to $35.00. To prevent private gold holders from earning a windfall in terms of dollars, Roosevelt confiscated privately-held gold. In the process, contractual obligations of the U.S. government, such as bonds payable in gold, were abrogated, with the approval of the Supreme Court. This goes to show how governments, in a period of emergency, can change rules and break their own laws.

In any event, to end the turmoil of depression and war, and to provide a foundation for global recovery, a conference was held at Bretton Woods, N.H. in 1944, with the major allied powers attending. Recognizing that the U.S. represented nearly half of global GDP in 1944, the U.S. dollar was made the global reserve currency. All other currencies had fixed exchange rates to the dollar, which in turn was redeemable for gold.

As in the late 19th century, the post-World War II Bretton Woods system ushered in a period of prosperity and rapid economic recovery. But there was a flaw in the system, spotted by some observers as early as the late 1950s. Nothing in the Bretton Woods agreement prevented the U.S. Federal Reserve from expanding the supply of Federal Reserve Notes (FRNs, or “ferns”), which were backed by Treasury debt rather than by metallic reserves. As the supply of FRNs expanded, the gold backing behind each dollar steadily declined, such that there was not enough gold to back all of the dollars. By the mid-1960s, the resulting paper money inflation forced the U.S. Treasury to abandon silver coins for sandwich coins made of cheaper metals. Discontinued "silver certificate" dollar bills were quickly hoarded, so that only FRNs circulated anymore.

Meanwhile, as the Vietnam War intensified, the U.S. was running budget deficits and flooding the world with paper dollars. The French, under President DeGaulle, become suspicious that the U.S. would be unable to honor its Bretton Woods obligations to redeem overseas dollars into gold for official holders. As the French exchanged their dollar trade surpluses for gold, the U.S. Treasury's gold stocks declined alarmingly. Finally, President Nixon declared force majeure on 15 August 1971, and suspended the dollar's gold convertibility. That's what governments usually do during wartime, and the U.S. followed the pattern. But this time, it affected the whole world, by destroying the foundation of the Bretton Woods system.

In effect, the current world monetary system of floating exchange rates is only 37 years old. It was not planned, but simply emerged out of a crisis. The unredeemable U.S. dollar remains a popular reserve currency as a matter of convenience, but nothing requires or guarantees that it will retain this role. Meanwhile, with the last restraint on U.S. credit creation removed, it's no coincidence that the U.S. dollar slid sharply in value during the 1970s, which is remembered as an inflationary decade. In a highly competitive world, competitive devaluation once again brings benefits to countries which must export in order to import. Only the U.S. is able to use its eroding reserve currency status to borrow and print dollars to pay for its trade deficits. However, as the dollar loses its reserve currency status from this abuse, the U.S. will be forced to export more to pay for imports, or else take on ever-heavier levels of debt. If these actions cause the dollar to keep falling, other countries will be tempted to devalue their currencies to keep pace and remain competitive. The potential for an inflationary epoch is evident, which brings us to the topic of inflation.