The Rise and Fall of Hard Money
Now that nearly a century has elapsed, most current analysis of the Great Depression is predicated upon Keynesian and Monetarist intellectual perspectives, largely focusing upon what happened in the 1930s. By editorial omission, the turbulence of the First World War and its aftermath might even be imagined to be serene by students unfamiliar with it, in comparison to the hardship of the Roosevelt years. But what happened in the interwar period was extraordinary.
Certainly in the 19th century the United States had its share of volatility. It had suspended linkage to gold, monetized Treasury debt through printing, shifted between centralized and decentralized banking systems, and had witnessed private credit bubbles built despite the potential discipline of depositors’ demanding conversion to specie.
But in the interwar era, the world had detached itself significantly from sound money more or less permanently, rather than for brief interludes such as when necessary to finance the War of 1812 or the Civil War.
Once the Great Depression unraveled the artificial stimulus of growth through leverage that occurred under the gold-exchange standard, the United States did not exactly abandon gold. Instead it became the highest and in fact dominant bidder in the world market for gold, and exhibited a crazed preference for the metal.
The price increase from $20.67 to $35 triggered a mining boom, and the United States bought more than the total production of the world’s mines through the Great Depression. By the early 1950s, the United States would own three-fourths of all monetary gold and half of cumulative world production since the beginning of time.
The establishment of pegged exchange rates in the Bretton Woods Agreement of 1944 could be seen as a global gold-exchange standard pyramiding all the world ’ s money upon gold held by the United States, placing America in a position not unlike that of Britain at the height of its empire.
Ironically, from that moment forward, the United States mimicked the actions of its aging parent, repudiating this backing of its currency and providing a beacon for the world to follow it down the path of adopting a purely paper-based currency system. In a perverse way, the hoarding of so much gold by the United States might have destabilized a genuine return to a classical gold standard globally until decades later when the cumulative hefty expansion of credit would cause the country’s stockpile to be drained to the point of severing the United States’ link to gold entirely.
The farther the United States (and the world) departed from the use of gold, the more it built a currency that was primarily backed by credit. If the value of that indebtedness falls well below par, then the reserves that are negated are likely to need to be replaced by additional fiat money, although the popular hope has been that additional lending and liquidity provisioning might replenish equity as was the case in 1990.
After steadily losing gold reserves through the 1960s, the Nixonian era ushered in the adoption of a purely paper-based pyramid of banking and foreign exchange established upon the dollar as the world’s reserve currency. This would grease the skids for accelerated and completely unchecked leveraging of the banking system, securitization, and derivatives creation.
[Editor’s note: This passage is reprinted from William W. Baker’s book, Endless Money: The Moral Hazards of Socialism, with the permission of John Wiley & Sons, Inc (©2010). You can get your own copy here.]