Before we move on to current events, it’s vital that we know how we got here.
I will now present an extremely shortened version of recent US monetary history. The purpose of this section is to show you that the US government has radically shifted the rules during times of emergency and that our monetary system is really a lot younger than you might think.
After the panic of 1907, when private banker J.P. Morgan intervened as the lender of last resort, banks began agitating for a government solution. What was finally decided upon in 1913 was a federally-sponsored cartel, called the Federal Reserve, which sounded governmental but really was not. The stock of the Federal Reserve was to be held by its member banks, not the US government nor the public, which remains the case today. So what we call the Federal Reserve actually is a federally-sponsored banking cartel, licensed to lend money into existence.
By the 1930’s, a Federal-Reserve-fueled speculative bubble had burst, resulting in numerous bank failures, which shrank the money supply by nearly a third in three years. Despite being chartered as a lender of last resort, the Federal Reserve failed to halt a catastrophic banking collapse.
In 1933, newly-elected President Franklin D. Roosevelt decided to counter the falling money supply in a most drastic manner. To accomplish this he confiscated all privately-held gold and immediately devalued the US dollar. Prior to the seizure it took approximately $21 to buy an ounce of gold and afterwards it took $35. Soon after, contractual obligations of the US government, such as bonds payable in gold, were nullified, 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.
All of this seized gold either ended up in the vaults of the Federal Reserve, at the International Monetary Fund, or “on the books” of the Federal Reserve. A grand total of $11 billion was exchanged for all 261 million ounces of the nation’s gold. In other words, complete control of the gold supply of the most powerful and prosperous nation on earth was exchanged for eleven billion dollars, printed out of thin air, creating some very serious storage hardships for the Federal Reserve. I mean, have you ever tried lifting 70 pound gold bricks over your head?
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 all the major allied powers attending. Recognizing that the US then represented nearly half of the global economy, the US dollar was made the global reserve currency. All other currencies had fixed rates of exchange to the dollar, which in turn was redeemable for gold at $35 per ounce.
The Bretton Woods II system ushered in a period of prosperity and rapid economic recovery. But there was a flaw in the system. Nothing in the Bretton Woods agreement prevented the US Federal Reserve from expanding the supply of Federal Reserve notes. As this happened, the gold backing behind each dollar steadily declined, such that there was not enough gold to back all of the dollars.
Meanwhile, as the Vietnam War intensified, the US was running budget deficits and flooding the world with paper dollars. The French, under President Charles DeGaulle, became suspicious that the US would be unable to honor its Bretton Woods obligations to redeem their excess dollars into gold.
As the French exchanged their surplus dollar for gold, the US Treasury's gold stocks declined alarmingly. Finally, President Nixon declared force majeure on August 15th, 1971, and “slammed the gold window,” ending its dollar convertibility. That's what governments do during wartime, and the US followed the pattern. But this time, it affected the whole world, because the removal of gold convertibility of the dollar destroyed the foundation of the Bretton Woods system.
Without a gold backing, there was no hard, physical limit to how many paper dollars could be issued.
Since we now know that all dollars are backed by debt, what do you suppose happened to US debt levels once the externally applied rigor of gold was removed? Let’s find out.
This is a chart of US federal debt from the period of 1949 to 2004. Note that it looks like any other exponential chart we’ve already reviewed. But especially note that the graph “turns the corner” shortly after Nixon slammed the gold window – that is, when Nixon removed the last vestige of external physical restraint from the system. And also note how rapidly the debt levels have climbed recently. These past few years have seen the highest and most rapid accumulation of federal debt in our entire history, thanks in large measure to an experiment never before attempted in our country’s history – the conduct of two foreign wars AND a tax cut at the same time.
This rapid accumulation of debt is not a mysterious process at all; rather it is an entirely predictable consequence of the slamming of the gold window. How much longer can this continue? Unfortunately there’s no good answer to this, besides “as long as foreigners let us.”
A second predictable, and related, consequence concerns the total amount of money in circulation. Remember, all money is loaned into existence, so the shape of the federal debt chart should tip you off to the shape of this next chart of US money from the years 1959 to 2007. The first thing we can note here is that it took our country over three hundred years, from the very first pilgrim until 1973, to generate our first trillion dollars of money stock.
Every road, every bridge, and every marketplace on every corner of every town; every boat and every building, from the first colony until 1973, required a trillion dollars of money stock.
Our most recent trillion dollars? That was created in the last four-and-a-half-months. My questions to you are, “What will it be like to live here when our nation is creating a trillion dollars every four weeks? How about every four days? Every four hours? Four minutes? Where does it stop, if not in hyperinflation and the destruction of the dollar, and, by extension, our nation?”
If we view these events on a timeline, we can see that the Federal Reserve was formed in 1913. And only twenty years later, in 1933, our country had entered a form of bankruptcy and had turned over its collective gold supply, under force of law, to the Federal Reserve. Eleven years after that, the US dollar was enshrined as the world’s reserve currency, with an explicit backing by gold that was unilaterally removed by Nixon 27 years later.
In effect, the current global monetary system of unbacked currencies is now only 37 years old. It was not planned, but simply emerged out of a crisis. The unredeemable US dollar remains a popular reserve currency as a matter of convenience, but nothing requires or guarantees that it will retain this role.
Only the US 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 US will be forced to either export more to pay for imports, or 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 period is evident, which brings us to the next section on inflation.